In light of the significant recent volatility in the financial markets, set forth below are suggested steps that investment managers should consider taking:
- Trading Agreements: Take inventory of all trading agreements (ISDAs, repurchase agreements, securities lending agreements and prime brokerage agreements). Monitor NAV triggers closely. In the event that you expect to breach a trigger, we recommend contacting your counterparty and requesting a waiver and reset, rather than waiting for your counterparty to contact you. Being proactive in this regard will pay off in the long run. To the extent you have a term margin agreement, it is possible that a NAV trigger or current market conditions could trigger a termination clause. Accordingly, it is important to monitor these agreements. Financing and other charges that have not been fixed may also be adjusted by your counterparties on notice.
- Investor Communications & Treatment: Get organized and prepare for investor inquiries, particularly about liquidity. Mandate clear, consistent communication to all investors. For less liquid portfolios, be sensitive to the need for equal treatment of investors, should certain of them seek to exercise a special early liquidation option.
- Mandated Investor Notices: Various documents, including side letters and seed agreements, may require disclosure to investors at certain drawdown levels. In some cases, these drawdown breaches could trigger early redemption rights.
- Testing for Stress and Liquidity Risk: Management should be conducting regular assessments to identify portfolio vulnerabilities and liquidity concerns.
- Issuer Limitations: Be mindful of issuer limitations in your portfolios. It is not uncommon for there to be a limitation or risk guideline governing the amount of exposure permitted with respect to a position or group of positions. As certain investments may swing more disproportionately than others, these limitations may be triggered and could result in forced selling.
- Regulatory and Compliance Issues: Managers must ensure compliance with any regulations that may be triggered as a result of the extreme volatility, including Form PF (reporting for 20% losses or 20% increase in margin or collateral), as well as Sections 13 and 16. In addition, managers need to be aware of any applicable temporary regulations that may be passed during the period.
- Fund Governance: Managers should be in contact with fund directors and advisory committee members, as needed.
- Technology Evaluation: Systems personnel at the firm should be focused on ensuring that all systems are operating in a manner to handle increased trading volume and volatility, and also to protect the firm from outside hackers and the like who may try to exploit vulnerabilities during this time where management may be focused elsewhere.
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Seward & Kissel will continue to monitor and keep our clients informed of any future developments.
