UBS AG - European...

UBS AG P.O. Box 8098 Zürich Public Policy EMEA Group Governmental Affairs Dr. Gabriele C. Holstein Bahnhofstrasse 45 P.O. Box 8098 Zürich Tel. +41-44-234 44 86 Fax +41-44-234 32 45 [email protected] www.ubs.com

DG Markt European Commission Rue de spa 2 1000 Bruxelles

18 October 2012

Re: European Commission consultation document on ‘Undertakings for Collective Investment in Transferable Securities (UCITS) – Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-term Investments’

Dear Sir/Madam,

UBS would like to thank the European Commission for the opportunity to comment on the consultation document on ‘Undertakings for Collective Investment in Transferable Securities (UCITS) - Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-term Investments’. Please find attached our response to the Paper. We would be happy to discuss with you, in further detail, any comments you may have. Please do not hesitate to contact Gabriele Holstein on +41 44 234 4486.

Yours sincerely, UBS AG

Dr. Thomas Bischof Dr. Gabriele C. Holstein Head of Legislative & Regulatory Initiatives

Head of Public Policy EMEA Group Governmental Affairs

Response from UBS of 39

UBS Response to the European Commission consultation on Undertakings for

Collective Investment in Transferable Securities (UCITS)

Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-

term Investments

INTRODUCTION

UBS would like to thank the European Commission for the opportunity to comment on

its consultation paper on further regulation of UCITS. Please find below our high-level

comments as well as detailed responses to the specific questions posed in the

consultation.

As a general point, we consider it important to recognise that there has been a

significant amount of regulatory change impacting investment management in Europe

in recent years. In light of this, we believe it is important to have a period in which

further regulatory change is limited in order for recent changes to effectively bed-down.

For example, the recent UCITS IV requirements further enhanced the level of investor

protection offered by UCITS. Also, we consider that several of the issues covered in this

consultation, including in respect of transparency regarding counterparties,

collateralisation, type of collateral and securities lending revenues and costs, are already

appropriately addressed in the recently published ESMA “Guidelines on ETFs and other

UCITS issues”.

In relation to the question whether there is a need to review the UCITS requirements

regarding the scope of assets and exposures deemed eligible for a UCITS fund, we

highlight that, whilst the classification of eligible instruments does not cause any

problems, the lack of guidance as to how these assets could be used to implement

investment strategies leads to inconsistent interpretations across the EU. Therefore,

instead of reviewing the UCITS rules, we believe that the focus should be on ESMA

providing further guidance to ensure consistent interpretation of existing requirements.

We also note that, in our view, the most fundamental change that is required to ensure

the effective operation of UCITS is greater harmonisation of the tax framework at an EU

level.

ELIGIBLE ASSETS


The European Commission (EC) notes that, under the UCITS framework, UCITS funds

are required to invest in instruments that are sufficiently liquid. For this purpose, Article

50 of the UCITS Directive provides a list of eligible assets which comprises transferable

securities, money market instruments, units of collective investment schemes, bank

deposits and financial derivative instruments (FDI). It is also possible for a UCITS to gain

exposure to an index through the use of FDI provided that the index complies with a

defined set of criteria.

The UCITS Directive currently permits UCITS funds to gain exposure to non-eligible

assets in a number of ways. Derivative instruments may be used to gain exposure to

eligible assets as long as the global exposure relating to financial derivative instruments

does not exceed 100 percent of the total net value of the UCITS portfolio and complies

with the risk spreading rules. Currently the global exposure is measured by leverage

(commitment approach) or by the value at risk (VaR). However, VaR does not measure

leverage. Regarding the FDI itself, the manager is free to choose the most appropriate

structure, ranging from plain vanilla to exotic payoffs.

Box 1

Q1: Do you consider there is a need to review the scope of assets and

exposures that are deemed eligible for a UCITS fund?

The UCITS Directive provides a robust framework ensuring strong investor protection

which has only recently has been enhanced with the UCITS IV requirements. We hence

do not consider that there is a need to review the scope of assets and exposures

deemed eligible for a UCITS fund. But whilst the classification of eligible instruments

does not cause any problems, the lack of guidance as to how these assets could be used

to implement investment strategies leads to inconsistent interpretations across the EU.

Therefore, instead of reviewing the UCITS rules, we believe that the focus should be on

ESMA providing further guidance to ensure consistent interpretation of existing

requirements.

Q2: 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?


Expectations and needs of investors vary widely. We believe that it is important that the

UCITS framework remains flexible enough to allow a well-diversified product offering

while maintaining a high level of investor protection. Whether actual investment

strategies are aligned with expectations for a UCITS product are dependant on how

investment objectives and strategy as well as risks are communicated to investors. It is of

upmost importance that investors’ expectations are set in the right manner. Alongside

the prospectus and the annual report, the recently introduced KIIDs will ensure that this

communication takes place in a client-focused way i.e. ensuring that expectations are

aligned with the fund’s investment strategy.

Q3: 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.

Liquidity risk deals with the situation where “a fund cannot meet the redemption

payment or is able to do so but with such an investment deviation that it could generate

claims from investors”. It can also relate to the situation when “a transaction cannot be

conducted at quoted market price due to the size of the required trade relative to

normal trading lots”. A fund is required to assess and to manage liquidity risk (see e.g.

CESR 09-963 / Level 2).

Measures to mitigate liquidity risk include having liquidity buffers (cash, more highly

liquid instruments, credit lines) as well as other measures such as redemption fees /

limits, temporary suspension, swing pricing and side pockets. The difficulty of managing

liquidity risk is, however, that not all measures are equally applicable to all types of

funds and that pure quantitative models and rules are often unable to capture situations

in which liquidity dries up. The management of liquidity risk is hence a science, but to

some extent, also an art.

Where an additional set of quantitative rules / restrictions related to liquidity

management are defined, it bears the risk that liquidity management is no longer

considered holistically by the fund. Mechanistic rules – in particular when applied to all

types of funds – will not be able to ensure that liquidity needs will be met all times.

Instead of strengthening liquidity, such rules may instead weaken the liquidity

management of funds. Instead of developing additional rules on the liquidity of eligible

assets, the focus should be set on ensuring consistent interpretation and application of

existing requirements across the industry.


Q4: 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 do not have any information on the percentage of UCITS exposed to non-eligible

assets and on the average proportion of such assets in such a UCITS’ portfolio.

A UCITS may directly or indirectly gain exposure to non-eligible assets. Directly via the so

called ‘trash ratio’ or indirectly by investing into eligible assets (e.g. structured financial

instruments that qualify as a transferable security, derivatives on eligible indices, closed

end funds) with the performance of such instruments linked to the performance of

assets not eligible to be purchased directly by the UCITS.

Regulation sets a variety of requirements for such cases. As an example, when an index

follows certain diversification criteria, no “look-through” is required, which allows, for

example, a UCITS to build up exposure to certain commodity indices.

Typically, we see exposures being built up to asset classes like real estate, hedge funds /

fund-of-funds, commodities or private equity. In our view, this allows a UCITS to build

up a better diversified portfolio.

Q5: 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: (i) 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). (ii) Defining specific

exposure limits and risk spreading rules (e.g. diversification) at the level of the

underlying assets.

We are in general not supportive of preventing exposures to certain non-eligible assets.

The outlined “look through” approach is, in our view sub-optimal, for a number of

reasons.


First, we expect a “look through” approach to have a broad impact on the use of

financial indices, both in the case of eligible and non-eligible assets, by restricting the

use of a certain part of such indices.

Second, the approach is very difficult to operate in practice. It will require the

regrouping of non-eligible assets into eligible assets (that can be considered as

underlying) versus those which continue to be non-eligible assets (and still cannot be

considered as underlying). It is in our view difficult to make a comprehensive grouping

of all assets into these two categories. We would as an example, be unsure whether

“Infrastructure” should be considered a distinct asset class or a “Private Equity”

investment into infrastructure.

Third, a look though approach assumes that (only) assets which are eligible for direct

investment are eligible as an underlying. Thus, it would deem inconsistent to have assets

eligible as an underlying, but not allow the fund to directly invest into such assets. Thus,

under such an approach, we would argue the assets eligible as an underlying would also

have to be eligible for direct investment.

