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1 DEPARTMENT Prudential Supervision of Collective Investment Undertakings GZ FMA-IF /0198-INV/2012 (To be quoted in further correspondence) EXPERT Robert Hellwagner PHONE (+43-1) FAX (+43-1) VIENNA, October 30th 2012 FMA comments on the consultation document on Undertakings for Collective Investment in Transferable Securities (UCITS) Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-term Investments General Comments The Austrian FMA welcomes the current consultation on Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-Term Investments for Undertakings for Collective Investment in Transferable Securities. Effective regulation should be resilient in times of crisis, should allow innovation and should address issues of market failures including the protection of retail and professional investors. Unfortunately, despite the good intention, the UCITS III framework (including the accompanying Directive on Eligible Assets (2007/16/EC)) introduced unintended complexity and regulatory ambiguities (e.g. to allow indirect investments in non-eligible assets by adding additional counterparty risk in the case of Structured Products ). This complexity leads to products with unpredictable risk/return-profiles which are not suitable for retail investors, and most probably not even for professional investors. Therefore, the Austrian FMA believes that the ultimate goal concerning the next revision of the UCITS framework should be the removal and avoidance of complexity, the introduction of clear rules for eligible assets and the reconsideration of the Derivatives rules. The following general remarks address these issues in more detail. 1. From the Austrian Financial Markets Authority s point of view, there is definitely a need to review the provisions on derivatives. A priority is that the economic aspect of derivatives should be the focus of regulation and no longer the legal form ( function over form -approach).

2 Since the legal formal definition of the use of derivatives failed to protect investors from complexity, it is necessary to find less complex ways in defining which derivatives are eligible and which are not eligible. We believe that this could be achieved by analyzing the pay off profile of derivatives. Referring to the Swiss Derivative Map 1, derivatives and structured products are described in terms of payoff profiles i.e. how profits and losses are attained (see diagrams below). The decision concerning which pay-off-profile may be eligible could be based on the assumption which pay-off-profile might be conceivable and thereby be understood by retail investors. For instance, the Austrian FMA considers the first two examples as eligible whereas the latter two examples (complex pay-off profiles) would not be eligible. It should be of no relevance whether the name or the structure of a derivative are highly sophisticated or not, as long the payoff profile is clear and bears no uncertainties. The advantage of this approach is that (i) the economic aspect is the focus of regulation, (ii) innovation is not restrained (as long as the pay-off-profile is considered to be eligible) and (iii) 1 2/5

3 there is avoidance of regulatory arbitrage by simply using a different legal form (e.g. shifting from swaps to futures even that both instruments have almost the same economic profile). 2. The Austrian FMA believes that the formal/legal approach for defining the scope of eligible assets has opened too much room for regulatory arbitrage and introduction of unintended complexity for investments. Therefore, the objective should be the move from the form over function approach to the function over form-approach. This means (i) the introduction of the important principle that investments that are not eligible at the first layer cannot be made eligible by adding additional complexity with legal wrappers such as Closed-Ended Funds, Structured Products and Financial indices, (ii) the removal of so-called Efficient portfolio techniques, which in fact are nothing more than another form of eligible assets, (iii) the circumvention of eligible asset rules by the use of derivatives as substitutes. 3. The financial crisis has shown that the risk measurement approach of the Value-at-Risk needs to be reconsidered, especially as an indicator of leverage and in connection with the UCITS framework. We believe that the commitment approach is sufficient. This would also limit the use of complex derivatives and would make sure that the leverage is limited to the total net value of the UCITS portfolio. Please also refer to our specific remarks in the corresponding sections below. 2. ELIGIBLE ASSETS Box 1 (1) Do you consider there is a need to review the scope of assets and exposures that are deemed eligible for a UCITS fund? Yes, we believe the scope of assets has to be reviewed in order to reduce complexity. (2) Do you consider that all investment strategies current observed in the marketplace are in line with what investors expect of a product regulated by UCITS? No, we believe that there are investment strategies available in the marketplace, which are NOT in line with what investors expect from a product regulated by UCITS, e.g. hedge fund strategies wrapped in financial indices, complex structured products like Delta-One-Certificates or complex derivatives strategies. (3) Do you consider there is a need to further develop rules on the liquidity of eligible assets? What kind of rules could be envisaged? Please evaluate possible consequences for all stakeholders involved. Yes, in addition to our general remarks, we believe that the requirement of a regulated market listing should NOT be considered anymore as a substitute for liquidity, e.g. there are a lot of eligible assets which are listed that have no liquidity at all. 3/5

