Rules Writing Style Guide – Highwire Extensions

Objective

Our objective to is to ensure that rules are written clearly and precisely. For an example of clear, concise rule writing click here.

Please see below for summary details of our rules writing style guide and for an overview of how we interpret prospectus wording.

Rules Naming Conventions

We have a very specific approach to Rule Naming. A rule name is made up of, for example:

The relevant Holdings Group / User Defined Selection goes first
Then a full stop
Then the limit
Then the rule theme

Correct Approach	Incorrect Approach
[Equities].Prohibited	Equities are prohibited
[Open ended Funds].Max 3% NAV Exposure to any one Security	Max 3% in CIS
[Fixed Income] (Below A- Rating]. Prohibited	Bonds must be rated A- or above at point of investment
[All Investments ]. Between 5 and 25 holdings in Portfolio	Min / max number of holdings: 60 to 100

Mainly, Primarily, Predominantly etc.

When reviewing and interpreting a prospectus, we translate the terminology into appropriate investment restrictions on which we can use to construct the rule. Examples below:

Example
Significant Influence	Min 20% NAV
Focused Portfolio	25 to 40 Stocks
Core	Min 50% NAV
Control	Min 50% Ownership
Mainly	Min 50% NAV
Majority	Min 51% NAV
Emphasis	Min 60% NAV
Primarily	Min 70% NAV
Principally	Min 70% NAV
Predominantly	Min 80% NAV
Significantly	Min 80% NAV
Exclusively	Min 90% NAV

Taxonomies and User Defined Selections

Whilst the rules engine enables complex definition of rules to be built up, the recommended approach is instead to use the pre-defined groupings of assets already available. These are:

Taxonomies – this is where every holdings is classified.(e.g. exchange traded or OTC) and where that field is available in holding reports
User Defined Selections – a flexibly defined grouping of assets, e.g. Convertible Bonds.
These cover most of the below concepts on Asset Groupings, Issuer Types, Country exposure, Capitalisations etc.

Asset Groupings & Types

Prospectus use lots of different terms for different types of assets. Below is a summary as to how we interpret some of the key terms.

Asset Types Summary
Assets	All assets, including all Holdings, FFX for hedging, payables/receivables etc.
Holdings	Securities (see below), plus Derivatives (see below), plus deposits, but not including FFX for hedging, payables / receivables or cash.
Securities	Equities, Bonds and Close-end Funds. It does not include cash, deposits, derivatives and open-end funds.
Derivatives	All derivatives, including FFX
CIS	CIS is a reference to open-ended funds and ETFs only; it does not include closed-end funds or investment trusts.
Funds	Funds is a reference to all funds, open and closed ended.
UCI	This is a reference to CIS. See above.
Equities	This is referring to direct equities. Unless identified as meaning otherwise, equities are assumed to include depositary receipts and equity related securities. It does not include CIS with exposure to equities or equity derivatives.
Equity related securities / Equity like instruments	This refers to common stock, preferred shares, equity related, ADR, GDR, P-Notes, ELN etc. It does not include convertible bonds.
ADRs	A reference to ADRs is taken to mean a reference to Depositary Receipts generally, including ADRs, GDRs etc.
Shares	Equities. See above.
Stocks	Equities. See above.
Fixed Income	Fixed income is reference to debt. It also includes asset backed securities (ABS) and structured debt securities. This will include debt instruments that also fall under the MMI definition, such as certain T-Bills, Commercial Paper.
Bonds	See Fixed Income above.
Debt	See Fixed Income above.
ABS	A general reference to ABS is taken to include sub-categories of asset backed securities, such as MBS, RMBS, CMBS, etc.
MMI	A general reference to MMI is taken to include MMI, Bank deposits, CDs, CPs, Cash is excluded. It will include those debt instruments that also fall under the regulatory MMI definition such as certain T-Bills, Commercial Paper.
Direct Investments	Direct investments are standard equities (ordinary and preferred), bonds, real estate, commodities and deposits.
Indirect Investments	Indirect investments include open and closed end funds, equity related securities, depositary receipts.
Deposits	Deposits is taken to exclude uninvested cash.
Traded Cash	This will be traded cash from the fund accounting records. This typically includes traded cash plus pending payables / receivables. This excludes Deposits and excludes margin.
Settled Cash	This will be settled cash from the custody records. This excludes Deposits and excludes margin.
Cash	Where the rules simply apply to cash, then we will typically use traded cash (see above). For the purposes of the UCTS regulatory rules we used Settled cash (see above).
Cash Equivalents	Cash equivalents are interpreted in line with the AIFMD definition 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." This is set to include the following, when in base currency of the Portfolio: cash, certificates of deposit, AAA government debt with less than 3 years to maturity, Short term money market funds. It is narrower than Money Market instruments.
Near Cash	Cash and Cash Equivalents; see above.
Ancillary Liquid Assets	Cash.
Borrowing	Negative Cash.
Negative Cash	See Borrowing, above.
Real Estate	This is a reference to physical real estate.
Property	See Real Estate, above.
Immovables	See Real Estate, above.
Real Estate Securities	Real Estate Securities refer to equities, bonds, closed end funds where the underlying sector = Real Estate.