Compared with the first measure, we are more supportive of the second i.e. defining

specific exposure limits and risk spreading rules (e.g. diversification) at the level of the

underlying assets. We note that this is already the case for financial indices and could

also be applied for alternative wrappers.

Q6: 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?

We do not see any particular merit in distinguishing or limiting the scope of eligible

derivatives based on the payoff of the derivative. It is in our view more important to

consider the use of the derivative and the impact it has on the fund profile.

Should the EC nevertheless consider making such a distinction, we would emphasize

our view that any criteria for doing so would need to be well defined. Typically, a certain

payoff can be created by using or combining different instruments. As an example, to

get the payoff of a call option, a portfolio manager can buy/sell a call option or he can


combine cash, the underlying asset and a put option to receive an identical payoff.

Regulations preventing the portfolio manager to use call options would thus not restrict

him to get the pay-off of a call option (the regulatory intention), but he could rather

apply more complex and expensive techniques to get that pay-off. It is therefore

important to recognise that the complexity of a derivative is not the same as its risk and

a distinction based only on complexity may not be appropriate.

To distinguish plain vanilla derivatives and exotic derivatives, we would suggest to apply

criteria similar to those of the Swiss FINMA. According to the FINMA Ordinance on

Collective Investment Schemes, CISO-FINMA (951.312) an exotic derivative is defined as

a “derivative with a mode of operation that cannot be described as a basic form of

derivative or a combination of basic forms of derivatives” e.g. a path-dependent option,

option with several factors or option with contract modification. Plain-vanilla derivatives

would in particular be any combination of futures/forwards and options such as e.g.

swaps and swaptions.

Most UCITS use derivatives in some form; be it for the purpose of hedging or for the

purpose of efficient portfolio management. Typically, most instruments are “plain

vanilla” derivatives, with the exception of funds that run quite complex derivative

strategies. Any attempt to distinguish between, or limit the scope of, eligible derivatives

based on the payoff should ensure that the use of plain vanilla derivatives is not

restricted by any means.

Q7: 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.

We have no figures on the proportion of strategies which employ VaR as a measure for

global exposure, but believe the figure to be increasing.

Initially the VaR approach was used by funds with complex strategies in particular and

those hitting the limits defined by the commitment approach. Given that the

commitment approach is an over-simplifying approach to measure leverage / risk and


the VaR approach requires a manager to better understand the characteristics of the

portfolio giving a much more accurate picture on the actual risk / risk factors, we see

some trend towards the VaR approach. This is also supported by the fact that the SRRI

on the KIIDs, is in certain cases, also based on a VaR approach.

We do not agree that the leverage test (gross leverage or commitment approach) should

be the only available method to calculate global exposure. Such a limitation is likely to

put significant additional restrictions on the management of UCITS investment

strategies, potentially increasing both the risk of the strategy and the cost to the

investor. As an example, actively managing the currency risk of a portfolio often uses a

large portion of the allowed leverage. The commitment approach thus restricts such

currency risk management, which might have an adverse effect in terms of investor

protection by increasing the overall risk of the portfolio.

We thus strongly recommend that the VaR approach continues to be permitted as a

means of managing and restricting the risk of a UCITS portfolio. We also believe that

the VaR approach should be permitted to be used by a fund as the single measure of

global exposure and should not have to be used in conjunction with other measures.

Q8: 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?

We do not agree that derivatives should be limited to instruments that are traded or

would be traded on multilateral platforms. Currently multilateral platforms only cover a

limited range of derivatives in a broad and efficient manner. A requirement to have all

derivatives to be traded on such platform would have strong negative implication for

many strategies (e.g. in high yield or emerging market debt funds) by limiting the ability

of UCITS to manage the market risk of their portfolios. Furthermore FX forwards are not

exchange traded. If UCITS were limited to using only derivatives traded on multilateral

platforms, they would be significantly restricted in their ability to hedge currency risk. It

should also be noted that EMIR introduces reporting requirements for derivatives that

should materially increase the transparency of the derivatives market. Furthermore, EMIR

introduces risk mitigation requirements for non-cleared OTC derivatives including with

regard to margin (non-cleared derivatives would not be required to be traded on a


trading venue under MiFIR). These requirements should significantly enhance the

robustness of the market for derivatives not traded on trading venues.

EFFICIENT PORTFOLIO MANAGEMENT (EPM)

The EC highlights that, according to the UCITS Directive, Member States are

empowered to authorise UCITS to employ certain techniques and instruments for the

purpose of EPM subject to conditions laid down by Member States. EPM techniques

may for example include securities lending and repurchase agreements (repos). Criteria

that must be fulfilled for techniques and instruments to be considered for the purpose

of EPM are risk reduction, reduction of cost or generation of additional capital or

income, provided that the level of risk is consistent with the risk profile of the UCITS and

risk diversification rules.

EPM techniques are widely used and potentially involve a substantial proportion of any

given UCITS' portfolio. Questions have been raised regarding: (1) the transparency of

EPM techniques; (2) counterparty risk assumed by those funds using EPM; (3) the quality

of collateral or the reinvestment of collateral. Regulators around the world are currently

assessing the systemic risk inherent in the use of EPM techniques. The EC Green Paper

on Shadow Banking also addressed certain aspects of the above topics.

Box 2

Q9: Please describe the type of transaction and instruments that are currently

considered as EPM techniques. Please describe the type of transactions and

instruments that, in your view, should be considered as EPM techniques.

Currently, securities lending, repurchase agreements (repos), reverse repos and

reinvestment of cash collateral are considered as EPM techniques. There are two

fundamentally different securities lending models: i) principal lending and ii) agent

lending. In the principal lending model, all credit risk from the lending market stops with

the principal, i.e. is not borne by the Fund. Another differentiating dimension is what

type of lending activity the lender engages in, significantly impacting the level of return

generated.

Q10: Do you consider there is a specific need to further address issues or risks

related to the use of EPM techniques? If yes, please describe the issues you

consider merit attention and the appropriate way of addressing such issues.


We believe that the recently published ESMA “Guidelines on ETFs and other UCITS

issues” thoroughly address the need for more transparency regarding counterparties,

collateralization, type of collateral and securities lending revenues and costs. However,

we would like to express our concern that different securities lending models will be

compared at the level of the ‘revenue split’ only, not properly taking into account the

underlying differences and ultimate revenue outcomes for the Funds. While we consider

that a forced comparison across providers is a sensible idea per se, we would emphasize

the importance that it is done in proper way, e.g. as in the case of OGC where the

scope is clearly defined. We regret that this approach has not been chosen for the

disclosure of securities lending revenues and costs/fees and would support a

reevaluation of the potential benefits of this approach.

Q11: What is the current market practice regarding the use of EPM techniques:

counterparties involved, volumes, liquidity constraints, revenues and revenue

sharing arrangements?

The use of EPM techniques is a common practice in the market place. The securities

lending models (principal vs. agent lending model), type of lending activities, i.e.

number of income sources (general collateral trading, special trading, dividend

business), volumes (utilization/lending ratio), quality and number of counterparties,

quality of indemnifications received, quality of collateral, diversification and constraints

(strict vs. loose limits), liquidity and minimum credit rating requirements, as well as

revenues and revenue sharing arrangements, vary widely across market participants.

Furthermore, volumes vary not only across market participants, but also across time as a

function of changing market demand for lending. The collateralisation ratios are also

subject to variation; some Luxembourg Funds apply the legally required 90%

collateralization ratio while others are 5% overcollateralized.

Q12: Please describe the type of policies generally in place for the use of EPM

techniques. Are any limits applied to the amount of portfolio assets that may,

at any given point in time, be the object of EPM techniques? Do you see any

merit in prescribing limits to the amount of fund assets that may be subject to

EPM? If yes, what would be the appropriate limit and what consequences

would such limits have on all the stakeholders affected by such limits? If you

are an asset manager, please provide also information specific to your business.


Over time, on average and across UBS (Lux) Funds (ex MMFs which do not participate in

any lending programme), the lending ratio ‘only’ amounts to 25-30% (with significant

variation across markets and time) even in the absence of a specified maximum lending

ratio (not exceeding 100%) and despite the incentive for the securities lending principal

to maximize securities lending revenues where he participates proportionally in the

revenues. This is due to the fact that the cost of equity capital acts as a

counterbalancing mechanism to the incentive to maximise securities lending revenues

and thus ensures that securities lending is not used without bound.

