VaR Limit Clarification

Author:Mr Stephen Carty
Profession:Dillon Eustace


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 –

Sophisticated UCITS

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...

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