Risk management framework: Key concepts Components of the risk management framework

fees to third-party managers. For example, the Philippine Investment Alliance for Infrastructure, externally managed by infrastructure fund manager macquarie, engages only in direct investing. Conversely, SIFs managed by an internal team whose remuneration has a greater fixed component may be more open to indirect investing, to capture the benefits discussed earlier. SIFs that are internally managed or whose public sponsor is invested in the fund manager— for example, FOnSIS, ISIF, nIIF, and nSIA–nIF—commonly pursue indirect and direct investing.38 Typically a SIF limits the amount of assets that can be delegated to an external manager. For example, the nSIA-nIF Investment Policy Statement permits nIF to use external managers as long as they do not manage over 50 percent of nIF assets (nSIA 2019, Article 7.2).

Several aspects of a SIF’s investment policy and strategy are unique and unlike those of PCFs or SWFs. unlike traditional SWFs formed as stabilization or savings funds, SIFs invest in privately traded assets. The SIF’s double bottom line objective results in an investment policy unlike that of both PCFs and SWFs in that it simultaneously seeks financial and economic returns. The choices of geography and sector in the investment policy of a SIF are often driven by economic or policy considerations; for PCFs, these choices are entirely driven by commercial investment pipeline and return factors, as identified by the fund manager. SIFs’ often-explicit crowding-in objective also sets such funds apart, differentiating their investment approach from PCFs. For instance, SIFs often focus on co-investment and minority investment strategies to facilitate capital mobilization, and explicitly avoid crowding out private capital. marguerite II’s minority investment strategy, for example, seeks to minimize crowding out private capital, unlike standard infrastructure funds that prefer full control. Through their investment choices, SIFs seek also to differentiate themselves from PCFs and provide additionality to the investment landscape. For instance, ISIF’s investment strategy is to capitalize on its “key differentiating features of flexibility, long-term timeframe and credibility as a sovereign investment partner to fill investment gaps and enable transactions which would not otherwise easily be completed.”39 Similarly, nSIA-nIF’s investment policy allows it to add value to the infrastructure landscape by acting as project developer and sponsor, or by building capacity among local institutional investors.40 SIFs may also provide capacity building to their public sponsor. India’s nIIF engages in proactive discussions with central and local government authorities to steer new infrastructure development to commercial models.41 Finally, SIF investment strategies may also reflect unique advantages not typically found in PCFs. For instance, IFC [International Finance Corporation] Asset management Company’s funds have relied on cost efficiencies achieved through investing alongside the IFC, thus capitalizing on access to the IFC’s proprietary pipeline. Conversely, SIF investment approaches may also contain restrictions resulting from being subject to an authorizing environment that does not apply to PCFs. For instance, as a government agency, ISIF must ensure that its investments do not breach eu State Aid rules that prohibit unfair financial support for private sector enterprises.42

RISK MANAGEMENT FRAMEWORK: KEY CONCEPTS

The risk management framework for a SIF is a system that identifies, measures, manages, and regularly tracks all relevant risks that could potentially inhibit the

fund’s success (european union 2011).43 The risk management framework is therefore a critical component of the overall governance and accountability framework for a SIF. Because the mandates and investment policies of SIFs vary widely, risk management frameworks are bespoke systems that reflect the dnA of the specific fund and its particular risk appetite. The risk policies for a traditional SWF that invests primarily in publicly traded investments will be markedly different from the policies of funds investing primarily in private markets (like SIFs). Likewise, and at a more granular level, the risk policies for a SIF that invests directly in physical infrastructure will assume different characteristics from one that invests in infrastructure through a fund of funds model.

High risk management standards are important not only to meet a fund’s investment objectives but also to preserve legitimacy and maintain a stable, transparent, and open investment environment.44 The legitimacy argument is particularly cogent for SIFs because of their affiliation with a public sponsor. It is also important because SIFs’ ability to attract investments at the fund level and co-investments at the project level rests, among other factors, on their perception as professional and trusted investors.

A robust risk management system is an expected feature for alternative investment funds in the private sector and for SWFs based on accepted governance standards. global PCF industry best practices, such as the eu directive 2011/61/eu on Alternative Investment Fund managers (hereinafter, eu AIFmd), which was established after the global financial crisis, place a premium on strong risk management frameworks for alternative investment funds both to stem the systemic risk they can pose to the financial sector and to ensure investors are better protected. SIFs set up under the the eu AIFmd framework—like marguerite II—must therefore comply with the stringent standards articulated in the directive (see box 5.5 on key aspects of the eu AIFmd). Key risk management requirements applicable to SWFs, and consequently to most SIFs, are also spelled out in gAPP 22 of the Santiago Principles (see box 5.6 on the Santiago Principles related to risk). The requirements of the eu AIFmd and the Santiago Principles broadly converge except that—as expected for sovereign investment agencies—the Santiago Principles recommend public disclosure of the risk management framework, which is not typically a requirement for regulated PCFs. In addition, the eu AIFmd provides more detailed guidelines on aspects such as safeguarding the risk management function through an independent reporting structure and ensuring that remuneration structures do not cause excessive risk-taking behavior. risk management requirements are usually embedded in the investment policy of the SIF, articulated in ancillary risk-specific policy documents of the SIF, or imposed by the investment fund regulatory framework in force in the SIF’s jurisdiction. The risk management framework is usually formalized in one or a series of policies and procedures, depending on the variety of risks to which the SIF is exposed. note that elements of a SIF’s risk policy will be articulated within its investment policy and managed through the fund’s investment strategy, so there will be some overlaps between the two frameworks. Provisions in the investment policy and strategy, including investment limits and restrictions, highlight the public sponsor’s risk tolerance and have an implicit investment risk management purpose. For instance, ISIF has adopted a Portfolio diversification Framework for the Irish Portfolio that sets investment limits based on maximum exposure by sector and by risk category (IFSWF 2019),45 noninvestment risks, by contrast, may be addressed by separate policies, such as employee codes of