When identifying amounts of assets a UCITS will make available to lend, many factors

should be taken into account (including, but not limited to, risk appetite, asset type and

level of redemptions). Therefore, a regulatory limit may be inappropriate.

Q13: What is the current market practice regarding the collateral received in

EPM? More specifically:

- are EPM transactions as a rule fully collateralized? Are EPM and collateral

positions marked-to-market on a daily basis? How often are margin calls made

and what are the usual minimum thresholds?

- does the collateral include assets that would be considered as non-eligible

under the UCITS Directive? Does the collateral include assets that are not

included in a UCITS fund's investment policy? If so, to what extent?

- to what extent do UCITS engage in collateral swap (collateral

upgrade/downgrade) trades on a fix-term basis?

We do not believe that securities lent are, as a rule, fully collateralized. UBS Global Asset

Management consistently applies 100% plus a margin and collateral is transferred daily

with all loans and collateral positions being marked-to-market on a daily basis.

We note that collateral is received as security and should not be subject to UCITS asset

eligibility rules. Notwithstanding this, collateral received generally complies with the

UCITS eligible assets requirement and in particular with ESMA’s “Guidelines on ETFs and

other UCITS issues”. Collateral received - not only in the case of UBS, but also more

generally in the market - is often not included in the UCITS’ investment policy. As

collateral serves to mitigate against the risk of the securities lending counterparty

defaulting, it is important to require the collateral to be of high quality, liquid and well

diversified, but of a different type than the securities under the UCITS investment policy.


Although we currently do not engage in collateral swap transactions on a fix term basis,

we note increased demand for such transactions following recent regulatory

developments. With prudent risk management, a UCITS that appropriately aligns the

fund objectives with its own risk management could undertake this activity – the level of

such activity should be defined by the UCITS.

Q14: Do you think that there is a need to define criteria on the eligibility,

liquidity, diversification and re-use of received collateral? If yes, what should

such criteria be?

We do not think that there is a need to define criteria on the eligibility, liquidity,

diversification and re-use of received collateral beyond ESMA’s “Guidelines on ETFs and

other UCITS issues”.

Q15: What is the market practice regarding haircuts on received collateral? Do

you see any merit in prescribing mandatory haircuts on received collateral by a

UCITS in EPM? If you are an asset manager, please provide also information


Please find below an example of a haircut schedule:

1. MarginAs collateral for the lent securities we require to receive a portfolio of equal value plus margin.

Volatility regime Standard VolatileMargin 5% 5%

2. HaircutsThe collateral value of any security equals its market value net of the following haircuts:

Equities (constituents of one of the indices mentioned under point 3 below) 8% 10%

Government bonds US, JP, UK, DE, CH 0% 0%

Government bonds (Minimum rating A, excpet US, JP, UK, DE, CH) 2% 3%

Corporate bonds (Minimum rating A) 4% 5%

We do not see any merit in prescribing mandatory haircuts on collateral received by a

UCITS in EPM. Rather, a requirement to disclose the haircut policy, or more generally,

the whole collateral requirement, could be considered. We would, however, highlight in

this context that sophisticated clients already request and receive this type of

information today.


Q16: Do you see a need to apply liquidity considerations when deciding the

term or duration of EPM transactions? What would the consequences be for the

fund if the EPM transactions were not "recallable" at any time? What would be

the consequences of making all EPM transactions "recallable" at any time?

We already have in place a policy that securities lent are recallable at any time. A

mandatory requirement to make all EPM transactions recallable would, however,

change the nature of the setup in that we would be legally required to do so. Further,

prohibiting UCITS from utilising term REPO or Securities Lending transactions would

reduce the effectiveness of EPM techniques.

Q17 Do you think that EPM transactions should be treated according to their

economic substance for the purpose of assessment of risks arising from such

transactions?

Whilst securities lending and repo are very similar in risk profile, the underlying contracts

differ, and they are therefore treated differently for accounting purposes, which we

believe to be entirely appropriate and consistent across UCITS and other funds. When a

loan is settled, title transfers to the borrower, but the UCITS retains the economic

exposure to the assets via the legal agreements used. Equally, when a UCITS holds an

asset as collateral, the economic exposure is retained by the borrower. This is one

reason why the mark to market process and daily collateral process is so important. In

the event of an asset which is on loan defaulting, any losses would be incurred by the

UCITS in the same way as they would if the asset were not lent. If an asset held as

collateral defaults, it is marked to market and additional collateral called for.

Q18: What is the current market practice regarding collateral provided by UCITS

through EPM transactions? More specifically, is the EPM counterparty allowed

to re-use the assets provided by a UCITS as collateral? If so, to what extent?

UBS UCITS funds do not engage in repo agreements. We therefore choose not to

comment on this question.

Q19: Do you think that there is a need to define criteria regarding the collateral

provided by a UCITS? If yes, what would be such criteria?


No, we do not believe that there is a need to define such criteria. Collateral

requirements are thoroughly described in ESMA’s “Guidelines on ETFs and other UCITS

issues”.

Q20: What is the market practice in terms of information provided to investors

as regards EPM? Do you think that there should be greater transparency related

to the risks inherent in EPM techniques, collateral received in the context of

such techniques or earnings achieved thereby as well as their distribution?

The current market practice is to provide information to clients who request it, with

such clients generally being well informed and sophisticated clients. Consistent with

this, we believe information on EPM should be available to those who request it, but we

do not see a need for a mandatory requirement for greater transparency in relation to

the risks inherent in EPM techniques, collateral received or earnings achieved in the

context of such techniques as well as their distribution, beyond what is already required

by ESMA’s “Guidelines on ETFs and other UCITS issues”.

OTC DERIVATIVES

The EC considers that the introduction of the clearing obligation in EMIR raises the

question of how OTC derivative transactions should be dealt with when assessing UCITS

limits on counterparty risk. UCITS rules permit management companies to reduce UCITS

exposure to a counterparty of an OTC derivative transaction through the receipt of

collateral. Therefore, should a counterparty provide sufficient collateral (covering more

than 90% of the UCITS' exposure to this counterparty), even an investment strategy

where the entire UCITS portfolio consists of an exposure to a single counterparty does

not breach the counterparty risk exposure limits. Exposure to a single counterparty, even

if highly collateralised, raises concerns relating to insolvency or potential conflicts of

interest.

Management companies are required to calculate UCITS global exposure on at least a

daily basis. There is no corresponding requirement with respect to the calculation of the

OTC counterparty risk and issuer concentration. This discrepancy could lead to different

market practices with inherent risks to investor protection. The counterparty risk limit is

set as a percentage of UCITS assets. In order to apply this percentage, both the value of

the counterparty exposure (mark-to-market value of the derivative minus mark-to-

market value of the collateral) and the value of the UCITS assets must be up-to-date (or


calculated on a daily basis). However, this requirement may be difficult to reconcile with

the fact that UCITS are permitted to value certain eligible assets on less frequent

intervals, such as units in closed-ended funds or securities that are not traded on

regulated markets.

Box 3

Q21: When assessing counterparty risk, do you see merit in clarifying the

treatment of OTC derivatives cleared through central counterparties? If so,

what would be the appropriate approach?

Yes, we agree that the counterparty risk of cleared OTC derivatives should be treated

differently. The requirement to centrally clear OTC derivatives that are clearing eligible

will result in a change in market practice with regard to margining of OTC derivative

trades. Whereas, currently, OTC derivative margin requirements are determined

bilaterally between the counterparties, EMIR prescribes minimum requirements for initial

margin and variation margin for centrally cleared derivatives. Furthermore, asset

managers will be required to post a narrow range of eligible collateral to CCPs as initial

and variation margin, thereby losing the previous flexibility of types of collateral

considered acceptable. We understand that the initial margin posted to a CCP would be

treated as an exposure to the CCP that could not be offset. Consequently, it is

important that clarification is provided as to how the currently defined limits on OTC

derivative exposures to a single counterparty apply in the context of central clearing. We

would advocate that the 5-10% limits are removed for any exposure to a CCP as such a

limit could prevent UCITS moving to central clearing. Also, the prohibition from re-using

cash obtained through repo transactions for the collateralisation of other investment

should be reviewed in the context of central clearing as UCITS should not be subject to

restrictions impeding their ability to provide sufficiently liquid collateral to CCPs.

