On 9 July 2012 ESMA issued a question and answers document1 in relation to its risk measurement guidelines for UCITS2. The Q&A document is intended to address the divergent approaches which had developed across the EU on particular issues and seeks to ensure that a common supervisory approach and common practices are followed throughout the EU. In response to the issue of the ESMA Q&A the Central Bank has issued a letter to the Irish funds industry addressing its requirements where leverage is used by UCITS. The purpose of this client briefing is to explain the Central Bank's requirements on the calculation of leverage and the disclosure required in a UCITS prospectus relating to leverage.
Gross Notional Leverage
The ESMA Q&A states that for any UCITS using Value at Risk ("VaR") to calculate global exposure the leverage disclosed by that UCITS must be calculated as the sum of the notionals of the derivatives used. Leverage must not be calculated on a net basis (i.e., leverage calculated after any netting/hedging arrangements are taken into account). This leverage figure (based on the sum of the notionals) can be supplemented by also disclosing the leverage calculated on the basis of the commitment approach. However, the commitment approach cannot be used as an alternative to the sum of the notionals figure.
Whilst it is acknowledged that there are limitations on the use of the sum of the notionals as a measure of the risk profile of a UCITS, this clarification of the disclosure requirement is welcome if for no other reason than it should ensure that a consistent approach is now taken by regulators across the EU.
Minimum Subscription Amount
For UCITS funds established since July 2011 with leverage limits in excess of 500% the Central Bank has generally imposed both a minimum subscription requirement and a restriction on the limit of leverage employed by the fund. The application of this policy by the Central Bank presented various practical issues for a number of promoters who employed significant leverage in their UCITS. However, as a consequence of the publication of the ESMA Q&A the Central Bank has agreed that it will no longer impose a minimum subscription requirement or limit the level of leverage employed by Irish authorised UCITS.
For those UCITS which had included a minimum subscription amount in their prospectus and a limit on the level of leverage to be used by the fund amendments to the prospectus deleting these requirements will be required if they wish to avail of the new rules.
It is also worth noting that the Central Bank had required those UCITS whose global exposure may be in excess of 500% based on the sum of the notionals to report the actual levels of leverage in a written report to the Central Bank on a six monthly basis. The Central Bank has confirmed that it will no longer require this six monthly report from these UCITS.
The clarification of the way in which the leverage is to be calculated in the ESMA Q&A provides the certainty the funds industry needed to ensure that all UCITS using VaR, irrespective of domicile, calculate and disclose the leverage figure in the same way. The decision by the Central Bank to dispense with the minimum subscription requirement and limit on the level of leverage employed by an Irish authorised UCITS is also a welcome change.
1 2012/ESMA 429
2 CESR/10/788 - Guidelines on Risk Measurement and Calculation of Global Exposure and Counterparty Risk for UCITS.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.