Shedding Light on Non-Financial Risks – a European Survey

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

Executive Summary

The study insists that 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 rating of these risks in the Key Information Document (KID) of each fund. This measure could notably evaluate elements related to sub-custody risk, infrastructure and operational risk, or counterparty risk for funds involved in derivatives operations. The financial responsibility of the industry comes out a close second as a 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 party’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. Regulation on restitution and depositary liabilities would add to these measures. The responsibility for restitution could also be defined in law or by contract between depositaries, sub-custodians and asset managers, together with its conditionality and its “reasonable delay”. When it comes to protecting the final investor, distribution certainly has a major role to play. After all, mis-selling is a large source of risk, and re-sellers of funds should therefore provide their

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, 2010). 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 first-year study (Amenc and Sender, 2010b) pointed to the rise of non-financial risks within the fund management 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 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. First-year study: Non-Financial Risks Need to be Properly Dealt with by Regulators and the Industry

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An EDHEC-Risk Institute Publication