Q22: For OTC derivatives not cleared through central counterparties, do you

think that collateral requirements should be consistent between the

requirements for OTC and EPM transactions?

While we are in favour of a consistent approach as it would facilitate the operational

management of collateral, it should also allow for sufficient flexibility in the approach to

to reflect differences in the nature of each transaction. We would emphasize the fact

that for an OTC deal, specific collateral is one to one related to a specific transaction. In

our EPM business, securities to be lent out are pooled across all funds being part of the


securities lending agreement. As such EPM collateral is usually better diversified and

although the minimum credit quality might be marginally lower than in the OTC

business, it is still high quality. In the current CSA contracts between UBS wholesale

funds Switzerland / Luxembourg and third parties we only accept highly rated

government bonds and cash as collateral.

Q23: Do you agree that there are specific operational or other risks resulting

from UCITS contracting with a single counterparty? What measures could be

envisaged to mitigate those risks?

Yes, we agree that there are specific risks resulting from the use of a single

counterparty. The first risk which we would like to highlight is the time lag between the

execution and confirmation of an OTC deal which is best mitigated through a timely

confirmation such as confirmation within 24 hours instead of two days before maturity.

Another risk is where the counterparty would seek to unwind a position for whatever

reason.

Q24: What is the current market practice in terms of frequency of calculation of

counterparty risk and issuer concentration and valuation of UCITS assets? If you

are an asset manager, please also provide information specific to your business.

Daily valuation is current market practice.

Q25: What would be the benefits and costs for all stakeholders involved of

requiring calculation of counterparty risk and issuer concentration of the UCITS

on an at least daily basis?

For UBS wholesale funds, we apply daily valuation and daily calculation of counterparty

risk and issuer concentration. The benefit is to receive a transparent up to date overview

on exposures not only related to counterparty and concentration risk but also on

investment risk. These are the principles of good quality Portfolio Management practice.

Costs relate to data maintenance, data consolidation and updates on IT infrastructure.

Q26: How could such a calculation be implemented for assets with less frequent

valuations?


For assets with less frequent valuations we would stress the importance of having clear

processes and controls in place. The procedures for the valuation of UBS wholesale

funds are set out in the policy of the UBS Global Valuation Committee. In the absence

of market or vendor pricing, or if market or vendor pricing is deemed unreliable, illiquid

securities and financial instruments are valued based on a number of factors: (i)

analytical data, including analysts’ reports and financial statements, (ii) type of security,

(iii) public trading in similar securities of the issuer or of comparable companies, (iv) the

liquidity of the market for the security, including the nature and duration of restrictions

on trading, (v) whether the issuer has other securities and, if so, how those securities are

valued and (vi) other factors the portfolio manager deems relevant.

For illiquid securities and financial instruments without regular prices from an

independent pricing service, or readily-available indicative prices or bids from more than

one independent broker, valuation will be the mean of indicative prices obtained from

at least [X] independent dealers that have been approved by the Committee. If the only

indicative price can be obtained from an independent dealer, that price may be used,

however, where it is only available from an affiliate of UBS Global AM, the price must

be approved by the Committee. If indicative prices are not obtainable, the securities

shall be valued based on available information and thereafter submitted for final

approval by the respective Committee.

EXTRAORDINARY LIQUIDITY MANAGEMENT TOOLS

The EC outlines that a UCITS is required to redeem units on request by investors, but

that the Directive does not specify how in practice such a right must be applied. The

temporary suspension of redemptions is the only derogation from the general right to

redeem units of UCITS on request which are allowed only in "exceptional cases where

circumstances so require and where temporary suspension is justified having regard to

the interests of the unit-holders". The EC further stresses that no guidance is provided

as regards to the meaning of "exceptional cases" which has led to different

interpretations among the Member States. Some take the view that more developed

rules on a European-wide basis may help fund managers facing liquidity bottlenecks,

better ensure high-levels of investor protection and support a better functioning of the

single market. Any framework should seek an appropriate balance between the

interests of investors who are redeeming their investments and those investors

remaining invested in the fund.


The EC further outlines that deferred redemptions aim at preventing a situation in which

a UCITS would be obliged to sell a large part of its portfolio in a short period of time

and at a potentially deflated price because it is confronted with an unusual amount of

redemption orders. The mechanisms involve postponing the execution of all or part of

the redemption orders. Side-pockets can be applied in situations where a part of the

assets in the UCITS portfolio becomes illiquid. In such a case, liquid assets are separated

from illiquid assets and a new fund is created. Member States shall prohibit UCITS,

however, from transforming themselves into non-UCITS funds.

Box 4

Q27: What type of internal policies does a UCITS use in order to face liquidity

constraints? If you are an asset manager, please provide also information


UBS Global Asset Management is subject to a liquidity risk policy that sets out the

liquidity monitoring requirements for funds it manages. The primary goal is to ensure

that the degree of liquidity in the funds allows the funds to meet redemptions

obligations in a variety of situations, while respecting the requirement of equal

treatment of investors. When appropriate to its objective and liquidity risk tolerance, a

fund can also have a liquidity contingency plan setting the process for addressing

liquidity issues in extreme circumstances.

Q28: Do you see a need to further develop a common framework, as part of the

UCITS Directive, for dealing with liquidity bottlenecks in exceptional cases?

We would potentially support the development of a common framework for dealing

with liquidity bottlenecks in exceptional case, as it would be of interest in sustaining and

differentiating UCITS as a “high liquidity standards” brand. But we highlight that it is

not possible to give a firm response to this question given the high level concept of a

‘common framework’ and lack of detail as to exactly what that would entail in practice.

In order to protect the interests of investors, we believe any common framework should

be developed in a way that does not reduce the flexibility of UCITS managers in dealing

with exceptional cases. Therefore, we do not support detailed rules or limits on the

ability of UCITS managers to address such cases as it is necessary to retain flexibility to

take the most appropriate course of action given the specific circumstances.


In addition, it should be made clear to investors that meeting redemptions is a

commitment on means (sound and proactive management of liquidity) and not on

results. In exceptional circumstances, UCITS managers still have the ability to suspend

redemptions in the interests of unit holders as foreseen in Article 84 of the UCITS

Directive.

Q29: What would be the criteria needed to define the "exceptional case"

referred to in Article 84(2)? Should the decision be based on quantitative and/or

qualitative criteria? Should the occurrence of "exceptional cases" be left to the

manager's self-assessment and/or should this be assessed by the competent

authorities? Please give an indicative list of criteria.

Being aware of the inherent limitations of defining criteria for “exceptional cases”, an

indicative list of criteria could include i) the closure of exchanges on which a significant

portion of the fund’s investments are traded or suspension or restrictions on trading; ii)

levels of redemptions exceeding a predefined threshold combined with a significant dry

out of the liquidity of a fund’s assets; iii) any significant request for redemption that, if

met, could threaten the requirement of equal treatment of investors by for example,

leaving remaining investors with potentially illiquid assets. The decision should, where

possible, be based on quantitative criteria. The occurrence of exceptional cases should

be left to the assessment of the Fund’s Board of Directors which has the duty to act in

the best interest of investors.

Q30: Regarding the temporary suspension of redemptions, should time limits be

introduced that would require the fund to be liquidated once they are

breached? If yes, what would such limits be? Please evaluate benefits and costs

for all stakeholders involved.

Whilst we acknowledge that the introduction of time limits regarding the temporary

suspension of redemption may better ensure the equal treatment of investors,

consistent with our response to Q28, we would prefer not to have prescriptive

restrictions that might impede the flexibility of the UCITS. There is already a strong

incentive in UCITS to keep the suspension period of redemptions short, and setting

additional limits, and thus impeding the flexibility of liquidity management of the UCITS,

might not be in the best interests of investors. We note that prescribed time limits

would mean that, during the liquidation process, performance would no longer be the

main objective.


Q31: Regarding deferred redemption, would quantitative thresholds and time

limits better ensure fairness between different investors? How would such a

mechanism work and what would be the appropriate limits? Please evaluate

benefits and costs for all the stakeholders involved.

