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AQR Capital Management, LLC | Two Greenwich Plaza | Greenwich, CT 06830 | U.S 1 F ebruary 2019 Via Em ail: [email protected] Dr. Shane Worner International Organization of Securities Commissions Calle O quen do 12 28006 M adrid Sp ai n Re: Comm ents on IOSCO Report: Leverage D ear Si r , AQR Capital M anagement, LLC (“AQR”) welcomes the opportunity to respond to the International Organization of Securities Commissions’ (“IOSCO”) consultation report on assessi n g th e use of leverage by in vestm en t fu n ds (th e “ Report”). W e are very grat efu l to h ave had the opportunity to contribute to IOSCO’s work on this im portant topic over the past 15 months, speci fically i n bei n g able to at ten d I OSCO m eet in gs an d m eet I OSCO coun try represen t atives. T h is en gagem en t has given us an appreciation for the im port an t ch allen ges presen t ed to I OSCO and its constituent national regulators in im plem enting the Financial Stability Board’s (“FSB”) Recom m en dation s an d w e com m en d I O SCO for i ts th ough t ful an alysi s i n th e Report addr essi n g Recom m en dat i on 10, t h e iden ti fication an d developm en t of con si sten t m easures of leverage for fin an cial st abili ty purposes (th e “R ecom m en dation ”). Background to AQR E st ablish ed in 1999, A Q R is a global asset m an agem en t firm based in G reen w ich , Con n ecticut , Un ited States1 and as at 31 December 2018 has approximately $200 billion in assets under m anagem ent across both traditional long-only equity strategies and alternative investm ent strategies, of which the firm is one of the world’s largest providers. We offer investors access to 1 With additional offices in London, Sydney, Tokyo and Hong Kong. AQR Capital Management, LLC | Two Greenwich Plaza | Greenwich, CT 06830 | U.S. | p: +1.203.742.3600 | f: +1.203.742.3100 | w: aqr.com 2 th ese i n vestm en t s th rough separ ate accoun ts, U CI T S fun ds, L u xem bourg SI F s, offsh ore an d onshore pooled vehicles, and through sub-advised mutual funds and U.S. open-end mutual funds. A QR h as been a leader i n offeri n g alt ern ative in vestm en t strat egi es as regist ered m utual an d U CI T S fun ds an d em ph asi zes ri sk con trol an d best practi ces i n fun d govern an ce. W e possess a substan ti al understanding of derivatives, securi ties fin an ce an d alt ern ative in vestm en t st rat egi es, w h ich w e beli eve positi ons us well to com m ent knowledgeably on the Recom m endation and m ore speci fically th e R eport. Object i ves of t h e R ecom m en dat ion an d Repor t W e are m i n dful of th e specific objectives set out by the FSB in the Recommendation that m easures of leverage ou gh t to be con si sten t, com par able across fun ds an d to th e exten t possi ble across sectors, m inim ize the shortcom ings of existin g m easu res, additi ve an d facilit at e m ore m ean in gful m on itorin g of leverage for fin an cial st ability purposes. W e n ote th at in th e R eport IOSCO h as also suggest ed th at key m et rics sh ould be of gen eral application across st rategi es an d funds, avoid model risk and facilitate the identification of funds which may pose a risk to financial stability. W e furth er recogn ize th at on e of th e cen tral ch allen ges posed by th e R ecom m en dation is th e ten sion bet w een a preferen ce for th e sim plicity of a si n gle m easure of leverage such as total gross notional exposure, which can be misinformative, and m odest ly m ore com plicated, yet inform ative m easurem en ts th at en able regulators to meaningfully assess sources of syst em i c ri sk. Suggest ed A pproach W e beli eve th at in large part, the Report can ach ieve th e objectives of t h e R ecom m en dation th rough th e proposed t w o step fram ew ork. I n particu lar, th e R eport clearly an d accurat ely articulat es th e st ren gth s an d w eakn esses of th e th ree key pot en ti al “Step On e” m etrics for m easurin g leverage, as w ell as the need to analyze each m etric by asset class rather than as a sin gle aggregat e n um ber. W e support th e overall approach proposed in th e R eport , an d i n th e rest of th is lett er provide ou r suggest ed refin em en ts to th e “St ep O n e” process w ith in th e Report’s broader construct. The approach w e advocate for m eets several, if n ot all, of th e objectives set out i n th e Recom m en dation an d Report. I t is also relatively sim ple, con sist en t , m odel in depen den t an d importantly, allows regulators to enhance their underst an di n g of poten tial risks that leverage m ay 3 pose to financial stability by allow i n g i n form at i ve sum m ati on across fun ds th at distinguishes betw een exposures to m ean in gfully di fferen t risks in securiti es an d deri vatives m arket s. A v oi d a si n gl e a ggr ega t ed n u m ber The most important aspect of the “Step One” process is that it excludes any gross notional leverage m etric based on an aggregated single num ber. It is our strongly held view that aggregation is the fatal step that destroys the value of any n oti on al m easur e as i t adds up n u m bers that do not reflect even rough ly com parable risks, allowing important risks to be disguised within broader benign risks. F or th i s r eason , aggr egat ed gross n oti on al i s a useless sum of usefu l part s. T h ere are vast differen ces in th e relati ve riski n ess of un derlyi n g asset types i n derivatives contracts an d securiti es w h ich m ake a sin gle aggregat ed leverage n um ber m ean in gless in term s of assessi n g th e riskin ess or th e speculative ch aracter of a fun d. A si n gle aggregat ed n um ber m i xes exposures to high risk asset classes with exposu res to low ri sk asset classes an d m akes i t m ore difficult to differentiate between hedged exposures and unhedged exposures, or between portfolios th at use leverage to am plify risk and on es that use it to reduce risk. Maintaining the distinction between high and low risk exposures by reporting on each underlying asset class en ables m ore m ean i n gful di sclosu res that do not allow exposures to h igh risk assets to be m asked by the often-larger exposures to low ri sk assets. T h e problem s w ith reportin g an aggregat ed n u m ber exi st n ot on ly w h ere such a n um ber i s reported in isolation, but even w h ere it is reported alon g w i th oth er supplem en t ary m easures. Despite the additional con text th at m ay be provided by supplem en t ary m easures, a si n gle aggregated num ber will focus attention on the misleading measurement and lessen the import of any other measures that might be reported. Su m ea ch a sset cl a ss’ l on g ex p osu r es a n d sh or t ex p osu r es, sep a r a t el y W e beli eve th at a furth er disti n ction sh ould be m ade betw een lon g exposures an d sh ort exposures, w ith leverage reported for each , broken down by asset class. Just as aggregating exposure across asset classes of very di ffer en t ri sk levels provides an u n in form ative view of leverage, so to do measures that aggregate long and short positions. There are typically vastly different contributions to both portfolio and systemic risk from positions of the sam e aggregate notional w h ere on e is lon g-only and the other is long and short.
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