EDHEC-Risk Institute proposes limits to non-financial risk to secure Ucits label

EDHEC-Risk Institute, together with Caceis Investor Services, has put forward a series of proposals to limit risks that it says undermined the Ucits label during the 2007-8 financial crisis.

Following three years of research, EDHEC-Risk Institute has concluded that Ucits works against itself in terms of non-financial risks.

“These risks are not the direct result of positions taken by funds on financial markets and for which they receive a reward proportional to their exposure, but rather produced by the operation of the value chain of the collective investment management industry itself,” it said.

It adds that the research findings suggest other regulation – AIFMD, Ucits V, MiFID II, IMD II, Prips, Emir – do not solve the problem of non-financial risk, even where they set out to improve investor protection.

“On the contrary, such security-related discourse pushing for restitution of assets guaranteed by the depositary, which in reality would only relate to a portion of these assets, would give less sophisticated investors, particularly retail investors, a false sense of security, thus leading them to select their funds without taking into account any of the associated non-financial risks.”

“On the other hand, the emphasis put on the depositary’s obligation to return assets (AIFMD and Ucits V) does not directly encourage other stakeholders in the value chain to contribute to the improvement of information and to manage non-financial risks better.”

EDHEC-Risk makes the following recommendations as a result of its research:

Reinforcement of information on non-financial risks. The Key Investor Information Document (KIID) to contain a description of gross risk exposure and how to manage these risks, as well as a synthetic indicator of the fund’s net risks. In the same vein, the duty to advise, as prescribed within MiFID, would be reinforced with respect to non-financial risks.

Increase the responsibility of all actors within the fund management industry. This breaks with the idea that depositaries can protect investors from all non-financial risks, which are often taken by fund managers. It will lead to the creation of incentives to better manage non-financial risks by associating the level of required regulatory capital with the level of residual non-financial risk taken by the major players in the value chain.

Create a new label of “Restricted Ucits”. This would establish a Ucits category with a scope for investment that is limited to what the depositary can actually hold and thus return without difficulty, thereby ensuring that the depositary would be able to benefit from a total guarantee. This “Restricted Ucits” label would allow Ucits funds, which would rightly benefit from a secure image, to be marketed not only to European retail clients, but also on a global platform.

A full description of the problems and the solutions proposed can be found here: EDHEC-Risk Publication Better Management of Non-Financial Risks


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