Shedding Light on Non-Financial Risks – a European Survey

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

1. Introduction

Amenc and Sender (2010b) argue that transparency was a major issue in European financial regulations, insufficiently tackled by regulatory works. Improved transparency and governance are at the forefront when trying to tackle non-financial risk. Those improvements could come from regulators, self-regulation by industry bodies, or both. It is suggested that a possible way to improve the transparency with respect to non-financial risks would be to include an explicit indicator of these risks (which we will call a rating because of its possible qualitative nature) in the Key Information Document (KID) of each fund (see Amenc and Sender, 2010b, p11 and 57). This measure could notably evaluate elements related to sub-custody risk, infrastructure and operational risk, or counterparty risk for funds involved in derivatives operations. We also suggest as in Amenc and Sender (2011) that fit-for- purpose product regulations ensure that products are adapted to the needs of investors and specific risk objectives. If there is a need or willingness to have funds that are fully protected against restitution risk, a notion of secure UCITS where depositaries are liable for the restitution of assets would fit this purpose. With definitions, measurement and reporting of non-financial risks all too vague, information was sometimes misleading – see the case of money-market funds (Amenc and Sender, 2010b, p. 21) or the Madoff affair as the prospectus was judged to be misleading in this case (Laurent and Protard, 2011). Who is responsible for transparency is also insufficiently detailed, so the legal ramifications of inadequate information are complex in the current environment.

The Irish High Court, based on UCITS law, ruled that Aforge Finance SAS, a French investor in Madoff’s feeder fund – Thema International Fund (UCITS), was entitled to turn to the depositary, HSBC, to obtain the mandatory annual report that Thema failed to release (Bodoni and Doyle, 2011). Means of supervision (which, in practice, also means supervisory powers) vary from one country to another. For instance, each national financial supervisor sets its penalties, and in case of a breach in the fair, clear and not misleading characteristics of the prospectus, the fine in Luxembourg is limited to 12,500 euros (compared to 100 million euros by the AMF in France) – a severe limit to the effectiveness of any transparency-related regulation. Then, as information is incomplete and because fund managers take decisions where the risk is formed, the financial responsibility of the fund management industry comes into play as a second complementary venue to mitigate non-financial risks. To avoid ill-defined chains of delegations that create opaqueness and uncertainty, it seems necessary to spell out each link’s duties, either in law or by explicitly defining them contractually at the inception of the fund. One logical approach would be to define obligations according to who controls which part of the information, and in a uniformed manner across Europe. Recently, the responsibilities of fund managers, intermediaries and distributors, have been judged differently in different jurisdictions in the Madoff case. 1818 Gestion was fined by the French Tribunal de Commerce for investing in Madoff’s feeder fund Luxalpha, as part of a 30% “other assets” category described as “low-risk” in the prospectus. These

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An EDHEC-Risk Institute Publication