Scope of the risk management section
FUND 3.7 reaches every fund a full-scope UK AIFM manages. A small authorised or small registered AIFM falls outside it.
Functional and hierarchical separation of the risk function
An AIFM must separate risk management functionally and hierarchically from the operating units, portfolio management included, and must be able to demonstrate both that safeguards against conflicts of interest allow it to be performed independently and that the risk management process is consistently effective.
Five safeguards under FUND 3.7.4(1) carry no proportionality qualifier: decisions based on reliable data subject to an appropriate degree of control by the risk function; remuneration reflecting the objectives of that function, independently of the business areas its people are engaged in; an appropriate independent review that decisions are reached independently; representation in the governing body, or the supervisory function where one exists, with at least the same authority as portfolio management; and proper segregation of conflicting duties.
Two further safeguards apply where proportionate to the AIFM's nature, scale and complexity: regular review of the function by internal audit, or by an external party appointed by the governing body where there is none, and a risk committee that is appropriately resourced and free of undue influence from its non-independent members. The governing body establishes all seven, reviews their effectiveness regularly and takes timely remedial action.
Risk management systems, due diligence and stress testing
FUND 3.7.5R requires adequate systems to identify, measure, manage and monitor all risks relevant to each fund's investment strategy and to which each fund is or may be exposed. The same rule prohibits sole or mechanistic reliance on credit ratings when assessing the creditworthiness of a fund's assets.
Limb (2) adds three minimum duties: a documented and regularly updated due diligence process for investing, set to the fund's investment strategy, objectives and risk profile; ongoing identification, measurement, management and monitoring of the risks of each investment position and their overall effect on the portfolio, including through appropriate stress testing procedures; and a risk profile corresponding to the size, portfolio structure and investment strategies and objectives of the fund as set out in the instrument constituting the fund, the prospectus and the offering documents.
Systems must be reviewed with appropriate frequency and at least once a year, and adapted whenever necessary (FUND 3.7.6R).
Maximum leverage levels and the reasonableness duty
FUND 3.7.7R requires a maximum level of leverage for each fund the AIFM manages, rather than one house limit across a range. Where the leverage arrangement allows the right to reuse collateral or the granting of a guarantee, the AIFM must also set out the extent of that right or guarantee.
Eight matters must be taken into account in setting the level: the type of AIF; its investment strategy; its sources of leverage; any other link or relevant relationship with other financial services institutions which could pose systemic risk; the need to limit exposure to any single counterparty; the extent to which the leverage is collateralised; the asset-liability ratio; and the scale, nature and extent of the AIFM's activity on the markets concerned.
FUND 3.7.9 guidance says an AIFM should report changes to its leverage limits to the FCA. Before investors invest, FUND 3.2.2R(1)(g) to (j) require disclosure of the circumstances in which the fund may use leverage, the types and sources permitted and the associated risks, any restrictions on its use together with the collateral and asset reuse arrangements, and the maximum level of leverage the AIFM is entitled to employ. Material changes to that information are caught by the same rule.
Substantial leverage and the reporting it triggers
Nothing in FUND 3.7 caps leverage, which the Glossary defines as any method by which an AIFM increases a fund's exposure, including borrowing of cash or securities and exposure embedded in derivatives. Three times net asset value is a reporting threshold, measured on the commitment method alone.
The leverage proposals in CP26/28
Proposed, not law
CP26/28 was published on 14 July 2026, with feedback due by 14 October 2026, final rules expected in 2027 and implementation intended for 2028. At 2.13 the FCA moves away from a leverage-based metric for classifying firms and would manage leverage through the risk management rules and data collected under FRAME. It also proposes removing the gross and commitment calculations and the substantially leveraged threshold, treating a fund that uses derivatives only for hedging as unleveraged for the risk management and liquidity rules, and leaving a manager of only closed-ended unleveraged funds with baseline requirements.
Alongside this module
Where this subject is covered elsewhere in the course.