This technique is used in the case of limited liquidity funds (mainly funds whose

investment process relies primarily on illiquid assets). We do not recommend extending

this technique to UCITS.

Q32: What is the current market practice when using side pockets? What

options might be considered for side pockets in the UCITS Directive? What

measures should be developed to ensure that all investors' interests are

protected? Please evaluate benefits and costs for all the stakeholders involved.

The use of side pockets is widespread in the hedge funds management industry. The

use of side pockets in the UCITS Directive could ensure a fair treatment of investors by

ensuring an unchanged risk profile for the fund. However, given the high standards on

liquidity for UCITS, this mechanism should only be used in some exceptional

circumstances. The criteria for setting up side pockets should, in our view, include the

“complete” liquidity dry out of some assets of the fund.

Q33: Do you see a need for liquidity safeguards in ETF secondary markets?

Should the ETF provider be directly involved in providing liquidity to secondary

market investors? What would be the consequences for all the stakeholders

involved? Do you see any other alternative?

We disagree with the statement that the ETF provider should be directly involved in

providing liquidity to secondary market investors. By doing so, the ETF provider may

potentially endanger the requirement of fair treatment of investors remaining in the

fund. Additionally, direct involvement of the ETF provider in the secondary market

would increase transaction costs at the expense of investors thus increasing the tracking

error.

Q34: Do you see a need for common rules (including time limits) for execution

of redemption orders in normal circumstances, i.e. in other than exceptional

cases? If so, what would such rules be?


We do not see a need for additional rules other than those stated in prospectuses or

agreed with clients. Best practice indicates that time limits for execution of redemption

should be aligned on the settlement terms of underlying assets.

DEPOSITARY PASSPORT

The EC outlines that at present, UCITS depositaries have no European passport as the

UCITS Directive requires that a depositary shall either have its registered office or be

established in the UCITS' home Member State. The fund industry has already for some

time been debating whether UCITS should be limited to the services of depositaries

located in the same jurisdiction as the fund. The AIFMD and the proposal on UCITS V

aim to harmonize the rules governing entities eligible to act as depositaries, the

definition of safekeeping duties and oversight functions, the depositary's liability, and

the conditions for delegation of the custody function. The introduction of a depositary

passport is sometimes seen as the capstone to this wide-ranging harmonisation.

Box 5

Q35: What advantages and drawbacks would a depositary passport create, in

your view, from the perspective of: the depositary (turnover, jobs, organisation,

operational complexities, economies of scale …), the fund (costs, cross border

activity, enforcement of its rights …), the competent authorities (supervisory

effectiveness and complexity …), and the investor (level of investor

protection)?

In principle, we are supportive of the idea of a passport. However, we believe it is crucial

that the interests of the investors are at all times protected. In order to achieve this, we

are of the view that harmonisation of the operation of depositaries across different EU

jurisdictions should be achieved before the passport is introduced. We do not believe

the introduction of the passport should be rushed but rather it should be available only

once the potential benefits clearly outweigh the costs.

We believe a passport would have the following advantages and disadvantages:

Advantages from the perspective of the Depositary: (i) We believe the passport would

result in new business opportunities for large firms who have in place the operational

infrastructures and networks to onboard large promoters and accommodate various


local regulatory constraints and (ii) the ability for depositaries to serve wider markets

should furthermore generate economies of scale.

Drawbacks from the perspective of the Depositary: (i) We consider there to be a material

risk that depositaries who use the passport to operate in member states in which they

have not previously operated could misinterpret and incorrectly apply local laws with a

potential increase in financial, regulatory and legal risk. The passport could furthermore

intensify cross-border competition and result in consolidation and fewer, more

specialised, custodian banks. This will increase concentration risk and potentially have

systemic risk implications.

Advantages from the perspective of the Fund: (i) The passport could enable

management companies to adopt a centralised operating model by leveraging

infrastructures and relationships located today in domestic markets and (ii) the passport

will trigger increased competition, economies of scale and should result in a reduction

of custodian fees.

Drawbacks from the perspective of the Fund: (i) Concentration risk: the passport will

likely benefit large firms to the detriment of smaller firms triggering a consolidation and,

as a consequence, a reduction of the number of service providers resulting in a

concentration risk for the overall fund business. (ii) Given the absence of harmonised tax

laws in the EU, there could be tax implications for funds and investors if the depositary

is located in a different member state to the fund.

Q36: If you are a fund manager or a depositary, do you encounter problems

stemming from the regulatory requirement that the depositary and the fund

need to be located in the same Member State? If you are a competent

authority, would you encounter problems linked to the dispersion of

supervisory functions and responsibilities? If yes, please give details and

describe the costs (financial and non-financial) associated with these burdens as

well as possible issues that a separation of fund and depositary might create in

terms of regulatory oversight and supervisory cooperation.

UBS, both in its role as a depository as well as fund manager, has not encountered

problems stemming from the regulatory requirement that the depositary and the fund

need to be located in the same Member State. We believe that there are benefits from

the fund and the depository being located in the same Member State as this ensures


that the depositary is familiar with the relevant local laws and regulatory requirements.

As previously stated however, we are supportive of a passport in principle provided the

appropriate framework is in place.

We also note that it is important that depositaries be permitted to delegate to sub-

custodians. This should include the ability to sub-delegate into jurisdictions that do not

provide for adequate supervision in certain exceptional circumstances where such

delegation is required for legal or other valid reasons as stated in the AIFMD.

Q37: In case a depositary passport were to be introduced, what areas do you

think might require further harmonisation (e.g. calculation of NAV, definition of

a depositary's tasks and permitted activities, conduct of business rules,

supervision, harmonisation or approximation of capital requirements for

depositaries…)?

Harmonisation within the EU is crucial to making a depository passport viable and

attributing an equal level of protection level to all investors. We believe harmonisation is

needed in respect of taxation, the liability of the depositary in case of insolvency,

depositary tasks and responsibilities. It would also be important to clearly set out how

the depositary passport would apply to third country depositaries. We do not consider

harmonisation of the NAV calculation to be a necessary condition for an effective

depositary passport as the calculation of NAV is not the responsibility of the depositary.

Q38: Should the depositary be subject to a fully-fledged authorisation regime

specific to depositaries or is reliance on other EU regulatory frameworks (e.g.,

credit institutions or investment firms) sufficient in case a passport for

depositary functions were to be introduced?

We believe it would be appropriate to introduce an authorisation regime specific to

depositaries. We believe this would be justified to reflect (i) the increased complexity

that is likely to arise as a result of a passporting regime and (ii) that the depositary

function has very specific duties and responsibilities which are not covered by sufficiently

tailored and granular requirements in other EU regulatory frameworks.

Q39: Are there specific issues to address for the supervision of a UCITS where

the depositary is not located in the same jurisdiction?


We consider this to be a question primarily for competent authorities. We do however

highlight that it is necessary to ensure clear allocation of responsibilities between

relevant competent authorities to avoid unnecessary and costly overlap whilst also

ensuring the interests of the investors are protected at all times.

MONEY MARKET FUNDS

The EC draws attention to the fact that that MMFs are widely used by all types of

investors such as households, corporate treasurers, pension funds or insurance

companies, who regard MMFs as a "safe" short term liquid asset class for investing

cash. In this case they are close substitutes to deposits. MMFs are themselves key

lenders to issuers of short dated high quality money market instruments. They provide

an important source of funding for a variety of institutions such as sovereigns, banks, or

companies. Active trading by MMFs is vital for liquid markets for commercial paper,

short-term bank debt and sovereign debt. Increased liquidity is in turn beneficial to

market efficiency and leads to a reduction in the cost of capital for firms. The potential

systemic importance MMFs, including their susceptibility to runs, have been analysed in

the context of FSB the shadow banking work stream. In the EU, CESR has already

adopted guidelines on a common definition of European MMFs.

Box 6

Q40: What role do MMFs play in the management of liquidity for investors and

in the financial markets generally? What are close alternatives for MMFs?

Please give indicative figures and/or estimates of cross-elasticity of demand

between MMFs and alternatives.

MMFs are important providers of short-term funding to financial institutions, businesses

and governments. However, the importance of this role and of the risks associated with

the link of MMFs to the short-term markets should not be overestimated as MMFs have

not reached a systemic size in Europe.

