Shedding Light on Non-Financial Risks – a European Survey

Shedding Light on Non-Financial Risks – a European Survey — January 2012

1. Introduction

This survey has been conducted within the research chair "Risk and Regulation in the European Fund Management Industry" sponsored by CACEIS, following a study of called “The European Fund Management Industry Needs a Better Grasp of Non-financial Risks” (Amenc and Sender, 2010b). In that paper, we identified major areas of concern for the European fund industry, examined the regulatory framework at the European level as well as country regulations and practices in France, the United Kingdom, Luxembourg and Ireland. We then described possible regulatory and industry solutions for different themes, such as transparency and governance, financial responsibility of the industry, restitution and depositary liabilities, distribution and judicial powers of investors. The term of “non-financial risks” does not have a single definition for everybody. For the purpose of this survey, we considered the scope of risks than were discussed in Amenc and Sender (2010b). Under the “non-financial risks” umbrella, we include the non-financial component of other risks that may have a financial dimension, for instance counterparty risk, liquidity risk or sub-custody risk. By counterparty risk, we understand the default of an intermediary rather than that of a bond issuer. Liquidity risk, in a non-financial perspective, is mostly the risk that assets would be frozen pending litigation or taking excessive time to be returned to their rightful owners. Sub-custody risk is the special case where sub-custodial arrangements are made regarding some assets, most usually in a totally opaque way for the investor. At least

outside of derivatives contracts, these risks can usually not be considered financial. For instance, the default of a custodian might prevent assets from being returned within reasonable delays (hence creating liquidity risk), or even returned at all in some specific cases. As pointed out in the first-year study, non-financial risks are on the rise within the industry. To date, no satisfactory measures have been taken either by the national and supranational regulators, or by the industry itself, to put these risks under control. Growing sophistication of operations and investment strategies, together with their progressive internationalisation, have outpaced the capacity of supervisors and the industry to establish proper risk management practices. Their need, however, appears increasingly salient, in the light of recent events such as the Lehman Brothers demise and the Madoff fraud. In the first section of the survey, we review the importance given to each of these risks and we assess how protected the industry feels against them and what has caused the rise in non-financial risks. As a broad assessment, we also investigate whether respondents think that currently drafted or implemented regulations, AIFMD and UCITS, will contribute to a rise or fall in non-financial risks. We then investigate more precisely the attitude of respondents regarding the main themes described in Amenc and Sender (2010b): transparency, information and governance; capital protection and financial responsibility of the industry; distribution; restitution; and the judicial powers of investors.

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An EDHEC-Risk Institute Publication