Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry

Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry - December 2012

Executive Summary

comes to providing information on non-financial risks . They must explain the source of these risks and, in conjunction with the depositary, they must assess not only these risks, but also the effectiveness of their management and mitigation. As a result, to achieve perfect investor information, EDHEC-Risk Institute believes that it is the fund manager’s responsibility to inform investors of the responsibilities, regarding non-financial risks, of active parties with which the fund manager has established contracts in the fund’s name. We therefore recommend that the KIID mentions all contractual agreements that detail the responsibilities of stakeholders as regards the restitution of assets or guarantees . As for the governance of non-financial risks, EDHEC-Risk Institute calls for clarification and a reinforcement of the fiduciary responsibilities of fund administrators or fund management companies . Such a clarification is all the more important at this time because the UCITS framework is not explicit on this point and does not allow for upward harmonisation of different systems of responsibility and modes of risk governance in Europe. In the same vein, EDHEC-Risk Institute recommends that depositaries be given the responsibility to directly inform distributors of anomalies or non-compliance with legal and contractual rules which they become aware of as part of their operation. Finally, as EDHEC-Risk Institute’s philosophy is that the actions of investors themselves lead down the best possible path for limiting

both financial and non-financial risks, we recommend giving investors the means to defend themselves and take legal action to protect their rights by introducing European class actions that will allow investors to seek redress and obtain fair compensation for the prejudice suffered. The second series of recommendations is linked to the establishment of economic incentives to encourage better management of non-financial risks. Within this context, EDHEC-Risk Institute has two principal proposals. On the one hand, we call for the adoption of capital requirements proportional to the level of non-financial risk assumed by the major players in the fund management industry value chain – namely depositaries and fund management companies. The calculation of the regulatory capital requirement would be addressed in an initial analysis within the framework of a standard model, for which the methods of calculation and parameters would be defined by ESMA. At the same time, we propose r educing this capital requirement by establishing a residual risk assessment in the form of an internal model whose calculation principles would also be harmonised at the European level. This internal model would allow for the reduction of regulatory capital requirements depending on the application of best practices for managing non-financial risks such as centralised clearing of OTC trades, tripartite agreements for the securing of collateral, or adequate segregation of a client’s assets.

This new approach for prudential capital and its assessment should not be seen as a

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An EDHEC-Risk Institute Publication