Government Securities

Different terms are referred to. The interpretation depends on context.

We apply the approach that securities can have an issuer and a guarantor, although few have guarantors. The issuer / guarantor types are as follows:

Government
Supranational
Public bodies
Corporate

How this applies depends on a particular rule.

In general,

A reference to Government and Public securities (GOPS) in a UCITS perspective is taken only to mean those particular (GOPS) that meet the UCITS criteria.
A reference to Government securities generally is taken only to mean where the Issuer Type = Government.
A reference to Corporate Bonds generally is taken only to mean where the Issuer Type is a Corporate.

Credit Ratings

We have 2 main defined terms of:

“Investment Grade” and
“Non-Investment Grade”

A rating of BBB- is the lower threshold for investment grade. Therefore,

Where the requirement refers to BBB- or above, then this is a reference to investment grade; and
Where the requirement refers to below BBB-, this is a reference to non-investment grade.

Credit Ratings are available at;

Instrument; and
Issuer Level

It is not always clear whether a rule is referring to the instrument or issuer rating. In general, unless specifically clarified:

If credit rating rules refer to debit or fixed income, then by default it refers to the instrument rating;
If the rule is wide enough to refer to equities also, then we would use the issuer credit rating.
Where the rules refer to cash, deposits etc, then we would use the issuer credit rating.

Country Rules

Country exposure rules can be written to refer to one, multiple or all of the below.

Company domicile
Security. Country of incorporation
Security. Country of listing
Security. Country of Economic exposure

Where it is not specified, then, we make the following assumptions:
It is assumed that meeting any of the criteria suffices.

E.g. Minimum 50% in European investments is met if there is 50% in holdings where either:

Company domicile is in Europe
Security. Country of incorporation is in Europe
Security. Country of listing is in Europe
Security. Country of Economic exposure is in Europe.

Capitalisation Rules

There are a range of rules in respect of market capitalisation. This includes a range of key terms like small cap, mid-cap, large cap. This can also be differentiated by region. E.g. capitalisation of a certain UK large cap may only be large enough to be a US Mid-cap, if it were a US company. Therefore, we adopt the approach set out in the Investment Association sector guides for the capitalisation limits; unless specified otherwise by the client.

The IA limits include:
Large Capitalisation	Over $10 bn
Medium Capitalisation	Between $2 bn and $10 bn
Small Capitalisation	Under $2 bn

United Kingdom Market Capitalisation:

Region: United Kingdom
Mega	Over £20bn
Large	Between £5 bn and £20 bn
Medium	Between £1bn and £5bn
Small	Between £250m and £1 bn
Micro	Under £250m

United Kingdom Smaller Companies:

Funds which invest at least 80% of their assets in UK equities of companies which form the bottom 10% by market capitalisation.

Region: United Kingdom
Small	Bottom 10%

Japan Smaller Companies:

Funds which invest at least 80% of their assets in Japanese equities of companies which form the bottom 30% by market capitalisation

Region: Japan
Small	Bottom 30%

North America Smaller Companies:

Funds which invest at least 80% of their assets in North American equities of companies which form the bottom 20% by market capitalisation.

Region: Japan
Small	Bottom 30%

European Smaller Companies:

Funds which invest at least 80% of their assets in European equities of companies which form the bottom 20% by market capitalisation in the European market.

They may include UK equities, but these must not exceed 80% of the fund’s assets. (‘Europe’ includes all countries in the MSCI/FSTE pan European indices).

Region: Europe
Small	Bottom 20%

The monetary thresholds for the limits are updated on a monthly basis.

