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

2. Key Topics on the European Regulatory Agenda

the regulatory and supervisory framework in what it calls a sectoral way (in effect adding harmonising provisions in its proposals e.g. the new capital requirements package (CRD IV) , the new MiFID package (MiFID II), the new Market Abuse Directive package (MAD II), the new Transparency Directive (Transparency II), and UCITS V). UCITS V focuses on clarifying the duties and liabilities of UCITS depositaries, controlling remuneration of UCITS managers to discourage excessive risk taking and foster alignment with the investment objectives of the UCITS and the long-term interests of investors; and presenting a harmonised approach to sanctioning core breaches of the UCITS legal framework. On some of the other issues brought to light by the crisis, such as eligible assets and liquidity, work is still at an early stage as the Commission has only recently conducted a very open-ended first consultation (UCITS VI consultation). 29 It is worth noting that an ill-defined debate on the risks of exchange-traded funds (ETFs) evolved into a review of counterparty risk in UCITS and led to new ESMA guidelines enhancing counterparty risk and collateral management requirements for UCITS, in particular in relation to efficient portfolio management techniques such as securities lending (Ducoulombier, 2012); the contents of the UCITS VI consultation shows that discussions will continue on the counterparty and collateral risks involved with the efficient portfolio management techniques and OTC derivatives used by UCITS. Regulation of OTC derivatives In the wake of the downfall of Bear Sterns, Lehman Brothers and AIG, all of which were major counterparties in the

over-the-counter (OTC) derivatives markets and in particular for Credit Default Swaps (CDS), regulators’ actions with respect to counterparty risk have been focused on the OTC derivatives markets. Regulators first focused on CDS and, in March 2009, the European Commission secured the commitment of leading dealers in CDS to centrally clear their trades on European reference entities and indices in a European clearing house before August 2009. Based on an analysis of the benefits and risks of derivatives, the European Commission identified longer-term measures to increase transparency, reduce counterparty and operational risks and enhance market integrity and oversight. The key resulting piece of legislation is the Regulation on Financial markets: OTC derivatives, central counterparties and trade repositories (Regulation (EU) No 648/2012) and better known as the European Market Infrastructure Regulation (EMIR). This Regulation requires clearing of standardised OTC derivatives through prudentially regulated central counterparties (CCPs) to reduce counterparty risk and systemic risk, reporting of all derivatives contracts to trade repositories that will publish aggregate data, and improvement of counterparty risk and collateral management practicesfornon-centrallyclearedderivatives. This orientation triggers related updates of the European Regulation on capital requirements 30 with a view to differentiating the capital charges between centrally- and non-centrally-cleared contracts; of the Markets in Financial Instruments Directive (MiFID) 31 so as to align trading and reporting requirements (updating EMIR where needed); and of the Regulation on market abuse 32 to extend its coverage to derivatives.

29 - This consultation touched upon eligible assets and use of derivatives, efficient portfolio management techniques, OTC derivatives, extraordinary liquidity management rules, depositary passport, money market funds, long term investments and feedback on UCITS IV. 30 - 2006/48/EC and 2006/49/EC with draft Directive COM(2011) 0453 and draft Regulation COM(2011) 0452, hereafter CRD IV.

31 - Directives 2004/39/ EC and 2006/73/EC plus Regulation 1287/2006 with draft Directive

COM(2011)0656 and draft Regulation COM(2011) 652. 32 - 2003/6/EC and 2004/72/ EC with draft Directive COM(2011) 654 and draft Regulation COM(2011) 651.

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An EDHEC-Risk Institute Publication