A new study conducted by EDHEC-Risk Institute as part of the ‘Risk and Regulation in the European Fund Management Industry’ research chair in partnership with CACEIS, looks at how non-financial risks and failures have impacted the regulatory agenda in Europe. The report, entitled ‘The European Fund Management Industry Needs a Better Grasp of Non-financial Risks’, traces the management of liquidity, counterparty, compliance, misinformation, and other non-financial risks in the fund industry.
By identifying the distribution of risks and responsibilities in the industry, the authors, Noël Amenc, director, EDHEC-Risk Institute, and Samuel Sender, applied research manager, EDHEC-Risk Institute, examine how convergence between country regulations could be achieved. They also assess how fund unit-holders can best be protected with appropriate regulations, improved risk management practices, and greater transparency.
The study includes a series of observations and recommendations:
- The fund management industry as a whole has paid insufficient attention to non-financial risks and has failed to measure the operational consequences of financial innovation.
- The UCITS directive itself fails to make adequate allowances for the operational consequences of financial innovation. Although investment funds have diversified internationally, made growing use of derivatives and other sophisticated strategies, and evolved in other ways, and although EU regulations and recommendations have recognised or even favoured these changes, they have failed to do studies on their impact and have failed to modify regulation accordingly.
- The determination to harmonise the depositary liability regime that has not yet been fully transposed into regulation should not mask the need to manage non-financial risks throughout the fund management industry.
- Strengthening of capital requirements and improvement of information should be linked to the evaluation of non-financial risks.
- Improved governance and greater involvement of unit-holders would make it possible for fund management firms to improve the ways they take non-financial risks into account.
- Better regulation should lead to improved methods of managing such non-financial risks as counterparty risk, liquidity risk, or sub-custody risk.
- Homogenisation of country regulations and of supervisory cultures is necessary to prevent regulatory arbitrage.
- UCITS not exposed to non-financial risks should be distinguished from more modern UCITS that have potentially greater exposure to these risks.