As reported by the FSB in its report dated 27 October 2011, the assets of MMFs

domiciled in Europe amounted to EUR 1,171 million at end 2010, of which CNAV

(VNAV) MMF assets domiciled in Europe totalled EUR 464 (707) million. Monetary data

from the European Central Bank (ECB) indicate that MMF shares/units held by euro area

investors are very small relative to the deposits managed by euro area credit institutions

(only 3.7% at end 2010). At the end of September 2011, MMF shares/units were held


by euro area investors as follows: households (EUR 196 billion), non-financial

corporations (EUR 169 billion), insurance corporations and pension funds (EUR 81

billion), and other sectors (EUR 162 billion). The ECB data also indicates that MMFs held

less than 2% of all debt securities issued by euro area non-financial sectors in mid 2010,

and 7% of all debt securities issued by euro area credit institutions.

Thus, bank deposit is the principle vehicle used by retail investors in Europe to manage

their cash and MMFs are playing a very modest role in credit intermediation in Europe.

This is largely due to the fact that the European financial system is bank-dominated.

The answer to the question in regards to the closest substitute to MMFs is dependant

on the type of MMF and the type of client:

CNAV MMF VNAV MMF

Institutional

clients

MM mandate with

capital guarantee

MM mandate without

capital guarantee

Retail clients Insured bank deposit Insured bank deposit

We believe that institutional investors have a very close substitute at hand (namely a

separately managed MM mandate), especially with regard to investment objectives and

mitigation of credit risk (diversification of counterparties). The same does not hold true

for retail clients, however, as their closest substitute (bank deposit covered by deposit

insurance) is not at all diversified and credit risk becomes a key issue for holdings

exceeding deposit insurance coverage.

For institutional (retail) clients, we would expect the cross-elasticity of MMF demand to

its closest substitute to amount to about -0.9 (-0.7) with a relatively small (large)

variance in case of institutional (retail) clients.

Q41: What type of investors are MMFs mostly targeting? Please give indicative

figures.

MMFs are mainly targeting retail and institutional (primarily corporate) clients. For

figures, please refer to our answer to Q40.

Q42: What types of assets are MMFs mostly invested in? From what type of

issuers? Please give indicative figures.


The types of assets MMFs mostly invest in are Certificates of Deposit, Commercial Paper

and Treasury Bills. The range of issuers covers banks, corporate issuers and

governments.

Q43: To what extent do MMFs engage in transactions such as repo and

securities lending? What proportion of these transactions is open-ended and

can be recalled at any time, and what proportion is fixed-term? What assets do

MMFs accept as collateral in these transactions? Is the collateral marked-to-

market daily and how often are margin calls made? Do MMFs engage in

collateral swap (collateral upgrade/downgrade) trades on a fixed-term basis?

Our MMFs do not engage in transactions such as repo and securities lending. Therefore

we do not wish to comment on this question.

Q44: Do you agree that MMFs, individually or collectively, may represent a

source of systemic risk ('runs' by investors, contagion, etc…) due to their central

role in the short term funding market? Please explain.

It is important to make the distinction between different types of MMFs. Due to their

(implicit) capital guarantee, CNAV MMFs are much more susceptible to runs than VNAV

funds with their variable NAVs. But we do not agree with the idea that MMFs may

represent a source of systemic risk as we consider that their role in the short term

funding market in Europe is far from being central. Indeed, monetary data form the

European Central Bank show that MMF shares/units held by euro area investors are very

small relative to the deposits managed by euro area credit institutions (only 3.7% at the

end of 2010). This statistic confirms that bank deposit is the principle vehicle used by

retail investors in Europe to manage their cash and MMFs are playing a very modest role

in credit intermediation in Europe.

Q45: Do you see a need for more detailed and harmonised regulation on MMFs

at the EU level? If yes, should it be part of the UCITS Directive, of the AIFM

Directive, of both Directives or a separate and self-standing instrument? Do you

believe that EU rules on MMF should apply to all funds that are marketed as

MMF or fall within the European Central Bank's definition15?

We do not see the need for a more detailed and harmonised regulation on MMFs at EU

level as we believe that the CESR/ESMA Guidelines, which took effect in July 2011,


provide a sufficient regulatory framework. In addition to defining two MMF

subcategories, “short-term money market funds” and “money market funds”, the

guidelines provide a robust framework to limit the main risks to which MMFs are

exposed, i.e. interest rate risk, credit/credit spread risk and liquidity risk.

While the reduction in the weighted average maturity (to no more than 60 days for

Short-term MMFs and 120 days for MMFs) limits the overall sensitivity of the funds’ NAV

to changing interest rates, the reduction of the weighted average life (to no more than

6 months for Short-Term MMFs and no more than 1 year for MMFs) limits credit and

credit spread risk. Overall, the requirement to invest in high quality money market

instruments reduces credit risks. In practice, the requirements from the CESR/ESMA

guidelines and the UCITS Directive oblige MMF managers to keep high-quality and

liquid portfolios to avoid running into liquidity difficulties.

The CESR/ESMA guidelines also require managers of MMFs to draw investors’ attention

to the difference between the MMF and investment in a bank deposit. Enhancing

investor awareness about the exact nature of MMFs will strengthen MMFs’ resilience in

crises.

It should also be noted that the vast majority of MMFs are UCITS. This means that their

managers must, amongst others, employ a risk management process which enables

them to monitor and measure at any time the risk of the positions and their

contribution to the overall risk profile of the portfolio. For a MMF, this includes a

prudent approach to the management of currency, credit, interest rate, and liquidity risk

and a proactive stress-testing regime. In addition, managers of MMFs must have

appropriate expertise and experience in managing these types of funds.

We would also emphasize that according to the European Central Bank, the change in

the definition brought about by the CESR/ESMA guidelines had a significant impact on

the size of the MMF industry. In Ireland and Luxembourg, in particular, the redefined

MMF industry was approximately 28% respectively 22% smaller in terms of the total

net asset value. The overall impact of changes to the reporting funds in the euro area

amounts to a reduction of EUR 193.7 billion (18%) of the MMF sector’s total net asset

value since July 2001.


Q46: Should a new framework distinguish between different types of MMFs,

e.g. maturity (short term MMF vs. MMF as in CESR guidelines) or asset type?

Should other definitions and distinctions be included?

As mentioned in our response to Q45, the CESR/ESMA guidelines already make the

distinction between different maturity types of MMFs, therefore we do not believe that

there would be any merit in further differentiating between asset types. However, as

mentioned, a difference indeed exists between CNAV and VNAV MMFs with regards to

the former’s (implicit) capital guarantee.

VALUATION AND CAPITAL

According to the EC, the low or almost non-existent fluctuation of the net asset value

(NAV) of so-called Constant NAV MMFs (CNAV MMFs) and regular sponsor support to

maintain a stable NAV may give the impression to investors that CNAV MMFs contain a

capital guarantee. This has been held to give rise to a run once investors fear that the

CNAV MMF is prone to 'break the buck' and no longer be able to offer redemption at

par (e.g. the "Reserve Primary Fund" in the US). There is also a concern that the

amortized cost valuation method (used by CNAV MMFs) allows MMFs to disregard the

gap between the real value and the book value of assets. Variable NAV MMFs (VNAV

MMFs) value their assets on the basis of the mark-to-market model, therefore they allow

for changes in the NAV. It is estimated that in Europe, 60% of the MMFs follow a VNAV

model whereas 40% follow the CNAV model.

Box 7

Q47: What factors do investors consider when they make a choice between

CNAV and VNAV? Do some specific investment criteria or restrictions exist

regarding both versions? Please develop.

In our experience it is primarily institutional investors who differentiate between CNAV

and VNAV MMFs. In our view, a very important differentiating factor is the settlement

period which is typically shorter (t+0 or t+1) for CNAV than for VNAV (t+2 or t+3)

MMFs. This is because CNAV MMFs are primarily used for liquidity management

purposes of corporate treasuries and hence are required to redeem as quickly as

possible. VNAV MMFs are primarily used by retail clients who temporarily park their

money (within a mandate or advisory based) when redeeming from other (Bond or

Equity) Funds which also have a long, and hence, matching settlement period.


