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Risk Management Under UCITS IV

ISBN: 978-1-84821-394-4
November 2014, Wiley-ISTE
Risk Management Under UCITS IV (1848213948) cover image
This Handbook on UCITS provides a one-stop source for investors whether being institutional or retail, professionals in the fund or banking industry, service providers, students, researchers, and practitioners to learn the necessary knowledge and analytical skills they need when setting, managing and monitoring a UCITS fund. It systematically introduces recent developments in different areas of UCITS through a multi-disciplinary approach.
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Introduction  xiii

Christian SZYLAR

Chapter 1. Setting up a UCITS Fund  1

Jerome WIGNY and Celine WILMET

1.1. Introduction to the UCITS concept  1

1.1.1. A half-century of legal developments  2

1.1.2. Legal/regulatory framework  3

1.1.3. EU passport/brand  5

1.2. Legal forms and structures  5

1.2.1. Legal forms available  5

1.2.2. Capital requirements  8

1.2.3. Multicompartment/class structures  9

1.2.4. Management  11

1.2.5. Choosing between legal forms and structures  16

1.3. Issue/redemption of shares/units  17

1.3.1. Investors  17

1.3.2. Open- versus closed-ended  18

1.3.3. Issue/redemption price  18

1.3.4. Valuation of assets  18

1.3.5. Suspension of issues/redemptions  19

1.4. Parties involved  20

1.4.1. Promoter  20

1.4.2. Central administration  22

1.4.3. Depositary  23

1.4.4. Auditor  25

1.4.5. Investment manager  26

1.4.6. Investment adviser  26

1.4.7. Distributor  27

1.5. Legal documentation  27

1.5.1. Prospectus  27

1.5.2. Key investor information document  28

1.5.3. Articles of incorporation/management regulations  29

1.5.4. Agreements with service providers  32

1.5.5. Other documents  32

1.6. Reporting obligations  33

1.7. Expenses  33

1.7.1. Formation expenses  34

1.7.2. Ongoing expenses  34

1.7.3. Prospectus disclosure  35

1.8. CSSF authorization  35

1.8.1. Approval process  35

1.8.2. Timing  38

1.8.3. Withdrawal of CSSF approval  38

1.9. Incorporation process  39

1.9.1. Investment company  39

1.9.2. FCP  40

Chapter 2. UCITS Management Companies  41

Jerome WIGNY and Celine WILMET

2.1. Introductory comment  41

2.2. Luxembourg legal/regulatory framework  42

2.3. Conditions for setting up a Chapter 15 Management Company  43

2.3.1. CSSF approval  43

2.3.2. Functions  44

2.3.3. Capital requirements  48

2.3.4. Legal forms  50

2.3.5. Management  50

2.3.6. Auditor  52

2.3.7. Shareholders  54

2.3.8. Registered office and central administration  54

2.4. Operating conditions applicable to Luxembourg management companies  55

2.4.1. Organizational requirements  55

2.4.2. Conflicts of interest  61

2.4.3. Rules of conduct  62

2.4.4. Risk management  63

2.5. CSSF supervision  63

2.5.1. Approval process  63

2.5.2. CSSF approval and inclusion on the list  69

2.5.3. Reporting to the CSSF  69

2.5.4. CSSF taxes  70

2.5.5. Withdrawal of CSSF authorization  70

2.6. Management company passport  71

2.6.1. Notification procedure  71

2.6.2. Cooperation agreement  72

2.6.3. Supervision  74

Chapter 3. Risk Management in the Context of UCITS IV  77

Thierry LÓPEZ and Benjamin GAUTHIER

3.1. Introduction  77

3.2. Regulator expectations  78

3.2.1. From European directives to local regulation  78

3.2.2. Risk management requirements  80

3.3. Market risk  81

3.3.1. Definition  81

3.3.2. How to measure market risk  81

3.3.3. Regulator expectations  82

3.3.4. Risk profiling  83

3.3.5. The commitment approach  84

3.3.6. Value at risk (VaR)  94

3.3.7. Global exposure: VaR versus commitment  106

3.3.8. Leverage  108

3.4. Counterparty risk  109

3.4.1. Definition  109

3.4.2. Regulator expectations  109

3.5. Liquidity risk management  110

3.5.1. Definition  110

3.5.2. Regulator expectations  111

3.5.3. How to approach liquidity risk in the context of investment funds  111

3.5.4. Methods and techniques to measure and monitor liquidity risk (asset side)  112

3.5.5. Methods and techniques to measure and monitor liquidity risk (liability side)  116

3.5.6. Limiting redemptions  120

3.6. Operational risk  120

3.6.1. Definition  120

3.6.2. Regulator expectations  120

3.6.3. How to approach operational risk for UCITS  121

3.7. Internal risk limits  124

3.8. Disclosure  124

Chapter 4. Counterparty, Issuer and Concentration Risk Management for UCITS funds  127

