United States: FRB highlights the need for risk management in lending to private funds

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In a supervisory and regulatory letter to institutions with large derivative portfolios and investment fund relationships, the Federal Reserve (“FRB”) reiterated previously expressed expectations regarding credit risk management counterparty and the margin practices of the big banks.

After an investigation into the cause of Archegos Capital Management’s default, which resulted in losses of more than $ 10 billion for banking organizations, the FRB reminded banking organizations of their obligations to conduct and maintain due diligence and Recommended that companies obtain information regarding the size, leverage, and largest or most concentrated positions of a fund, as well as its access to other lines of credit.

The FRB has warned banking organizations that poor communication frameworks and inadequate risk management functions, along with fragmented systems and ineffective governance, hamper their ability to identify and manage risk. In addition, the FRB has cautioned lenders against accepting improper margin terms at the risk of their investment fund clients. In accordance with the guidelines of the Interagency Supervisory Guidance on Counterparty Credit Risk Management, the FRB recommended that companies:

  • receive adequate information with an appropriate frequency to understand the risks of the investment fund, including the position and concentrations of counterparties;
  • ensure that the risk management and governance approach applied to the investment fund is able to identify the fund’s risk and monitor it throughout the relationship; and
  • ensure that margin practices remain relevant to the fund’s risk profile as it evolves, avoiding inflexible and risk-insensitive margin conditions or extended closing periods.

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