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

investment decisions and understanding the risks involved.

and Sender, 2010 for more on these) would favour funds that implement best practices.

• Require prescriptive disclosures on non-financial risks in the prospectus and KIID The proposal is to strengthen transparency on non-financial risks by requiring asset managers to assess, for each fund, the exposure to non-financial risks; explain why these risks are taken; assess the likelihood and the severity of risk materialisation; describe and justify their risk mitigation methods; estimate residual risk to which investors will be subjected and confirm that the level of unmitigated financial risk is consistent with the risk profile of the fund. The analysis would be presented in the Prospectus in detailed form and in the KIID in a concise format, along with a synthetic indicator of non-financial risks whose calculation would be standardised by ESMA. Should this proposal be implemented, the recommendation on rating would still be justified to independently verify the information provided by the fund and assess the quality of its risk mitigation methods. Such ratings would reinforce the internal evaluations done by asset managers (or help them identify areas for progress). Coordinating the roles for the production and diffusion of information on non-financial risks The role of the distributor In the context of MiFID, firms providing investment advice or individual portfolio management need to conduct suitability and appropriateness tests prior to giving any advice, recommendation or offer to a particular client.

It would be unreasonable to expect that a non-professional investor will have the wherewithal to do the due diligence required to assess the materiality of these non-financial risks. It is also socially desirable to reduce the costs of due diligence for all investors. Therefore, a framework should be put in place that results in the production and diffusion of adequate information with respect to non-financial risks. With this in mind, we suggest two directions to improve transparency: • Promote best practices for transparency and management of non-financial risks through rating The idea is to foster adherence to CESR’s guide of good practices by rating funds against this non-binding benchmark and making these ratings publicly available. Without further regulation, this approach would facilitate investment in funds that provide helpful transparency on their financial risks and acknowledge their responsibility to identify, measure and monitor these risks. Naturally, rating that would go beyond checking whether a fund complies with recommended practices in terms of transparency and provide investors with an assessment of the fund’s quality of management of non-financial risks and residual risk would be more useful for decision making. Such rating would look at the key non-financial risks and benchmark fund practices against best practices and translate the level of residual risk into a synthetic indicator. Such ratings (see Amenc

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An EDHEC-Risk Institute Publication