Handbook of Market Risk

Chapter Seven

Market Risk: A Historical Perspective from Market Events and Diverse Mathematics to the Value-at-Risk

If you don't make mistakes, you're not working on hard enough problems. And that's a big mistake.

—Frank Wilczer

The European UCITS Directives gives asset managers and investment trusts increased flexibility when it comes to selecting investment products, particularly with regard to derivatives, structured products, and hedge funds. This new freedom comes at a price: The implementation of UCITS has placed new regulatory requirements on risk management and risk measurement for funds that use derivatives to control risk and enhance their performance. This has far-reaching consequences for processes, systems, and controls. These challenges, however, are not at all fundamentally new to the financial markets as a whole. In UCITS space, many long-standing requirements for modern risk management at banks—such as internal value-at-risk (VaR) models—are arguably extended to asset managers.

The recent financial crisis has also put risk management functions under scrutiny and will constitute an important pillar for the re-construction of trust among investors.

If banks with Basel requirements for measuring their capital adequacy were the first to have strong risk management departments, it was not always the case for most asset managers (traditional and alternative managers). Before UCITS III came into force, there was no formal requirement of the EU Regulators to have a formal ...