Using Exposure rather than Market Value

Many rules refer to the diversification as a percentage of NAV. Typically, these can be written as the market value in base currency / NAV in base currency.

However, our standard approach to such rules is to not use Market Value, but instead to use the Absolute (Commitment Exposure netted at underlying instrument level).

Note; this makes no difference for long-only funds which invest only in non-derivatives, including cash, equities, bonds, funds etc., as for these the market value will be the same as the exposure. However, for funds that do invest in derivatives, this is important to ensure that the portfolio is truly in compliance.

Note also that this is the standard required for UCITS regulatory rules and avoids problems where for example cash and derivatives have negative values.

Example 1: A portfolio is only allowed to invest Max 10% in any one instrument, any one sector and any one country. In the example below, the portfolio has direct equities but also some long CFDs. The CFDs happen to have losses. If we look at the Market Value then the fund seems to be in compliance, but this is not the case if we take into account the exposure.

	Country	Sector	MV	Exposure
BP	GB	Oil	100	100
BP CFD	GB	Oil	12	-50
Others			xxx	xxx
Total NAV			1000	1000+

Example 2: A portfolio must have a minimum of 10% in any stock invested into any one sector, country etc. In the example below, the portfolio has direct equities but also some short CFDs. The CFDs happen to have gains. If we look at the Market Value then the fund seems to be in compliance, but this is not the case if we take into account the exposure.

	Country	Sector	MV	Exposure
BP	GB	Oil	100	100
BP CFD	GB	Oil	12	-50
Others			xxx	xxx
Total NAV			1000	1000+

Using USD Values for Rules

Many rules refer to the diversification as a percentage of NAV. Typically, these can be written as the market value in base currency / NAV in base currency. However, we instead use numerators and denominators in USD. This is done for a number of reasons including:

For market capitalisation rules as holding currency may not be in same currency as issuer market capitalisation.
For investment into other CIS where the share class invested into may be in a different currency into the CIS’s currency, which may be different again to the Portfolio’s base currency.

Example 1 – Maximum 15% in any one security having regard to its market capitalisation.

The portfolio has a base currency of USD and owns £20m GBP in XYZ Plc and XYZ Plc has a market capitalisation of 110m Euro. To enable a consistent calculation to be made, the holding value / exposure and the issuer market capitalisation denominator are converted into USD.

Example 2 – See attached a CIS example.

Long and Short Positions

Prospectus rules may refer to long and short positions. These are interpreted as below.

Note, that separate interpretations are applicable to the 13F Reporting.

Long and Short Positions
Long Positions	References to long positions is taken to mean a reference to the economic exposure being long. Therefore, sold CDS are considered long. Sold / written put options are considered long.
Short Positions	References to short positions is taken to mean a reference to the economic exposure being short. Therefore, purchased CDS are considered short. Purchased put options are considered long.

No Short Selling

From a Regulatory perspective,

UCITS are not able to short sell, except for via derivatives.
There are global short selling rules (which differ from country to country)

For the regulatory rules, we determine which is the correct rules to apply.

For prospectus rules it can be less clear. Prospectus may refer to “no short selling” / “short sales” / “short positions.” Below is a summary of some of the potential scenario. The applicable scenario needs to be agreed.

Number	Scenario	How Coded
1	No Physical short positions	Holdings Shorts Prohibited
2	Short sales for hedging only. This is the scenario where you can have short derivative positions, but only so long as it is hedging exposure. Overall, taking derivatives and physical positions together, there needs to be long exposure.	Underlying instrument. Exposure <0, Prohibited. FFX Currency Exposure?
3	No uncovered shorts - meaning that: You can be physically short so long as there is no cover As in the example above, overall, taking derivatives and physical positions together, there needs to be long exposure. For funds using stock borrowing as cover, the stock borrowing can also come within the rule.	Underlying instrument. Exposure <0, Prohibited.
4	No synthetic shorts, even if for hedging. (This is very unlikely to be a rule).	Derivatives Shorts Prohibited.
5	No shorts (physical or short). (This is equally unlikely to be a rule).	Shorts Prohibited.

Leverage / Exposure

There is a challenge with prospectus terminology referring to leverage and exposure.This is caused by:

Differences in terminology between UCITS and AIFMD;
Different types of exposure.

UCITS vs. AIFMD

For UCITS, a UCITS can have a commitment exposure of Max 100%. This is the incremental leverage through derivatives.

