Ucits' use of derivative instruments

Author: | Published: 1 Jul 2005
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On April 5 2005, the Commission de Surveillance du Secteur Financier (CSSF) published Circular 05/176 establishing, for the benefit of undertakings for collective investment in transferable securities (Ucits), the lines of conduct for using financial derivative instruments. This Circular implements in Luxembourg the principles of Recommendation 2004/383/EC of the Commission of April 27 2004 on the use of financial derivative instruments for Ucits.

The Circular provides guidelines for risk-assessment methods adapted to the specific nature of derivative financial instruments in which a Ucits may invest in compliance with the Law of December 20 2002, as amended (the 2002 Law).

The 2002 Law provides that a Ucits must ensure that its global exposure relating to derivative instruments does not exceed the total net value of its portfolio. The global exposure must be calculated taking into account not only the current value of the underlying assets, but also the counterparty risk, future foreseeable market movements and the time available to liquidate the positions.

The Circular clarifies the measurement methodologies to be applied to the assessment of market risk, the assessment of leverage, the counterparty risk, the issuer risk, the use of financial indices, and the use of adapted cover rules in transactions both with listed and over-the-counter derivatives.

However, the Circular and the EC Recommendation differ on several points.

The Circular has not adopted the Recommendation's definition of sophisticated and non-sophisticated Ucits. The Circular has added the possibility of netting in the calculation of the market risk of a non-sophisticated Ucits in compliance with the commitment approach.

As far as the assessment of leverage is concerned, the Circular, in compliance with the Recommendation, has recommended the use of the value at risk (VaR) approaches and stress tests, in the case of sophisticated Ucits. However, unlike the Recommendation, the Circular does not contain the recommendation that the VaR/stress test value be compared with the VaR/stress test value of an adequate benchmark or reference portfolio.

Lastly, the Circular has also added some clarifications on the conditions to be met for the reduction of the counterparty risk by posting collateral, as well as on the idea of company groups for the calculation of counterparty risk.