4 (4) What is the current market practice regarding the exposure to non-eligible assets? What is the estimated percentage of UCITS exposed to non-eligible assets and what is the average proportion of these assets in such a UCITS' portfolio? Please describe the strategies used to gain exposure to non-eligible assets and the non-eligible assets involved. If you are an asset manager, please provide also information specific to your business. We believe that the rule should be reconsidered that direct investments in assets like commodities are forbidden while on the other hand their investment is allowed and possible in structures like Financial Indices or Closed-Ended Funds (thereby adding additional counterparty and issuer risk). (5) Do you consider there is a need to further refine rules on exposure to non-eligible assets? What would be the consequences of the following measures for all stakeholders involved: We believe that a refinement is not necessary but propose a complete overhaul of the current approach to non-eligible assets. We support the below mentioned two remarks. - Preventing exposure to certain non-eligible assets (e.g. by adopting a "look through" approach for transferable securities, investments in financial indices, or closed ended funds). - Defining specific exposure limits and risk spreading rules (e.g. diversification) at the level of the underlying assets. (6) Do you see merit in distinguishing or limiting the scope of eligible derivatives based on the payoff of the derivative (e.g. plain vanilla vs. exotic derivatives)? If yes, what would be the consequences of introducing such a distinction? Do you see a need for other distinctions? Yes, please see our general remark above. (7) Do you consider that market risk is a consistent indicator of global exposure relating to derivative instruments? Which type of strategy employs VaR as a measure for global exposure? What is the proportion of funds using VaR to measure global exposure? What would be the consequence for different stakeholders of using only leverage (commitment method) as a measure of global exposure? If you are an asset manager, please provide also information specific to your business. Yes, please see our general remark above (8) Do you consider that the use of derivatives should be limited to instruments that are traded or would be required to be traded on multilateral platforms in accordance with the legislative proposal on MiFIR? What would be the consequences for different stakeholders of introducing such an obligation? This approach could be a reasonable one in order to mitigate systemic risks. 3. EFFICIENT PORTFOLIO MANAGEMENT (EPM) 4/5

5 Please see our general remarks. Furthermore we would like to stress that at least the provisions of the ESMA Guidelines on ETF and other structured products should be included in a revision of the UCITS framework. 4. OTC DERIVATIVES We support the conclusions of the European Commission. 5. EXTRAORDINARY LIQUIDITY MANAGEMENT TOOLS We believe a strengthening of the liquidity requirements of eligible assets would benefit the liquidity of the UCITS as well. The mentioned liquidity management tools may only cure the symptom but not the cause of the explained liquidity issues. 6. DEPOSITARY PASSPORT We believe that the introduction of a depositary passport should be delayed, at least until more experience is being made with the Management Company Passport. Furthermore, the introduction seems to be premature in terms of investor protection. 7. MONEY MARKET FUNDS We believe that the CESR Guidelines on a Definition of Money Market Funds should be included in a revision of the UCITS framework. 8. LONG-TERM INVESTMENTS We believe that the introduction of investments in EuSEF should be delayed, at least until more experience is being made with this vehicle. Furthermore, the introduction of EuSEFs seems to be premature in terms of investor protection. 9. UCITS IV IMPROVEMENTS We support the conclusions of the European Commission. Financial Market Authority On behalf of the Executive Board MR Mag. Andrea Mörtl Mag. Robert Hellwagner signed electron ically 5/5