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

Executive Summary

Additionally, we suggest that an explicit rating be used to promote best practices with regard to transparency and risk management. This rating would benchmark the fund based on its level of non-financial risk and it would thus provide the investor with a synthetic indicator of the risk exposure it is assuming when investing in the fund. This information would effectively be a catalyst for improved practices and transparency within the fund management industry on this issue, and it would promote the adoption of standards going beyond regulatory requirements. Of course no information is of any value unless it engages the liability of those who create or diffuse it. This is why we propose a clarification of the responsibility regime with regard to information on non-financial risks . Within the value chain, the distributor is the actor who has to ensure that the information provided on all of the fund’s risks is clear and comprehensible for the client . This information should allow the distributor to advise non-professional clientele on the nature and level of risks to which the fund is exposed and ensure that these fall in line with the client’s profile and level of competence/knowledge. There is a priori no reason to limit such advice to financial risks and one would presume that the objectives underlying such advice should extend to non-financial risks. However, this is rarely the case today. There is no choice but to accept that information on non-financial risks is often non-existent and that the due diligence questionnaires circulated during the know your customer process (as required by MiFID) do not allow the assessment of an investor’s level of

comprehension on these subjects. This lack of information should not absolve the distributors of their responsibility. They are certainly not in charge of producing the information or guaranteeing its accuracy, but their duty to advise should mean they refuse to sell a product which they feel has insufficient or incomprehensible information. Furthermore, given the distributor’s responsibility to verify the information’s clarity and ease of comprehension, we feel it is all the more important for the regulator to further clarify the distinction between those who are professional investors and those who are not. If the former are not subject to the provisions on advice as laid out by MiFID and therefore exempt from all costs associated with fund distribution, it would seem logical that they automatically acknowledge the fact that they are in a position to assess the quality of information provided by funds. As such, the reduced fees demanded by professional investors should clearly prevent the latter from claiming, ex post , any damages linked to mis-selling on the part of fund sponsors or managers. Bearing in mind the alignment of restitution obligations with the depositary’s liability regime for assets under its custody within the UCITS V framework, we consider it important for the depositary of each fund to clearly establish the percentage of assets covered by the obligation of restitution . This information would allow for risks posed by moral hazard, as previously highlighted, to be limited.

Lastly, we should remember that fund managers have a key role when it

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An EDHEC-Risk Institute Publication