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

misleading, inaccurate or inconsistent with the prospectus (Article 79 of 2009/65/EC).

of the counterparty risk to which the fund exposes investors. The same asset manager offers an ETF tracking the MSCI EM 10/40 Latin America Index, an index of companies from the emerging markets of Latin America. While disclosing that it may engage in EPM, transact in FDIs, but also invests in (American and Global) Depositary Receipts issued by depositary banks, the provider uses the exact same description for counterparty risk as the one used for its EURO STOXX tracking product. 58 The corresponding prospectus details the risks and the risk management methods but remain silent on exposure or severity in case of materialisation. While pedagogic, the information provided is insufficient to allow the investor to assess the non-financial risks to which the fund is exposed in relation to its objectives and investment policy of and their practical implementation by the manager (i.e. how exposure is generated via the manager’s choices of investment vehicles, the extent of its reliance on efficient portfolio management techniques or derivatives, or more broadly its selection of counterparties and agents and how it is mitigated). It is no more sufficient for a firm which provides investment advice or portfolio management to customers and is required under MiFID to assess the suitability of these products prior to transaction (and to be in a position to document and prove in case of a review). While a client has the right to renounce some of the protections afforded by the MiFID conduct of business rules, the duties of the investment firm are discharged only if an adequate assessment of the client’s competence, experience and knowledge, has given reasonable assurance to the firm that the client is capable of making his own

The CESR’s guidelines for the presentation of the KIID suggest that investment firms “go beyond a bald statement of the risk by briefly explaining its implications to the investor” and underline that, for the information to be helpful, an assessment of the risk’s materiality is required (CESR/10- 1320). Materiality could be assessed for each risk category (exposure, probability of occurrence, severity of impact in case of risk materialisation). The guide also notes that explanations on how each risk is mitigated may promote better understanding of materiality by the investor, and indicates that legally enforceable guarantees or protections modifying these risks should be mentioned. This CESR document is a non-binding guide to good practices. Early experience with the KIID 56 shows that, as far as non-financial risk disclosures are concerned, many investment firms do not go beyond what is strictly required by law. As an illustration 57 , an ETF tracking the EURO STOXX 50 Index, an index of eurozone blue-chip companies, which discloses that it may engage in efficient portfolio management techniques (without indicating any potential limit) and use derivatives (in a way it expects to be limited) underlines counterparty risk in the narrative section of the risk and reward profile as follows: “The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.” While accurate and in accordance with the letter of the law, this description does not constitute an assessment of the materiality

56 - All UCITS were required to have their KIID in place by 1 July 2012. 57 - We do not mean to suggest that the investment firm which prepared the KIIDs presented in this illustration is behaving any differently from its peers. 58 - Unsurprisingly, it also flags out liquidity risk.

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An EDHEC-Risk Institute Publication