Risk Management under UCITS III / IV

New Challenges for the Fund Industry

Christian Szylar

• Publisher: Wiley-ISTE
• Year: 2013
• Print ISBN:
  9781848212107
• Edition: 1
• eBook ISBN:
  9781118622773
• Topic: Business
• Subtopic: Insurance
• Index: Business

Risk Management under UCITS III/IV shows how asset managers, fund administrators, management companies and risk departments can satisfy the various financial regulators, which govern European markets, that they have adequate risk monitoring procedures in place for the funds they manage or administer. 

The book explains all the requirements for risk management under the new UCITS III/IV regime, as well as the universe of financial instruments which can be used by portfolio managers, and identifies their associated risks and possible mitigation strategies.  It is therefore required reading for anyone trying to fully understand and comply with UCITS III/IV requirements.

PART I

What You Have to Know
About UCITS to UCITS III

Chapter 1

UCITS to UCITS III

1.1. UCITS primer and market size

1.1.1. UCITS: a brand relying on investor protection

UCITS stands for Undertaking for Collective Investment in Transferable Securities. UCITS is a global investment brand and the key to the success of the brand to date has been and will always be its reputation, which comes from the heavy and systematic controls carried out by all various fund service providers. UCITS is therefore a recognized, authorized product with all necessary safeguards in place at all levels to provide investor protection. In recent years, sales of UCITS products have grown at a reported rate of 100% a year. This statistic alone can give an idea of how attractive this investment vehicle is. To get an idea of the value of UCITS abroad before the financial crisis, 90% of the net sales of international UCITS originated from Asia during 2007. Approximately 40% of UCITS funds are sold outside the EU – in Asia, the Middle East and Latin America – making them Europe’s most successful financial service export.

1.1.1.1. UCITS’ growth

The European Fund and Asset Management Association (EFAMA) releases monthly and quarterly statistics about UCITS. In its third quarter edition in 2009, the figures were still impressive. It stated that total net assets of UCITS had increased by 7.7% to reach €5,157 billion at the end of September 2009. Equity funds experienced the highest asset increase (€197 billion or 15%). Balanced and bond funds saw their assets increase by 9% and 8%, respectively. Since the end of 2008, UCITS’ total assets have increased by 13.5%, or €615 billion [EFA 09a].

Figure 1.1. Net asset of European UCTIS investment fund [EFA 09b]

Figure 1.2. European Investment Fund industry split by type of investment funds[EUR 06]. Non-UCTIs is a catch-all term referring to all non-harmonized funds whether subject to national regulation or not. This comprises a wide range of investment styles and products – ranging from retail-oriented project such as open-ended real estate funds, to more volatile products, such as community and private equity funds

Table 1.1 gives the net assets of the European UCITS industry where Luxembourg, France and Dublin are the leading places [EUR 06].

Luxembourg has a long-standing reputation as a jurisdiction for all types of alternative investment funds, mostly in the regulated sector. If we have a more detailed view on Luxembourg, which was historically the first country to specialize in UCITS fund administration and services, the increase in UCITS funds and assets under management is really astonishing.

Table 1.1. Net assets of the European UCTIS industry

Figure 1.3. Evolution of total net assets and number of UCITS (1997-2008)

Figure 1.4. Annual development of net assets and number of undertakings for collective investment (UCIs). Situation on December 31, 2008. (Source: [CSSF 10])

Figure 1.5. Luxemburg UCITS Funds history

It is also interesting to see who the promoters of such funds in Luxembourg are and deduce the international interest in these products.

Figure 1.6. Promoters of Luxembourg undertakings for collective. Situation as of Septmber 39, 2009 (Source: [CSSF 10])

Table 1.2. Net assets of Luxemburg UCITS funds

1.1.1.2. Why UCITS?

As we have seen above, the appetite for investing funds under UCITS has grown significantly over time and this trend will continue as some hedge fund managers are now considering the launch of UCITS products to enhance investor confidence or increase their distribution networks. Considering newcomers interest in UCITS, such as hedge fund managers, as well as increasing brand perception in countries outside the EU, the growth trend is not expected to end. Many hedge fund investors are now looking to more regulated products, such as the UCITS structure, which is known for its heightened liquidity, transparency, risk management and regulatory scrutiny. UCITS is attractive for many investors because:

– it offers a wider choice of funds;

– it offers greater transparency than any other products;

– its regulations are unique and strong;

– its funds usually have good returns compared to other investments;

– it is liquid;

– it has enhanced risk controls.

