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

3. Proposal towards Better Management of Non-Financial Risks

3.1. Organisation of and responsibility for the provision of information on non-financial risks.

The central place of the KIID should be underlined: not only its format is harmonised at the European level, but, in the context of the UCITS IV simplified notification procedure (whereby the home country regulator simply informs its host country counterpart that the fund is to be distributed in its jurisdiction), it is also the only document that needs to be translated into the language(s) of the host country where the UCITS will be marketed. The procedure replaced a cumbersome cross- border registration process and leads to automatic authorisation; the host country can still exert ex-post control on the fund provided this does not contradict the UCITS IV rules. Against this backdrop, Amenc and Sender (2010) observed that country supervisors could be tempted to compensate for the loss of control over domestic distribution of foreign funds by requiring extended responsibility of parties to the KIID. While the jury is still out, clarifying the extent to which parties are responsible for the information would be welcome. In terms of responsibility, it is relevant to highlight that the identification and explanation of risks that are material but not adequately captured by the synthetic indicator “shall be consistent with the internal process for identifying, measuring and monitoring risk adopted by the UCITS’ management company as laid down in Directive 2010/43/EU” (Article 9 of Commission Regulation (EU) No 583/2010). In other words, there needs to be consistency between the presentation of risks in the KIID and the risk management processes implemented by the asset manager. Note that no party will incur civil liability only on the basis of the KIID unless it is

Calling for transparency on non-financial risks

In its current form, the UCITS Key Investor Information Document (KIID) includes a Synthetic Risk and Reward Indicator (SRRI) that translates the volatility of the fund onto a numerical scale of 1 to 7. The volatility is computed from the returns of the previous five years, or derived from relevant simulations (CESR/10-763). By nature, this indicator cannot measure extreme risks that are not captured by the variations of the fund’s net asset value, until extreme situations materialise. Non-financial risks appear in the KIID section titled “risk and reward profile”, after the narrative explanation of the SRRI and its main limitations, provided they are material and not adequately captured by the synthetic indicator (Article 8(1)(b) of Commission Regulation (EU) No 583/2010). Risk categories identified by the Regulation are: credit risk; liquidity risk; counterparty risk; operational risks and risks related to safekeeping of assets; and impact of financial derivative instruments used to create or alter exposure to underlying assets (Article 8(5)). It is the asset manager’s responsibility to decide what risks need to be flagged out in the KIID, based on an analysis of the specific characteristics of each fund; since the KIID needs to remain concise, the narrative can refer to the prospectus, where a comprehensive explanation should be provided.

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An EDHEC-Risk Institute Publication