Romain BERRY

4.1. Introduction: no institution is “too big to fail”  127

4.1.1. Background and definitions  127

4.1.2. Managing counterparty risk within a UCITS framework  130

4.2. Measuring counterparty risk for a UCITS fund  131

4.3. Controlling and mitigating counterparty risk of a UCITS fund  132

4.3.1. Limits  132

4.3.2. Netting  138

4.3.3. Collateral management  143

4.3.4. Hedging  146

4.3.5. Early termination and other legal tools  148

4.3.6. Recouponing  151

4.3.7. Guarantees  152

4.3.8. Central counterparty clearing house (CCCH)  152

4.4. Policy and corporate governance guidelines to monitor counterparty risk  153

4.5. Measuring future counterparty credit exposure  156

4.5.1. Definitions  157

4.5.2. Formulation  161

4.6. Managing issuer risk  166

4.6.1. UCITS regulations on issuer risk  166

4.6.2. Measuring issuer risk  168

4.6.3. Stress testing issuer risk  170

4.6.4. Hedging issuer risk  174

4.7. Concentration risk management  174

4.7.1. Concentration risk within the UCITS framework  175

4.7.2. Identifying concentrations in a fund  178

4.7.3. Tools to manage concentration risk  180

4.8. Conclusion: what lies in the future?  182

4.9. Bibliography  183

Chapter 5. UCITS – The Investment Limits  185

Andrew P. WHITE

5.1. Introduction  185

5.1.1. Definitions  185

5.1.2. Structure  187

5.2. Investment restrictions  189

5.2.1. Permitted investments  189

5.2.2. Maximum of 10% NAV in securities other than those explicitly allowed  193

5.2.3. Maximum of 100% NAV global exposure  193

5.2.4. Maximum of 20% NAV in deposits made with the same body  194

5.2.5. Maximum of 10% NAV OTC derivative counterparty risk exposure with approved banks  194

5.2.6. Maximum of 5% NAV OTC derivative counterparty risk exposure with counterparties other than approved banks  195

5.2.7. Maximum of 10% NAV in securities or money market instruments of the same issuer (except qualified institutions)  195

5.2.8. Maximum of 40% NAV in securities and derivatives of issuers in which more than 5% is invested in  196

5.2.9. Maximum of 20% NAV in securities or money market instruments issued by the same body (except qualified institutions)  199

5.2.10. Maximum of 35% NAV in government and public body securities  200

5.2.11. Maximum of 25% NAV for bonds issued by EU credit institutions subject by law to special public supervision designed to protect bond holders (covered bonds)  201

5.2.12. Maximum of 80% NAV in the covered bonds of issuers in which more than 5% is invested in  201

5.2.13. Maximum of 20% NAV in respect of investment in the same issuing group  202

5.2.14. Index-tracking: maximum of 20% NAV in securities or money market instruments of the same issuer (except qualified institutions)  203

5.2.15. Index-tracking: Max 35% NAV in securities or money market instruments of the same issuer (except qualified institutions) for a single issuer  204

5.2.16. Minimum of six issues and maximum of 30% per issuance when more than 35% NAV is invested in a single public issuer  205

