EUROPE: CESR Consultation on Structured UCITS

Thursday November 18 2010

In July 2010 CESR issued Final Guidelines on the risk measurement, calculation of global exposure and counterparty risk for UCITS. This is part of the UCITS IV package that Managers must comply with by 1 July 2011 and in summary, these Guidelines deal with a range of issues including calculations for the commitment approach, procedures in respect of VaR calculations, stress testing, back testing and regulatory reporting, together with guidelines on hedging, collateral and netting.

However, CESR at that time proposed to carry out a further consultation on structured UCITS. This consultation has now been issued. Responses to the consultation must be submitted by 31 December.

Funds-Axis training – the implications of these Guidelines and the changes that Managers will need to make to their investment compliance monitoring systems, operating environments and reporting arrangements will be fully considered at the Funds-Axis training course on UCITS IV, Derivatives Exposure and Risk Management on 22nd February.

CESR `s Proposals

In the Consultation Paper, CESR provide a definition of structured UCITS (which is different from the definition for key Investor Information (KII) requirements). In summary, structured UCITS are passively managed and offer investors a predefined payoff depending on different scenarios based on the value of the underlying assets.The investor can only be exposed to one scenario at any time during the life of the UCITS.

CESR has came to the conclusion that, rather than introducing a specific regime per se for the calculation of the global exposure for these structured UCITS, it would be more appropriate to have an alternative approach to the application of the existing guidelines.

The specific approach as proposed by CESR consists of the calculation, for each scenario to which investors can be exposed at any one time, of the global exposure using the commitment approach. Under this approach, each scenario must comply at all times with the 100% global exposure limit using the existing CESR Guidelines. CESR have set out a very useful set of examples in this regard.

There is a risk that some existing structured UCITS will not comply with these proposals and also that it may limit the types of products that can be made available. Note for example the CESR comment that “UCITS which use derivatives that incorporate a barrier-type feature are required to ensure that the maximum loss the UCITS can suffer when the payoff switches from one scenario to another is limited.”

In this regard, CESR `s proposal is that existing structured UCITS will not need, as regards global exposure, to comply with CESR `s July Guidelines on Risk measurement, Calculation of Global exposure and counterparty risk, but that in this case, such structured UCITS will no longer be able to actively market their UCITS. However, this is provided that such UCITS comply with whatever provisions have been put in place by Member States.

Please feel free to contact us to discuss these proposals in more detail.