Why Internal Controls are Important when Considering the Operational Impact of Bank Debt Investing

Institutional investors are increasingly demanding more transparency around the controls and procedures of hedge funds, fund of funds, private equity funds and managed account manager. There are four key operational risk areas that fund managers should focus. Here we take a quick look at “Internal Controls and Process Risks”.

Account managers need to be aware of the complex nature of the asset class and should ensure that internal controls and procedures are in place for each stage of the trading and settlement process, interest rate types, accrual methodologies, borrowings, repricings, paydowns, amortization payments, commitment fees, penalty fees, facility fees, letter of credit fees and credit events should all be part of a specific procedure when determining the Net Asset Value (NAV).

It has been demonstrated time and time again that if this level of procedure and internal control is absent, then investment managers are unable to properly account for these instruments and accurately report on the results of investment activity. Maintaining the appropriate level of procedure should be something unique to each account or account type but here are some examples of areas that should be managed closely.

The management of the information flow, contact of the borrower, pricing information, credit agreements, trading confirms, funding memos, and agent notices need to be reviewed and processed as they represent the only source of information. With regard to trade settlements, LSA and LSTA settlement protocols need to be followed as a late settlement can lead to an actual loss of income. Any settlement of interest payments, principal reduction, credit event transactions, tracking of recurring and non-recurring fees will directly affect the cash management business of a client. Sometimes there is difficulty reconciling transactions – traders need to know at any point in time the holdings that are under custody. When there is a lack of action in the case of default – the client might be entitled a rage of remedies against the borrower, interest rates may increase and the borrower may lose consent rights. And lastly, entering results into an accounting system – upcoming coupon payments, projected currency exposure and projected interest risk exposure – are all areas that can be affected be incorrect accounting.