According to the AIFMD Regulation at Article 6, the leverage of an AIF shall be expressed as the ratio between the exposure of an AIF and its net asset value.

For example, an AIF with 100 equity investment and a further 200 derivative exposure would have total commitment exposure of 300. If its NAV is 100, then it would have 3 times leverage, at 300% AIFMD Commitment Exposure.

UCITS Global Exposure in contrast is a measure of the incremental exposure and, therefore, in the above example, the UCITS global exposure would be 200%.

This difference is unnecessary and confusing to investors. Further, the UCITS calculation is not always simply 100% less that than the AIFMD calculation. This is explained further below.

UCITS Global Exposure is “a measure designed to limit either the incremental exposure and leverage generated by a UCITS through the use of financial derivative instruments (including embedded derivatives).”

The above suggests / requires that our starting point is to look at the derivatives on the portfolio.

Nevertheless, in practice, regard needs to be had to all portfolio assets in order to properly calculate UCITS Global Exposure, as:

As set out in the table in Part 1, both AIFMD and UCITS require the calculation of exposure from derivatives based on the conversion of derivatives into the equivalent underlying positions; both provide for netting and hedging; both provide for delta adjustment and both provide for the same exceptions (with minor differences in wording) including in respect of cash and cash equivalents (see below).

Whilst AIFMD Commitment Exposure and UCITS Global Exposure are overwhelmingly similar and both in practice (as explained above) require you to consider all portfolio assets in the calculations, nevertheless the UCITS calculation is not always simply 100% less than the AIFMD calculation. This is explained further below.

This is caused by, amongst other issues, differences in the treatment of borrowing and inclusion of unrealised gains or losses on derivatives. All of these differences stem from the fact that the UCITS Guidelines prescribe a mechanical calculation for UCITS Global Exposure as follows, at Box 2, Para

AIFMD Gross Exposure provides that you should not take into account the exposure from cash and cash equivalents.

Cash equivalents is defined at AIFMD Regulation, Article 7(a) as “highly liquid investments held in the base currency of the AIF, that are readily convertible to a known amount of cash, are subject to an insignificant risk of change in value and provide a return no greater than the rate of a three-month high-quality government bond.”

AIFMD Commitment approach and UCITS Global Exposure take a different approach of permitting the reduction of derivative exposure to the extent that they are backed by cash and cash equivalents / risk free assets. In practice, though different, these calculations very often reach exactly the same conclusion.

Example:

In the above example, the calculations for AIFMD Gross Exposure, AIFMD Commitment Exposure and UCITS Global Exposure all lead to the result that there is no leverage, but achieve this through 3 different calculation methodologies:

There are also differences in the wording between AIFMD Commitment Exposure and UCITS Global Exposure.

AIFMD COMMITMENT EXPOSURE

AIFMD Regulation – Article 8 provides that

“…. a derivative instrument shall not be converted into an equivalent position in the underlying asset when calculating the exposure according to the commitment method if it meets both of the following conditions: (a) the combined holding by the AIF of a derivative instrument relating to a financial asset and cash which is invested in cash equivalent as defined in Article 7(a) is equivalent to holding a long position in the given financial asset; (b) the derivative instrument shall not generate any incremental exposure and leverage or risk.

UCITS GLOBAL EXPOSURE

For UCITS Global Exposure, it is provided in the UCITS Guidelines that a financial derivative instrument is not taken into account if the combined holding by the UCITS of a financial derivative instrument relating to a financial asset and cash which is invested in risk free assets is equivalent to holding a cash position in the given financial asset. (see UCITS Guidelines at Box 4).

In this context, Risk Free Assets means: Assets which provide the return of short-dated (generally 3-month) high quality government bonds, for example 3-month US T-bills.

DIFFERENCES

Intentional or otherwise, there are the following differences in wording, albeit the same could be quite possibly inferred for UCITS:

Under AIFMD Regulation, Article 6, AIFs shall exclude borrowing arrangements entered into if these are temporary in nature and are fully covered by contractual capital commitments from investors in the AIF. Other than that, borrowing should be included. This is clarified further at Schedule 3, Annex 1 – methods of increasing exposure.

“Unsecured cash borrowings: When cash borrowings are invested they have the propensity to increase the exposure of the AIF by the total amount of those borrowings. Therefore, the minimum exposure is always the amount of the borrowing. It might be higher if the value of the investment realised with the borrowing is greater than the borrowed amount. To avoid double counting, cash borrowings that are used to finance the exposure shall not be included within the calculation. If the cash borrowings are not invested but remain in cash or cash equivalent as defined in Article 7(a) they will not increase the exposure of the AIF.”

Under UCITS, there is good argument that borrowing does not need to be included when calculating Global Exposure. Our understanding is that only the UK FCA have specifically dealt with this, stating that borrowing need not be included – COLL 5.3.10(4).

The implication would be that 2 different UCITS could report the same Global Exposure, notwithstanding that one has in fact 11% more leverage that the other, see Example 4 in Part 4. In our view, this is unhelpful as well as confusing to investors.

There is an equally good argument that borrowing should also be included for UCITS, but it is unclear whether that would be within the 100% limit or an increased 100% limit.

In this regard, whilst acknowledging that ESMA does not refer to taking into account borrowing in its Guidelines on Risk Measurement and the Calculation of Global Exposure and Counterparty Risk for UCITS, it should also be noted that

Whilst the above can be dismissed as minor differences in terminology with no material impact, we consider some examples where the impact can be seen: