On 29th October, 2008, the Financial Regulator published a short
paper1 and revised Guidance Note 3/03 providing for a
clarification of the limits to be applied by a UCITS when
calculating global exposure using the absolute Value at Risk
methodology (absolute VAR).
VaR Limit Clarification
The Paper describes the change as a technical clarification
which allows flexibility in the quantitative parameters used to
measure risk while ensuring that existing limits are not
Revision to Guidance Notes 3/03
Guidance Note 3/03 - Purpose
A Commission Recommendation on the use of derivatives by UCITS
(the "Commission Recommendation")2 was issued
in 2004 requiring competent authorities in Member States to
implement risk management guidelines in line with standards
indicated in the Commission Recommendation in order to ensure
investor protection. In light of this, Guidance Note 3/03 was
issued by the Financial Regulator outlining the parameters for the
use of derivatives by UCITS and providing guidance on the
measurement and control of derivative associated risk by UCITS.
Guidance Note 3/03 contains detailed requirements regarding:
the format and content of the Risk Management Process;
the options for measuring and controlling risk exposure;
requirements and limits on position exposure; counterparty
exposure; and counterparty restrictions.
Measurement of Global Exposure and Leverage –
A sophisticated UCITS fund is required to use an advanced risk
measurement methodology to measure global exposure. The Financial
Regulator recommends the use of the Value-at- Risk (VaR) method and
requires that the VaR model employed by the UCITS meets certain
quantitative and qualitative criteria.
VaR may be calculated using an acceptable proprietary or
commercially available model. Absolute VaR or Relative VaR may be
applied. Absolute VaR is the VaR of the fund capped as a percentage
of net asset value. The changes to the Guidance Note relate to the
parameters for the use of absolute VaR and are considered in detail
below. Relative VaR is the VaR of the fund divided by the VaR of a
benchmark or a comparable, derivatives-free portfolio. Under
Relative VaR, VaR is limited to twice the VaR on the benchmark or
comparable, derivatives-free portfolio.
Changes to Parameters for Absolute VaR
Guidance Note 3/03 now applies a general limit (that may be
raised only in exceptional cases) for absolute VaR of 20% of net
asset value. This...