The UCITS III Directive which entered into force in 2004 allowed UCITS fund managers to invest in a much wider range of eligible assets and to pursue new types of investment strategies. A survey that we conducted in 2007 on behalf of the European Commission showed a higher degree of sophistication both in terms of the types of derivatives used and in terms of quantity.
UCITS III has contributed to dramatic changes in portfolio composition and risk management processes. When it comes to the latter, some strong tools were already in place, but they had to adapt to more complex products and still have to face now a strong demand for financial innovation.
Challenges
The introduction of wider investment powers could lead to additional risks for retail investors, which in turn need to be assessed and evaluated. Practically, our survey showed that the increase in the use of derivatives does not result in more leverage or higher volatility. Ratios like volatility and historical VaR are only indicators of the market risk associated with an investment, and while market risk is a key risk for investors, there are also some other risks that need to be considered, e.g. leverage, valuation, liquidity risks or counterparty risks.
The latter is especially significant when it comes to the use of OTC derivatives, which is expected to grow as it allows more flexibility in terms of product structuring. The evaluation difficulties of OTC derivatives and new fund products are the major reason for the launch of a new product to collapse due to rejection of the product.
From a tax and regulatory perspective, a continuous increase of the use of sophisticated UCITS can be expected, as further regulatory clarification is ongoing.
PwC Solutions
- Regulatory, tax and operational advice in the structuring and setting-up of management companies and fund products, local and cross-border outsourcing and fund mergers;
- UcitsEuroFile™ - the pan-European tax and regulatory fund reporting service;
- UCITS III transition advisory services;
- OTC valuation and VaR calculation advisory;
- AML / KYC processes and systems review;
- Investment Compliance review, training and advice;
- Statutory audits and long form reports;
- SAS 70 on investment management, fund administration and custody operations;
- AIMR-GIPS certification;
- Fund accounting, transfer agency, compliance and AML systems selection and implementation;
- Fund administration, custody and compliance processes optimization;
- Benchmarking and cost optimization;
- Financial risk management;
- Market & regulatory research.
