CISO Derivatives – Highwire Extensions

CISO-FINMA – The use of Derivatives under the Commitment-II Approach

On 1 January 2015 the revised regulations of CISO-FINMA regarding the use of derivatives under the commitment came into force (with Transition rules until 1 January 2016).

The new requirements brought the arrangements for Swiss funds into line with UCITS funds, effectively implementing the European “Commitment approach” according to CESR-Guideline 10-788 into Swiss law.
In Switzerland, this is referred as the Commitment-II approach, with the earlier Swiss approach known as the Commitment-I approach.

In essence, compared to the previous provisions, this involved extending the definition of “Global Exposure” as follows:

Adding two more components to the calculation of Global Exposure:
o attributable amounts from derivative components (previously only required for structured products) and
o incremental exposure from EPM investment techniques, through the reinvestment of collateral;
Providing that derivatives exposure can be excluded from the calculation of the global exposure where there is a corresponding amount of cash equivalents so that the combination of the derivative and cash equivalent equals a direct investment in the underlying instrument without creating an additional market risk or leverage (“synthetic replication of a physical investment”);
More rigorous requirements for the recognition of a netting or hedging arrangement, under Art. 36 CISO-FINMA;
Recognition that the financial derivative instruments used for currency hedging purposes such as currency forwards, may be netted at any time when calculating the global exposure;
Specific exception to the defined criteria for hedging for duration hedging; and
Enhanced requirements from the independent risk management function consistent with the UCITS requirements, under Art. 70 CISO-FINMA.