IRELAND: IFSRA Publishes revised Guidance on Derivatives Usage

Wednesday May 31 2006

IFSRA has issued a revised Guidance Note 3/03 on the use of Financial Derivatives Instruments (FDI) by UCITS. The previous 9 page Guidance is now replaced with 21 pages of guidance. This Guidance should be made available on the IFSRA website at the above link. Funds-Axis will be publishing an overview of the new Guidance next week, but some of the key features are set out below: Firstly, the Guidance Note sets out substantial detail as regards the global exposure and leverage and counterparty exposure requirements in relation to derivative usage. This includes the following:

*Analysis of what is meant by global exposure, total exposure and leverage and the applicable regulatory limits for UCITS ;

*Analysis of the applicability of the `commitment approach` to calculation of exposures and what this entails as regards calculating global exposure, position risk and position cover. Appendix II very useful sets out the generic rules that must be followed for a range of financial derivative instruments by UCITS in calculating their exposure using this methodology;

*Details of the quantitative and qualitative standards that must be build into VaR models used by sophisticated UCITS in calculating global exposure ;

*How the exposures arising from derivatives embedded within structured financial instruments must be treated ;

*Application of the UCITS rules to index-based financial derivative instruments ;

*Calculation methodologies for counterparty risk.

The Guidance Note also then sets out the detailed reporting requirements in respect of the Risk Management Process document. Appendix I sets out in significant detail the filing requirements and information to be included in the Risk Management Process document. This also includes a checklist to assist in the completion of RMP submissions. The Guidance Note also contains details of what needs to be included within the Annual FDI Report which the UCITS must submit to the Financial Regulator. This report must include details of any breaches of the derivative exposure limits which have occured during the year along with details of remedial action taken and duration of the breaches.

Finally, the Guidance Note comes with the comment that the guidance in this area will evolve and change to respond to meet new market developments.