Another important consideration might be the strength of the (implicit) capital

guarantee by the fund sponsor but we have no strong evidence for that as the primary

target clients of our (VNAV) MMFs are private clients.

We are not aware of specific investment criteria or restrictions distinguishing CNAV and

VNAV.

Q48: Should CNAV MMFs be subject to additional regulation, their activities

reduced or even phased out? What would the consequences of such a measure

be for all stakeholders involved and how could a phase-out be implemented

while avoiding disruptions in the supply of MMF?

In order to ensure a level playing field between CNAV and VNAV MMFs, we would

favour a requirement to make the implicit capital guarantee of CNAV MMFs explicit,

e.g. by requiring the sponsor to record a deferred liability (for example 5% of the asset

value of each CNAV MMF sponsored) on his balance sheet and to disclose actual

‘support’ given to any CNAV MMF in the annual report.

Q49: Would you consider imposing capital buffers on CNAV funds as

appropriate? What are the relevant types of buffers: shareholder funded,

sponsor funded or other types? What would be the appropriate size of such

buffers in order to absorb first losses? For each type of the buffer, what would

be the benefits and costs of such a measure for all stakeholders involved?

No, we do not believe imposing capital buffers on CNAV funds to be appropriate. A

fund should reflect the value of its underlying holdings. Where this is too variable, a

capital guarantee should be considered by the fund. Investors unwilling to bear the

additional costs associated with the capital guarantee should be advised to invest into

VNAV MMFs or a mandate.

Q50: Should valuation methodologies other than mark-to-market be allowed in

stressed market conditions? What are the relevant criteria to define "stressed

market conditions"? What are your current policies to deal with such

situations?


We do not believe that valuation methodologies other than mark-to-market should be

allowed in stressed market conditions. We would emphasize our view that during

stressed market conditions mark-to-market valuation is the most appropriate valuation

methodology, also for MMFs. What is important, however, is to ensure appropriate

communication to clients. During a stressed market situation, we would consider to

quickly introduce Partial Single Swinging Pricing (“PSSP”) in order to compensate the

fund for increased illiquidity when investors are redeeming.

LIQUIDITY AND REDEMPTIONS

The EC outlines that MMFs allow investors to withdraw on demand, with almost

immediate execution and a relatively stable principal value. At the same time, MMFs

invest in assets that mature in the future and which do not necessarily display daily

liquidity and that this situation might impede MMF's ability to face large redemption

requests from investors. Different options are considered possible to increase the

stability of MMFs. Liquidity fees might reduce incentives for investors to redeem first,

because first redeemers would have to compensate remaining investors that might

thereby be disadvantaged. Redemption restrictions might serve to limit the number of

shares that a manager has to repurchase, thus limiting the risk and size of asset fire

sales. Liquidity constraints may be imposed so managers hold highly liquid assets to be

able to face redemptions.

Box 8

Q51: Do you think that the current regulatory framework for UCITS investing in

money market instruments is sufficient to prevent liquidity bottlenecks such as

those that have arisen during the recent financial crisis? If not, what solutions

would you propose?

Yes, we consider that the current regulatory framework is sufficient.

Q52: Do you think that imposing a liquidity fee on those investors that redeem

first would be an effective solution? How should such a mechanism work?

What, if any, would be the consequences, including in terms of investors'

confidence?

Yes, we refer to our response in Q50 and would consider introducing PSSP to our

MMFs.


For our UBS Switzerland and Luxembourg Fund range we introduced Single Swinging

Pricing (“SSP”) in 2007 and moved to Partial SSP (“PSSP”) in 2010 (”partial” in the

meaning that the fund-specific swing factor is only applied to its NAV if the daily net

flow in % of funds’ assets exceeds a pre-defined threshold). For the MMFs part of the

fund range we have SSP in the Prospectus with the intention to invoke it by MMF Board

of Directors decision during times of market stress/reduced liquidity. By and large our

experience with the system has been positive. It effectively compensates the funds from

transaction costs incurred by subscribing and redeeming investors. Swing factors are

adjusted quarterly, thresholds annually.

Q53: Different redemption restrictions may be envisaged: limits on share

repurchases, redemption in kind, retention scenarios etc. Do you think that they

represent viable solutions? How should they work concretely (length and

proportion of assets concerned) and what would be the consequences,

including in terms of investors' confidence?

Redemption restrictions should only be envisaged as a measure of last resort. If needed,

we would argue that one of the most effective and efficient measures is gating (without

preference given to any client type), i.e. to limit daily net redemptions in % of the

Funds’ net asset value (for example, at 5%, depending on the liquidity available in the

market place), apply the redemption amount pro rata to redeeming investors and defer

net redemption requests above the threshold to the next day. The threshold is lifted

when net redemptions and markets normalize. UBS Global Asset Management was only

once, in 2008, in a situation where such a gate had to be applied to an EM Debt Fund

for a short period of time. While investor’s confidence was not hampered in case of the

EM Debt Fund concerned, reactions in case of a MMF could be different.

Q54: Do you consider that adding liquidity constraints (overnight and weekly

maturing securities) would be useful? How should such a mechanism work and

what would be the proposed proportion of the assets that would have to

comply with these constraints? What would be the consequences, including in

terms of investors' confidence?

We are unclear as to whether the question refers to liquidity constraints at the Fund

level for redeeming investors or within the Fund and would appreciate clarification of

this point. Liquidity constraints at the Fund level would be only be partially feasible as it


is typically unclear how long an illiquid situation may last in which the fund may still not

be in a position to meet redemption requests.

Q55: Do you think that the 3 options (liquidity fees, redemption restrictions and

liquidity constraints) are mutually exclusive or could be adopted together?

We see the 3 options as staggered lines of defence as a response to an aggravating

special situation/crisis in money markets:

1) introduction of liquidity fee (PSSP in our case)

2) introduction of redemption restriction in size

3) introduction of liquidity constraints up to (temporary) suspension of redemption

Q56: If you are a MMF manager, what is the weighted average maturity (WAM)

and weighted average life (WAL) of the MMF you manage? What should be the

appropriate limits on WAM and WAL?

UBS (Lux) Global Asset Management EUR MMFs currently have a WAM of 79 days and a

WAL of 88 days.

INVESTMENT CRITERIA AND RATING

The EC notes that the MMF industry relies extensively on credit ratings in order to assess

credit risk associated with their assets. On the one hand MMFs may be rated and on the

other hand the assets in which they are authorized to invest have to follow credit ratings

criteria (CESR MMF guidelines) in many cases.

Most of the funds that are rated are awarded an AAA credit note. A downgrade of one

of these AAA-rated MMFs may have the consequences that investors may want to

switch their positions quickly to another AAA-rated fund. Such a sharp decline in the

fund's assets might have systemic effects. It is argued that banning the rating of MMFs

would force investors to assess for themselves the risk / reward profile of the funds

instead of relying on credit rating agencies' opinions. This would increase their

monitoring and reduce the potential for systemic overreactions to sudden new

developments.


MMF managers are required to invest only in assets that are awarded top quality credit

ratings. If a downgrade in these assets were to happen, the manager would be forced

to sell these assets in order to continue complying with the rules. The managers are

already currently required to assess the credit quality of their investments but a purely

internal assessment without reference to ratings is also sometimes discussed.

Box 9

Q57: Do you think that the definition of money market instruments (Article

2(1)(o) of the UCITS Directive and its clarification in Commission Directive

2007/16/EC16) should be reviewed? What changes would you consider?

We have no comments to provide.

Q58: Should it be still possible for MMFs to be rated? What would be the

consequences of a ban for all stakeholders involved?

The use of ratings is an established way to communicate the risk breakdowns to clients.

We would, however, be open to alternative solutions.

Q59: What would be the consequences of prohibiting investment criteria

related to credit ratings?

It is likely to make communications with clients more difficult.

Q60: MMFs are deemed to invest in high quality assets. What would be the

criteria needed for a proper internal assessment? Please give details as regards

investment type, maturity, liquidity, type of issuers, yield etc.


LONG-TERM INVESTMENTS

The EC notes that investing on a long-term basis is generally perceived as a factor for

growth for the economy. Although long term investing only offers returns over the long

term, such investing may better contribute to the financing of new projects and

expansion plans that normally require longer time horizons for completion.