5.2.17. Maximum of 20% NAV in any one CIS  207

5.2.18. Maximum of 30% NAV in aggregate in non-UCITS CIS  207

5.2.19. Significant influence of voting shares per single issuing body (excluding certain public bodies)  208

5.2.20. Maximum of 10% of non-voting shares per single issuing body (excluding certain public bodies)  208

5.2.21. Maximum of 10% of the debt securities of any single issuing body  209

5.2.22. Maximum of 25% of the units of any single CIS (excluding certain public bodies)  210

5.2.23. Maximum of 10% of money market instruments of any single issuing body  210

5.2.24. Six-month derogation  211

5.2.25. A fund may borrow up to 10% of NAV for temporary purposes  211

5.2.26. No uncovered sales of transferable securities, MMIs or other financial instruments  211

5.3. Look through  212

5.4. Market practices and specific cases  212

5.4.1. Trash ratio  212

5.4.2. VaR  213

5.4.3. Definition of transferable security  213

5.4.4. Borrowing  213

5.4.5. Other  214

5.4.6. Summary  214

5.5. Data issues  214

5.5.1. Specific issues  215

5.5.2. Data consistency  215

5.5.3. OTC data  216

5.5.4. Technology advances  217

5.5.5. Summary  217

5.6. Checking process  217

5.6.1. Ex-post  217

5.6.2. Ex-ante  222

5.7. Conclusion  224

Chapter 6. UCITS Distribution  225

Mark EVANS

6.1. Introduction and overview  225

6.2. Domestic distribution  228

6.2.1. France  228

6.2.2. Germany  229

6.2.3. Italy  229

6.2.4. Switzerland  229

6.2.5. UK  230

6.3. Cross-border distribution  230

6.3.1. Introduction  230

6.3.2. Development of the UCITS Directive  231

6.3.3. Key domiciles of cross-border UCITS  235

6.3.4. Attractiveness of domestic markets for cross-border distribution  237

6.3.5. Key target markets for cross-border UCITS distribution  238

6.4. The distribution process  241

6.4.1. Public distribution  241

6.4.2. Private placement  242

6.4.3. Fund wrappers  243

6.5. Distribution channels  244

6.5.1. Introduction  244

6.5.2. Channel architecture  245

6.6. Distribution Channels  247

6.6.1. Banking: retail/private  247

6.6.2. Insurance/Bank-Insurance (bancassurance)  249

6.6.3. Fund platform growth and the role of intermediaries  249

6.6.4. Boutique Intermediaries  250

6.6.5. Independent Financial Advisors (IFA)  250

6.6.6. Markets to target  252

6.6.7. Appropriate products  253

6.6.8. An effective marketing strategy  253

6.6.9. Fees to maximize sales  254

6.7. Distribution agreements, fees and payments  254

6.8. Future thoughts: UCITS in transition  259

Chapter 7. The UCITS Management Company and Delegation  261

Killian BUCKLEY and Ciara O’SULLIVAN

7.1. Introduction  261

7.1.1. Overview of chapter coverage  261

7.1.2. History of the organizational structure of a UCITS  262

7.1.3. Evolution to UCITS IV  263

7.1.4. UCITS IV organizational structure, conflicts of interest and rules of conduct  264

7.2. Roles and responsibilities within the organizational structure  272

7.2.1. The evolving role of the depositary  274

7.3. Reporting matrix – how parties interact for reporting  275

7.4. UCITS IV organizational framework – applying best practice  278

7.4.1. Driving best practice  278

7.4.2. MiFID-like requirements  279

7.4.3. Typical UCITS IV structure  279

7.5. Conclusion  283

Chapter 8. UCITS Taxation  285

Andre PESCH

8.1. Introduction  285

8.1.1. The contractual form: the Fonds Commun de Placement  286

8.1.2. The corporate form: investment company with variable or fixed share capital  286

8.2. Taxation of the fund  287

8.2.1. Corporate income and net worth tax  287

8.2.2. Registration duty  288

8.2.3. Annual subscription tax  288

8.2.4. Tax on dissolution  290

8.2.5. Indirect taxation  290

8.3. Taxation of investments made by UCIs  295

8.4. Taxation at the level of the UCI investor  297

8.4.1. Withholding tax  297

8.4.2. Luxembourg individual investor  298

8.4.3. Foreign investors  298

8.4.4. EU Savings Directive  298

8.4.5. Directors’ fees  301

8.5. Management and advisory companies  301

8.5.1. Corporate taxation  301

8.5.2. Indirect taxation  302

8.6. Impact of UCITS IV  305

8.6.1. General considerations  305

8.6.2. Additional queries and open points from a VAT point of view  307

Chapter 9. Alternative UCITS  311

Christian SZYLAR

9.1. Introduction  311

9.2. The main drivers for packaging hedge fund strategies under UCITS  314

9.3. Alternative strategies under UCITS and challenges  317

9.3.1. What is an alternative UCITS?  317

9.4. The cost of liquidity on alternative UCITS returns  324

9.5. Financial derivative instruments  334

9.5.1. Swap  334

9.5.2. Contracts for difference  343

9.5.3. The forward contract  345

9.5.4. The futures contract  345

9.5.5. Options  347

9.5.6. Warrant  349

9.6. Conclusion  350

Bibliography  353

List of Authors  355

Index   357

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