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

non-financial risks would result in increased operational costs; insurance and capital charge for net unmitigated risks would also weigh on costs. Confining oneself to this segment of UCITS would entail accepting these costs and opportunity costs. Unsurprisingly, this was not lost on the respondents of our survey who were presented with the concept. While 48% of respondents thought that the restitution of assets to investors should be unconditional (where 28% disagreed), 45% of respondents believed that a subset of UCITS for which unconditional restitution 75 would be guaranteed would generate large opportunity costs for investors (27% disagreed). Safety does not come cheap. However, it should be underlined that we are not suggesting that non-professional investors be restricted to this segment, but instead make the case for transparency about non-financial risks and enhanced incentives to mitigate these risks across the UCITS universe and for developing a segment of the UCITS space where investors are insulated against these risks to the highest degree possible. This dual approach is apt at reconciling the regulator’s desire for high protection of non-professional investors with the freedom of all investors to access a wide variety of funds and make informed decisions on the basis of suitably disclosed financial and non-financial risks, i.e. investment risks. Impact on distribution The legislation in force does not require to be updated to differentiate this segment from the wider UCITS universe as the

Regulation implementing the key investor documents of UCITS IV (Commission Regulation (EU) No 583/2010) requires disclosure of material risks not captured by the synthetic risk and reward indicator as part of the narrative appearing in the ‘risk and reward profile’ section and CESR has indicated that disclosing an assessment of the materiality of these risks would be good practice. In this context, a statement could follow the listing of risks and clarify that these are covered by way of a guarantee given by the depositary. In the context of MiFID II, restricted products could be distributed without advice on non-financial risks to non-professional investors and they could be offered via execution only services provided their payoffs were not complex. For clarity, we are making the controversial proposal for the strict enforcement of a zero tolerance policy on opacity about non-financial risks. Non-financial risks are an inherent part of investment risk and can have dramatic impact on the welfare of investors; the current practice of sweeping these risks under the rug should be discontinued as early as possible. Safety from non-financial risks cannot be assumed and non-restricted products should not fall into the scope of the execution-only or regime and should not be sold without advice, whatever their financial risk profiles. Adequate disclosures about non-financial risks should be available for assessment of risk materiality so that distributors can discharge their obligations in the context of advised sales. Restricted UCITS and the UCITS brand UCITS have become synonymous with a high degree of investor protection worldwide and a significant share of the growth of

75 - The concept presented in the survey was less ambitious in scope of restitution.

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An EDHEC-Risk Institute Publication