Long-term investments share one common feature: a low level of liquidity. They are

generally associated with long lock-up periods. This is why access to this type of

investments is normally reserved for institutional investors only. Nonetheless, some EU

Member States have sought to develop ways of facilitating access to long-term

investments for retail investors, though a common approach to this has not emerged.

Long-term investing remains therefore segmented along national lines, with barriers to

the free movement of capital across borders.

Promoting long term investment funds could take several forms, including different

legislative options; access to retail investors would of course entail high standards of

investor protection, as is already the case for UCITS.

Box 10

Q61: What options do retail investors currently have when wishing to invest in

long-term assets? Do retail investors have an appetite for long-term

investments? Do fund managers have an appetite for developing funds that

enable retail investors to make long-term investments?

Retail Investors can typically only invest in listed real assets, for example listed real estate

funds, listed PE funds, listed Infrastructure funds. Alternatively they can also invest in

shares of companies that are active in these sectors, for example utilities or

infrastructure concession companies. However, investing into listed products /

investments does bring additional volatility driven by overall market movements which

are less related to the investment intention.

Currently longer term investments cannot be captured by real retail-products which are

broadly distributable based on a registration (UCITS funds). If UCITS would allow for a

category of funds offering such asset classes to investors, this would certainly be of

interest by providers as well as retail and institutional investors alike.

Q62: Do you see a need to create a common framework dedicated to long-term

investments for retail investors? Would targeted modifications of UCITS rules or

a stand-alone initiative be more appropriate?

We refer to our comments in Q61. Such a common framework dedicated to long term

investments could be seen to be attractive.


Q63: Do you agree with the above list of possible eligible assets? What other

type of asset should be included? Please provide definitions and characteristics

for each type of asset.

Yes, we agree with the list. But we also believe consideration should be given to

expanding the range of eligible assets to include assets on less liquid and “newly”

emerging financial markets.

Q64: Should a secondary market for the assets be ensured? Should minimum

liquidity constraints be introduced? Please give details.

Due to the illiquid nature of the assets, a secondary market is difficult to organise. For

example, information regarding the investments is typically not publicly available and

there is a multitude of structural and tax aspects to consider.

Q65: What proportion of a fund's portfolio do you think should be dedicated to

such assets? What would be the possible impacts?

For a dedicated “Long-term Asset Fund”, no restriction on the proportion invested into

such assets should exist. But it would be very important to ensure there was clear

disclosure to investors of the nature of any long term investments and the risks posed.

We believe such funds should not make up more than, say, 10% of a clients total

financial assets. The exposure to Long-term Assets is a matter of proper overall asset

allocation across all different investments of a client rather than a question of the

specific maximum investment proportion within a fund.

Q66: What kind of diversification rules might be needed to avoid excessive

concentration risks and ensure adequate liquidity? Please give indicative figures

with possible impacts.

UBS Global Asset Management non-UCITS multi-manager products aim for broad

diversification across managers, sectors, geographies and investment styles in order to

avoid concentration risks. A typical multi-manager infrastructure product would have 20

or more underlying fund investments. It should be noted that even broad diversification

might not help to ensure adequate liquidity at the fund level if the liquidity of a fund’s

underlying holdings is poor.


Q67: Should the use of leverage or financial derivative instruments be banned?

If not, what specific constraints on their use might be considered?

Large infrastructure projects are very capital intensive and could not be financed without

leverage. We do not however support double layers of leverage at both an asset and on

a fund level and believe that this should be prevented.

Leverage is a core element of certain buyout strategies that rely on debt repayment in

terms of value creation. Also, interest and FX risks are partly managed with derivatives.

Therefore, a ban may increase the risk of such transactions.

Q68: Should a minimum lock-up period or other restrictions on exits be

allowed? How might such measures be practically implemented?

Liquidity in infrastructure products is only available upon exit/disposition of an asset.

Therefore prior liquidity options would represent a liquidity mismatch which we would

not propose. Private equity is illiquid and usually implies a multi year lock up for the

investor at the expense of liquidity.

Q69: To ensure high standards of investor protection, should parts of the UCITS

framework be used, e.g. management company rules or depositary

requirements? What other parts of the UCITS framework are deemed

necessary?


Q70: Regarding social investments only, would you support the possibility for

UCITS funds to invest in units of EuSEF? If so, under what conditions and limits?


UCITS IV IMPROVEMENT

9.1. Self-managed investment companies

The EC notes that Article 31 of the UCITS Directive lays down general requirements on

administrative procedures and internal control mechanisms for investment companies. It

mirrors, to a great extent, Article 12 of the UCITS Directive, which applies to


management companies. However, it does not provide for an empowerment for the

Commission to adopt delegated acts specifying the administrative procedures and

internal control mechanisms. As a result, the Level 2 measures developed for Article 12

do not apply to investment companies.

9.2. Master – feeder structures

The EC notes that Article 64(1) of the UCITS Directive requires UCITS to provide

information to investors in the following two cases: where an ordinary UCITS converts

into a feeder UCITS, and where a master UCITS changes. However, this article does not

cover a third possible scenario, that is, where a feeder UCITS converts into an ordinary

UCITS. Such conversions lead to a significant change in the investment strategy. It can

be argued that similar information standards should apply across all three scenarios.

9.3. Fund mergers

The EC notes that the merger of two UCITS is subject to prior authorisation by the

competent authorities of the merging UCITS home Member States. These authorities

must inform the merging UCITS about their decision within 20 working days from the

date of the receipt of the complete application. It is not clear how to reconcile the

general 20 working day time limit for the competent authorities of the merging UCITS

for their decision on the authorisation of the merger with a 20 working day time limit

for the competent authorities of the receiving UCITS for their assessment of the

modified version of the information to investors. Revision of the provisions on the

timelines for the mergers of the UCITS could therefore be considered so as to increase

legal certainty.

9.4. Notification procedure

The EC notes that UCITS IV has introduced a new electronic regulator-to-regulator

notification procedure. However, Article 93(8) of the UCITS Directive requires that any

change to the information on marketing arrangements in a host Member State or

marketing of a new share class should be notified to the UCITS host Member State in a

written form. The EC suggests two improvements could be considered: (i) Introduction

of the notification of the update to the UCITS host Member State in electronic form; (ii)

Clarification that information on a share class is limited to share classes marketed in a

host Member State. It can be also considered whether to introduce a regulator-to-

regulator notification for any changes to the notification file including the information

on arrangements for marketing or marketing of a new share class.


9.5. Alignment with the AIFM Directive

The EC notes that the AIFM Directive, which will apply as of July 2013, has been

adopted to cover alternative investment funds. In order to prevent systemic risks and to

create a safe environment for investors, many important provisions have been

introduced. Some of these provisions are more detailed in the AIFM Directive than

comparable ones in the UCITS Directive, including measures on organisational rules,

delegation, risk and liquidity management rules, valuation, reporting or calculation of

leverage.

Box 11

Q71: Do you think that the identified areas (points 1 to 4) require further

consideration and that options should be developed for amending the

respective provisions? Please provide an answer on each separate topic with

the possible costs / benefits of changes for each, considering the impact for all

stakeholders involved.

Yes, we agree.

Q72: Regarding point 5, do you consider that further alignment is needed in

order to improve consistency of rules in the European asset management

sector? If yes, which areas in the UCITS framework should be further

harmonised so as to improve consistency between the AIFM Directive and the

UCITS Directive? Please give details and the possible attached benefits and

costs.

No, we do not believe that further alignment is needed. As an overarching comment,

we highlight that there has been a significant amount of regulatory change impacting

investment management in Europe in recent years. In light of this, we believe it is

important to have a period in which further regulatory change is limited in order for

recent changes to effectively bed-down. Such a period would enable firms to better

integrate into their ongoing operations and business models the recent and current

regulatory reforms, whilst still having sufficient resources to concentrate on the core

business of investment managers which is to generate investment performance for their

UCITS investors. We note that, in our view, the most fundamental change that is

required to ensure the effective operation of UCITS is greater harmonisation of the tax

framework at an EU level. Such a harmonised tax framework is necessary to eliminate



tax uncertainties in cross-border fund operations and deliver the UCITS IV efficiencies to

investors.

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