New UCITS rules on VaR will hurt investors, damage brand, says EM Applications

June 2, 2010 - PRLog -- At a time of high market volatility , the latest consultation by the Committee of European Securities Regulators (CESR) , which closed on 31st May 2010, would allow  UCITS funds to be twice as risky as the riskiest equity markets. This poses significant risks for investors and could severely damage the reputation of UCITS funds, a globally trusted regime. Furthermore, the range of Value at Risk (VaR) calculated during a year will be at odds with the risk figure published in the “Key Information Document”. In a period when many investors are relying on UCITS funds as a safe investment choice, this is confusing and misleading.

Following the Credit Crunch CESR has been reviewing the rulebook on the use of VaR for UCITS funds.  Its latest consultation2 proposes to let funds use a “Relative VaR” measure with a maximum ratio of two. This means a UCITS fund would be permitted to have twice the risk of, e.g., a technology or emerging markets index. Think of the losses made by some technology funds in 2000-2003, double them, and it’s hard to believe that this is deemed suitable for the investing public.  Ironically, investor protection is a key purpose of the UCITS rules and they have, over the years, become a trusted standard not just in Europe but around the world, leading many investors to consider a UCITS-branded fund a safe choice.  

In recent weeks even mainstream developed market indices have seen daily moves of the order of five per cent, implying a UCITS fund with a relative VaR of two would be changing in value by as much as 10 per cent in one day.  Clearly, a fund where the investor could lose 10 per cent of their capital in one day is not a safe investment. Allowing very high risk funds to operate under the UCITS cover has the potential to undermine investors’ trust in UCITS funds, leading to a reduction in overall investment levels and widespread economic damage.

The forthcoming UCITS IV “Key Information Document” (KID) is designed, i.a., to facilitate investors’ understanding of the risk of different funds. It will include a single number between 1 and 6 to indicate a UCITS fund’s risk level. However, the risk will be measured over the past five years and will not consider current market conditions or the current make-up of the UCITS investment portfolio.  Consequently, the KID’s risk indication will be very different from the VaR measure, which is calculated to estimate the risk over the next month and takes the current investment portfolio into account. As managers must report the highest and the lowest VaR in the funds’ annual reports, investors will notice that their fund’s actual risk is quite different to that set out in the KID. This will confuse investors and further undermine their confidence in the reliability of UCITS.

EM Applications, a leading supplier of investment risk solutions to asset managers and securities firms, is critical of CESR’s proposals.  The firm compares the situation with one where the EU might be trying to reduce road accidents but is doing so by limiting the number of gears in a car, banning fourth and fifth gear, but not limiting the speed (revolutions per minute) of the engine. The only effect of this would be to make cars less efficient, burning more fuel and wearing out engines faster, without any impact on speed - the factor that contributes to accidents, as drivers can simply push their engines harder.  What’s more, in communicating how fast a car can go, the maximum speed of another, older model of car, is published. Clearly, if it is speed that contributes to risk then it is speed (VaR) that should be regulated, not gearing (Relative VaR). What investors need to know is how fast the car can go (VaR limit), not how fast an older model could go (KID risk indicator).

Peter Ainsworth, Managing Director of EM Applications, said: “Controlling risk and communicating the magnitude of potential losses to investors are crucial for the future success of the UCITS brand. If the rules allow a fund to be twice as risky as a high risk index, it is certain that somebody will launch such a fund. It is equally certain that, at some point, investors will suffer catastrophic losses. Combined with different risk measures being used by the manager and communicated to the investor, it’s a recipe for letting investors down and damaging the reputation of the UCITS brand.”

- Ends -

Contacts
For further information or interview requests, please contact:

•   Andrea Krug, tel. 07740 245 867, emapplications@krugcomms.com or
•   Peter Ainsworth, Managing Director, EM Applications Ltd, peter.ainsworth@emapplications.com.


Notes to Editors
Undertakings for Collective Investment in Transferable Securities (UCITS) are a set of European Union directives that aim to allow collective investment schemes to operate freely throughout the EU on the basis of a single authorisation from one member state. The original directive, known as UCITS I, restricted investment largely to “transferable securities” (equities and bonds). The revised Directive, known as “UCITS III”, effective from 2006, also allowed significant investments to be made in derivatives.

About EM Applications
EM Applications (www.emapplications.com) is a leading supplier of investment risk solutions to asset managers and securities firms. Asset managers rely on EM Applications’ systems to monitor and operate long-only, long-short, hedge and fund of funds strategies. Securities firms use EM Applications’ systems in proprietary trading and derivatives and to support the services they deliver to their clients. By delivering portfolio risk analytics to the fund manager’s desk in the form of a dynamic Excel workbook, EMA’s risk system is uniquely well suited to helping asset managers fully integrate risk analysis into their investment process.

# # #

EM Applications is a leading supplier of investment risk solutions to asset managers and securities firms.