A Better Grasp of Non-financial Risks

The European Fund Management Industry Needs a Better Grasp of Non-financial Risks — December 2010

4. Which Possible Protection of Unit-Holders?

restitution risk. Distributors would then have incentives to search for the relevant information and they would in turn require that the funds’ documentation be clear about non-financial risks. When the fund’s documentation lacks clarity, distributors should be able to decide not to sell the fund, or to sue investment firms and depositaries for incomplete information. So, the failure to provide relevant information about non-financial risks in the KID must be considered a potential problem for distributors and possibly for depositaries, too: if information about non-financial risks is unavailable to distributors, they cannot report it clearly to the end-investor; the lack of information about such risks makes depositaries the scapegoat, because investors and supervisors may wrongly assume that such risks are not supposed to exist. In addition, the KID is bound to become the essential piece of information in UCITS IV, as only the KID, a homogeneous European document, need be translated as part of the accelerated notification procedure for distributing funds throughout Europe. In UCITS IV, as in UCITS III, the greater share of responsibility for the KID will fall on the investment firm (UCITS III, article 78). 41 In the future, with a possible extension of information beyond that produced under the responsibility of the investment firm and with the simplified notification procedure, the extent to which parties are responsible for the information must be clarified. Could country supervisors try to compensate for a loss of control over domestic distribution of foreign funds by requiring more extended responsibility of parties to the KID? The responsibilities of the investment firm and of the depositary may vary from one country to another, as

the role of the valuator and the depositary vary today.

Again, improved transparency requires the KID to display clear information (such as the proposed ratings) about non-financial risks. The funds that display great extreme non-financial risks must be clearly identified as such in the KID. When the depositary commits to the unconditional restitution of assets, this commitment should be noted in the KID and could prove an advantage for depositaries and asset managers alike. Distribution incentives Funds with suitable practices could be given access to a wider range of clients. The UCITS designation already ensures that the fund can be distributed widely; the same incentives could be given to AIFMD-compliant funds; distribution rewards can be enhanced by distinguishing between funds that apply best practices and those with practices that involve more non-financial risks. Ratings of the non-financial risks borne by unit-holders could be used for that purpose. Making such ratings publicly available would, without further regulation, facilitate investment in funds, since investors are now eager for disclosures of non-financial risks; as such, ratings would implicitly favour the funds with better practices. 4.4 Towards Better Governance and Better Risk Management The strengthening of governance and the greater involvement of unit-holders (through the board or through class actions) would make it possible for investment firms better to take non-financial risks into account, and help improve the management of non-financial risks.

41 - At the moment the sole indication in UCITS IV regarding the responsibility of other parties is that civil charges cannot be brought against persons (EU 2009a, article. 79-2) “Member States shall ensure that a person does not incur civil liability solely on the basis of the key investor information, including any translation thereof, unless it is misleading, inaccurate or inconsistent with the relevant parts of the prospectus. Key investor information shall contain a clear warning in this respect”.

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An EDHEC-Risk Institute Publication