The European Securities and Markets Authority (ESMA) has published a Q&A document entitled “Risk measurement and calculation of global exposure and counterparty risk for UCITS”. The document attempts to promote common supervisory approaches and provide clarity to managers and other stakeholders on how the UCITS IV Directive is interpreted. While much of the text reflects the approach being taken by regulators and managers alike, there are some interesting nuggets which managers should consider further and review their own trade compliance procedures. For example:
UCITS using VaR should disclose the expected level of leverage and the possibility of higher leverage levels in the prospectus. Q&A 2a confirms, in what admittedly has become practice, that the required disclosure of leverage should be calculated as the sum of the notionals of the derivatives used, that is the required leverage disclosures cannot be made on a net basis. This method may result in some funds having large leverage percentages disclosed in their prospectus even though the actual leverage could be minimal due to netting/hedging arrangements. This appears to reinforce ESMA’s concern over the extensive use of derivatives in a UCITS portfolio. One solution would be to add the commitment approach leverage at the same time in order to reduce the negative marketing impact of the sum of notionals, as stated in Q&A 2b.
Furthermore, Q&A 3 clarifies that any exposure taken to assets referred to in article 54 (permitted assets that a UCITS may invest up to 100% of NAV), must include exposures through derivatives and EPM (for example, reinvestment of cash collateral) when calculating the 100% limit. We expect that a number of automatic systems in place today would not include these indirect exposures and therefore will need to be amended.
