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EDHEC-Risk Institute Puts Forward a Series of Proposals to Limit Non-Financial Risks in the European Fund Management Industry
In a summary document that concludes three years of research on better management of non-financial risks within the European fund management industry – conducted with the support of CACEIS – EDHEC-Risk Institute is putting forward a series of proposals to limit these risks which emerged during the 2007-2008 crisis and undermined the quality of the UCITS label.
For EDHEC-Risk Institute, the sophistication of UCITS is one of the principal causes of a rise in 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.
This analysis also leads to the conclusion that current regulation (AIFMD, UCITS V, MiFID II, IMD II, PRIPS and EMIR), even if it does contain some very positive elements in terms of investor protection against non-financial risks, will not really solve the problem. 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.
In order to deal with this, and add a new dynamic to the UCITS label, EDHEC-Risk Institute recommends the implementation of regulation and promotion of better practices with regard to non-financial risk. These proposals can be categorised into three major themes.
The first recommendation relates to the reinforcement of information on non-financial risks, particularly with a requirement for 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.
The second recommendation aims to increase the responsibility of all actors within the fund management industry. This new system of shared responsibility 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. In this perspective, EDHEC-Risk Institute does not favour the idea of extending the Investor Compensation Scheme Directive (ICSD) to UCITS: its excessive cost and failure to effectively take risks into account lead, at best, to a lack of accountability among actors and, at worst, to opportunistic risk-taking (moral hazard).
Lastly, with what is probably the flagship proposal of this study, EDHEC-Risk Institute recommends that as a reaction to the sophistication of UCITS, made possible by the evolution in regulations (UCITS III, EAD) and exploited to the absolute limit by NewCITS, a level of sophistication which potentially exposes investors to greater non-financial risks, a new label of “Restricted UCITS” be created. 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.
EDHEC-Risk Institute is located at campuses in Singapore, which was established at the invitation of the Monetary Authority of Singapore (MAS); the City of London in the United Kingdom; Nice and Paris in France; and New York in the United States. The philosophy of the institute is to validate its work by publication in prestigious academic journals, but also to make it available to professionals and to participate in industry debate through its Position Papers, published studies and conferences. Each year, EDHEC-Risk organises three conferences for professionals in order to present the results of its research, one in London (EDHEC-Risk Days Europe), one in Singapore (EDHEC-Risk Days Asia), and one in New York (EDHEC-Risk Days North America) attracting more than 2,500 professional delegates.
To ensure the distribution of its research to the industry, EDHEC-Risk also provides professionals with access to its website, www.edhec-risk.com, which is entirely devoted to international risk and asset management research. The website, which has more than 58,000 regular visitors, is aimed at professionals who wish to benefit from EDHEC-Risk’s analysis and expertise in the area of applied portfolio management research. Its monthly newsletter is distributed to more than 1.5 million readers.
EDHEC-Risk Institute also has highly significant executive education activities for professionals. In partnership with CFA Institute, it has developed advanced seminars based on its research which are available to CFA charterholders and have been taking place since 2008 in New York, Singapore and London. EDHEC-Risk Institute has an original PhD in Finance programme which, in addition to its highly selective residential track for young talents worldwide, has an executive track for high level professionals who already have master’s degrees from prestigious universities and significant industry experience. These professionals are looking to go beyond their usual activities in order to develop research on the concepts that are relevant to their occupation. Complementing the core faculty, this unique PhD in Finance programme has highly prestigious affiliate faculty from universities such as Princeton, Wharton, Oxford, Chicago and CalTech.
In 2012, EDHEC-Risk Institute signed two strategic partnership agreements with the Operations Research and Financial Engineering department of Princeton University to set up a joint research programme in the area of risk and investment management, and with Yale School of Management to set up joint certified executive training courses in North America and Europe in the area of investment management.
Building on its experience in the area of beta analysis and creation, EDHEC-Risk Institute has also created ERI Scientific Beta, which aims to be the leading provider of advanced beta for the investment industry. This initiative is based on all of the research conducted by EDHEC in the area of indices and benchmarks.