and key actors

In addition, it lays out its risk framework in ancillary documents,46 and outlines professional and ethical standards in documents such as the Compliance Policy and Conflict of Interest Policy.47 All funds managed by nIIF, as alternative investment funds regulated by India’s capital market authority, must comply with the risk management and disclosure requirements of India’s AIF regulations (2012).48

COMPONENTS OF THE RISK MANAGEMENT FRAMEWORK AND KEY ACTORS

The SIF’s risk management framework performs the following key functions:

• Clarifies risk appetite. It articulates the fund’s qualitative and quantitative risk appetite in line with its mandate, size, investment policy, and structure. • Identifies and measures risks. It identifies and assesses (quantifying where possible) potential risks that may impede the success of the SIF. • Establishes a governance structure for risk management and a set of procedures that can mitigate and monitor risks (european union 2011).

The public sponsor’s risk appetite is commonly articulated in a risk policy document. The risk tolerance of a SIF cannot be distilled into one indicator but is usually a composite of several indicators that capture the adverse outcomes to which the SIF could be susceptible.49 These indicators are used to assign an acceptable level of risk (for example, an acceptable probability of capital loss) based on the stated purpose of the SIF and the risk profile of its public sponsor.50 For instance, nSIA-nIF’s Investment Policy Statement requires the fund to seek a long-term return target of more than 5 percent of the uS Consumer Price Index, but also clarifies that the fund’s investments must be diversified within the infrastructure sector; that it cannot commit more than 25 percent of total assets to any one project or manager; and that no more than 35 percent of total assets can be committed to any specific infrastructure sector in nigeria (nSIA 2019).

The clarification of risk appetite serves multiple purposes, chief of which is to sensitize stakeholders to how the fund’s performance should be evaluated. The articulation of risk appetite is important because it prepares the public sponsor and co-investors for potentially unfavorable factors that could undermine the SIF’s success and jeopardize reaching the fund’s stated objectives (Al-Hassan et al. 2013). The articulation of risk tolerance is also important so that short-term fluctuations do not steer the public sponsor off course (Al-Hassan et al. 2013). In addition, explicit communication of risk tolerance helps ensure that other agents in the SIF’s authorizing environment do not thwart the SIF’s mandate by acting on contradictory views of risk tolerance. For instance, as discussed in chapter 2, a key agent influencing many of China’s government guidance funds (SIFs set up at the national, provincial, and municipal levels) is the State-Owned Assets Supervision and Administration Commission of the State Council, which assesses the funds according to its principles—oriented toward state-owned enterprises—of capital preservation and appreciation (mcginnis et al. 2017). Such principles can conflict with higher-risk-oriented investment strategies that may take years to bear fruit.

Like PCFs and SWFs, SIFs are exposed to a wide range of risks, which can be identified in two categories:

1. Investment risks. These are risks affecting a SIF’s individual investments and its portfolio, which should be rewarded by commensurate expected returns when an investment is approved (Al-Hassan et al. 2013). Such risks include the following: – Market risk (for example, interest rate, foreign currency, equity, and commodity price risks affecting a portfolio company’s prospects). These risks could result in either unrealized or realized losses (capital loss) to the portfolio of the SIF. – Credit risk (for example, a company’s creditworthiness and indebtedness level, counterparty risks). – Liquidity risk (for example, the inability to quickly sell an investment and convert it into cash).51 – Portfolio company risk. risks specific to a portfolio company’s business model, sector, organizational structure (for example, loss of core executives), and eSg compliance. – Third party risk. risks occurring as a result of co-investments or joint ventures with parties that have diverging financial and strategic interests.

