A Better Grasp of Non-financial Risks

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

Appendices

There, the term “sponsor” is little used, but the bank of the investment firm sometimes acts implicitly as a sponsor, which may lead it to bear some non-financial losses in funds. In Luxembourg, sponsors are subject to implicit capital requirements: the CSSF Circular 91/75 requires that the promoter (the sponsor) maintain an adequate line of credit with a bank for the satisfaction of possible investor claims. In Luxembourg as well as Ireland, two countries which seek to attract funds, a sponsor can be contracted, which facilitates the domiciling of funds from foreign companies. The central role of the investment firm The investment firm is responsible for financial management, centralisation, record-keeping, valuation, and regulatory reporting. Despite the obligations depositaries must take on, the main responsibility for decisions and for compliance with regulatory obligations rests with asset managers themselves (they select the depositary). They are responsible for valuation; for the choice of assets and due diligence; for compliance with quantitative restrictions; and for providing legal information, annual reports, and key information documents to unit-holders. Broadly, investment firms have great responsibilities in the management of non-financial risks: they choose the geographies and jurisdictions they invest in, they are responsible for liquidity and collateral risk management— depositaries also inherit responsibilities for collateral management because assets must be transferred within an appropriate time frame 45 and because of their responsibility for the pricing of contracts. UCITS investment firms

are subject to organisational and risk management requirements whose aim is to limit conflicts of interest and keep risks under control. The core function of an investment firm is the financial management of funds. This function, arguably the best understood by the general public and by investment professionals, involves the definition and implementation of the investment strategy. The investment manager may decide to delegate the financial management of the funds to third parties licensed to manage such funds. When financial management is outsourced, the investment manager is still liable for outsourced activity and must comply with certain requirements (he or she must have in place measures to monitor the work of the entity to which the management is delegated; the outsourcing must not lead to any conflicts of interests). French regulations provide for mandatory provisions in investment management agreements. Another core function involves reporting. The investment firm must report to the supervisor the net asset values of each fund; it must also disclose to the central bank (which is not the supervisor in all countries) the information necessary to the publication of monetary statistics. Article 27-1 of UCITS III requires that the investment company provide key information to unit-holders: “Both the simplified and the full prospectuses must include the information necessary for investors to be able to make an informed judgement of the investment proposed to them, and, in particular, of the risks attached thereto. The latter shall include, independent of the instruments invested in, a clear and easily understandable

45 - UCITS III, article 7-3: “A depositary must, moreover [...] ensure that in transactions involving a unit trust's assets any consideration is remitted to it within the usual time limits” (EC 2008).

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An EDHEC-Risk Institute Publication