On 19 April 2010, the Committee of European Securities Regulators (CESR) published its consultation on guidelines on risk measurement and the calculation of global exposure and counterparty risk for UCITS.
The consultation sets out proposed Level 3 guidelines to accompany the Level 2 implementing measures for the UCITS IV Directive (2009/65/EC). CESR has suggested that level 2 measures and Level 3 guidelines on this issue should be adopted as a single package by 1 July 2010.
The key purpose of these guidelines is to provide stakeholders with detailed methodologies and so to harmonise the approach of Member States to risk measurement and the calculation of global exposure and counterparty risk for UCITS. The proposed guidelines set out:
- Detailed methodologies to be followed by UCITS when they use the commitment approach or the VaR approach for the calculation of the global exposure. The paper repeatedly stresses that the calculation of the global exposure represents only one element of the UCITS' overall risk management process and that it is the responsibility of the UCITS to select an appropriate methodology to calculate the global exposure (it appears that funds will no longer have to categorise themselves as sophisticated or non sophisticated). UCITS will be required to disclose which methodology is used to calculate global exposure. The use of VaR will remain an option as well as the commitment approach and there is also scope for the use of other approaches.
- For the commitment approach, CESR sets out proposed guidelines for the conversion of financial derivatives into the equivalent position in the underlying assets of those derivatives; the methodologies for netting and hedging arrangements and the principles to be followed when calculating global exposure; and how to calculate global exposure when using EPM.
- Under the commitment approach, CESR requests views on two proposed methodologies to deal with interest rate related financial derivatives that only expose the UCITS to general interest rate risk. The two methodologies are based on sensitivity. In the context of the commitment approach, CESR also sets out its approach on structured UCITS.
- For the VaR approach CESR sets out proposed guidelines on the principles to be applied for the choice between Relative and Absolute VaR, the criteria to be used in the selection of the reference portfolio for use in the Relative VaR calculation, the methodology for the computation of the global exposure when using Relative and Absolute VaR together with quantitative and qualitative requirements to be followed; and additional safeguards which the UCITS should adopt when calculating the global exposure using VaR.
- The proposed guidelines set out high-level principles relating to assets used as collateral to reduce counterparty risk.
- The proposed guidelines also set out Cover rules for transactions in financial derivative instruments.
- The consultation will close on 31 May 2010. The revised UCITS Directive must be implemented by Member States by 1 July 2011. CESR has emphasised that it believes that the Level 2 measures and the Level 3 guidelines should be adopted as a single package by 1 July 2010.