2. Noninvestment risks. These are operational, regulatory, and reputational risks affecting the entire operation of a SIF. unlike financial risks, risks affecting the entire operation of a SIF will not be rewarded by higher investment returns and can be addressed only through mitigating measures (Al-Hassan et al. 2013). – Operational risk is the risk of loss from breakdowns in a SIF’s systems and procedures or from factors outside the SIF’s control. examples include staff-related risk (incompetence and fraud), business continuity risk, process risk, and technology risk. – Regulatory risks stem from changes in the laws and regulations governing the operation of SIFs, or changes in the application of such laws and regulations. – Reputational risk is the possibility that negative publicity regarding a SIF’s conduct, whether real or perceived, may negatively affect investment returns, result in expensive litigation or loss of counterparties, or damage the home country government’s international standing. – Political risk is the risk SIFs face from both global and domestic political events (see nSIA [2018], risk management, for examples related to nSIA in particular). It may result from shifts in geopolitical currents that affect a SIF’s ability to attract and retain strategic or sovereign-affiliated co-investors or from transformative domestic politics that threaten to upend the SIF’s legitimacy or alter its strategic focus.

The SIF typically captures the specific risks to which it is susceptible through a customized methodology that can systematically monitor, mitigate, and report on investment- and portfolio-level risk. Such a methodology identifies the top risks and where they originate, creates a scoring system that integrates both quantifiable and nonquantifiable risks,52 and assigns acceptable levels of risk as benchmarks. For instance, nSIA has developed a bespoke tool, employed by nSIA-nIF’s infrastructure team, to assess ex ante the risks for all infrastructure projects. The tool considers several quantitative and qualitative factors including a project’s fit with nIF’s mandate, integrity checks of project counterparts,

and any technical, commercial, and financial risks. Factors deemed medium or high risk are included in the investment memo for approval along with proposed actionable mitigants. Such a system can then be used to monitor and judge the risk level of a transaction before investment and of a portfolio company after investment (see, for example, the thematic review of CdP equity in appendix B).

The SIF’s risk management framework is articulated based on the delegated governance structure of the SIF and seeks to mainstream risk-consciousness throughout the organization. The variety of risks affecting a SIF may require the involvement and cooperation of other bodies, in addition to the risk manager. This consideration applies particularly to noninvestment risks, whose nature is very diverse.

The SIF’s top decision-making body—the public sponsor or its delegate, the board—usually has the responsibility for articulating the fund’s risk appetite, approving its risk management framework, and overseeing the management and monitoring of risks. For instance, Khazanah’s Framework of Integrity, governance and risk management, adopted by its board in 2004 and updated in 2018, includes a risk management policy and guide to manage risks.53 Less frequently, the public sponsor may delegate the authority to articulate the fund’s risk appetite to the manager. ISIF’s manager, nTmA, developed the risk management policy and framework and also the risk appetite framework for ISIF,54 likely because nTmA is part of the Irish government apparatus and is therefore considered a suitable proxy to elaborate on the sponsor’s risk tolerance. Once the risk policy is adopted, a SIF’s board may delegate part of its risk oversight function to a subcommittee of the board or management that monitors whether the SIF is adhering to risk governance and risk appetite criteria. For instance, at nSIA, the Board risk Committee supports the board in overseeing the identification, management, and monitoring of risks.55 At ISIF, the Audit and risk Committee and the enterprise risk management Committee, composed of nTmA management, support the nTmA board in its function of overseeing risk management. risk mitigation is then mainstreamed within the SIF’s management, often characterized through a “three lines of defense” approach whereby each tier has a responsibility to interrogate investment or operational decisions according to their risk impact on the SIF.

• Investment team. The first line of defense is primarily anchored by the investment team, which performs due diligence in line with the fund’s risk profile.

The SIF’s investment committee then provides oversight, assessing investment risks based on the respective analyses of the investment and risk teams, and adjudicates final approval. nSIA’s risk management framework, for example, relies on a first line of defense consisting of the investment team and support services like finance, legal, and information technology. risk assessment for nSIA-nIF transactions is performed in the due diligence phase, and results are included in the investment memo provided to the executive

Committee, direct Investment Committee, and board for decision-making (see the case study in appendix A). nSIA-nIF’s direct Investment Committee is accountable for assessing the risks of investment projects brought before it, undertaking a holistic risk-benefit analysis during its deliberations. • Risk management team. The second line of defense usually focuses on the

SIF’s risk management team. The risk management function defines clear risk guidelines and reporting procedures based on the SIF’s investment policy and strategy. The risk management team usually assesses risk at the