1.2. UCITS – a success story: from UCITS to UCITS III/IV

1.2.1. From UCITS to UCITS III/IV

UCITS was first introduced in 1985. It was intended to establish a common legislative framework for open-ended funds investing in transferable securities set up in any EU Member State with the goal that a fund authorized in one Member State could be sold in other Member States without local authorization being required. It was developed, in effect, to establish a free pan-European market in collective investment schemes.

UCITS’ history started with the UCITS Directive 85/611/EEC [EUR 85]. Its main objective was to create a harmonized legal framework to facilitate cross-border investment fund offers to the retail investor and to develop an integrated and competitive European single market for investment funds.

Another key objective followed by this first European Directive was to establish a defined level of investor protection through strict investment limits (based on the principle of risk diversification), capital, organizational and disclosure requirements, as well as asset safe-keeping and fund oversight, usually by an independent depositary.

UCITS Directive 85/611/EEC was adopted and published in late 1985¹. Its implementation by the Member States was due by October 1, 1989. It is not surprising that the Grand Duchy of Luxembourg was one of the first Member States to translate it into its national law, due to taxation requirements. This helped Luxembourg to become the first country in the world in terms of UCITS domiciliation.

At this stage, UCITS was limited to investment in transferable securities, a concept that was not properly defined by the first UCITS directive. In the absence of an agreed definition, transferable securities had been understood to mean simply listed bonds and equities. It is critical here to mention that the EU Directive of 1985 required 90% of UCITS’ assets to be invested in transferable securities, while the remaining 10% could be placed in certain other financial instruments. By the terms of the original directive, use of an UCITS did not allow fund managers to widely invest for speculative purposes in shares of other funds, derivative products or money market instruments among other things. Furthermore, due to diversification limitations inherent to UCITS I (i.e. generally no more than 5% of a UCITS’ assets could be invested in a single issuer, unless an increase on this level was authorized by an individual Member State), an index or tracker fund did not qualify as a UCITS. UCITS industry has not grown as it might have done due to these inherent limitations. In the meantime the financial industry had created evermore new financial instruments that asset managers increasingly wanted to incorporate as part of their investment strategies. These inherent limitations have also pushed the growth of hedge funds, which were subject to fewer constraints.

When the European Commission regulated the fund industry in 1985, it had three main objectives that have been partly achieved:

– to keep regulation up to speed with changes in the investment market;

– to create a level playing field for funds established in different Member States;

– to ensure investors were well-protected by a single regulator across all EU markets.

The UCITS industry remained regulated by this first European Directive for more than 15 years. As with anything designed by committee, what was intended to be a horse ended up as a camel and the planned free market did not really take off for a number of reasons. These included the obstacles created by each Member State’s own market rules, local taxation requirements and the relatively limited nature of the definition of transferable securities.

Even if UCITS I was implemented in 1985, the network of Member States’ rules and local laws did not permit them to achieve the original objectives of the Directive in practice. Throughout the 1990s there was much grumbling and discussion about the actions needed to make UCITS achieve its original objectives. This culminated in new proposals being put forward by the EU Commission in 1998 that were eventually formally adopted in December 2001. There were actually two directives published on the same day – UCITS II and UCITS III – but the two collectively are commonly known as UCITS III.

Significant amendments were made to Directives 2001/107/EC and 2001/108/EC and both were due for implementation in Member States by February 13, 2004. As we will see later, the significant amendments made by these two new European Directives are:

– the expansion of eligible assets;

...

Table of contents

• Cover
• Title Page
• Copyright
• Introduction
• Acknowledgements
• PART I: What You Have to Know About UCITS to UCITS III
• PART II. UCITS RISK MANAGEMENT
• Conclusion
• APPENDICES
• Bibliography
• Index