In contrast, according to AIFMD Regulation, Article 6. 1 “Leverage of an AIF shall be expressed as the ratio between the exposure of an AIF and its net asset value.” Therefore, an AIFMD portfolio with total portfolio exposure of 300 vs 100 NAV, has 3 times leverage – 300%, whereas for UCITS this would be expressed as 200%.

When reviewing prospectus leverage limits, we need to be mindful as to whether the portfolio is referring to the incremental leverage (e.g. as per UCITS) or the total leverage of the fund.

The general approach is that, unless it is clear from the context that an alternative interpretation is required: the following approach is taken:

UCITS vs. AIFMD
UCITS Prospectus	A reference to leverage is taken to mean the incremental leverage of the portfolio.
AIFMD Prospectus	A reference to leverage is taken to mean the total exposure of the portfolio / NAV of the fund.

To clarify this, when writing the rule, we will specify for example, Portfolio exposure – 300% NAV (200% incremental leverage), so that there is no confusion on this point.

Different Types of Exposure

We also need to determine which type of exposure the prospectus is actually referring to.

Below is a quick summary:

Summary
Total Value of AUM	Total value of assets under management. Under AIFMD Regulation Article 2, the AUM requires that derivatives are converted into its equivalent position in the underlying assets of that derivative using the conversion methodologies set out in Article 10. The absolute value of that equivalent position shall then be used for the calculation of the total value of assets. This involves the delta adjustment of positions, but does not include netting. It does not involve cash or risk-free assets.
Global Exposure	Global Exposure is the UCITS Regulatory term and is taken to be a reference to Commitment exposure - see below.
Leverage	Where rules refer simply to the leverage / exposure of the portfolio, this is understood to be the Commitment Exposure of the portfolio - see below.
Net Leverage	Where rules refer simply to the "Net Leverage" of the portfolio, this is also understood to be the "Commitment Exposure" leverage as the commitment exposure allows netting at the underlying instrument level. See below. Commitment exposure does not allow for netting between longs and shorts in different underlying instruments. If the intention is to measure the net of the long / shorts, then see below Net Long / Short Exposure.
Gross Leverage	This is referring to the AIFMD concept of gross leverage. It provides for delta adjustment of derivatives, but does not provide for netting. Cash and Cash Equivalents are excluded from the calculation.
Commitment Exposure / Leverage	This provides for delta adjustment and also for netting and hedging. The derivative exposure from long derivative positions can be excluded to the extent that it is backed by cash or risk-free assets.
Notional	This is referring to the Notional Exposure as per ESMA's Guidelines for UCITS on Global Exposure and Counterparty risk. This is referring to the exposure without delta adjustment or netting.
Gross Notional / Absolute Notional	This is interpreted as meaning Notional. Gross Notional or Absolute Notional are phrases sometimes found in prospectus, but which are not found in regulations and which seem to refer to two distinct regulatory terms - gross exposure (which allows delta adjustment) and Notional, which doesn't allow delta adjustment.
Net Long / Short Exposure	This is not a regulatory concept. If the intention is to measure the net of the long / shorts, then this calculation is used. It is the commitment exposure, after underlying instrument netting, but without the underlying exposure then being converted to an absolute exposure.
Long Exposure / Short Exposure	This is referring to the Gross Leverage method, as the commitment leverage method nets longs and shorts with the same underlying identifier.

Employing leverage on a substantial basis

There may a reference to a portfolio “employing leverage on a substantial basis.”

This is taken to mean 200% incremental exposure, 300% total exposure.

In accordance with AIFMD Regulation, Article 111, “Use of leverage on a ‘substantial basis’ shall be considered to be when the exposure of an AIF as calculated according to the commitment method under Article 8 of this Regulation exceeds three times its net asset value.”

Exposure / Leverage from Derviatives (FDI)

The prospectus may refer to exposure / leverage from derivatives, rather than generally.

References to notional leverage, gross leverage or to long and short leverage / exposure from derivatives are straight-forward.

It is more complicated where the calculation of leverage / exposure pertaining to FDI only is referring to the “commitment exposure” as this provides for netting and also for reduction of the leverage by the cash and risk-free assets. In this case, the Portfolio level rule for commitment exposure should be used.

No Leverage

Where the prospectus refers to no leverage through the use of derivatives, this implies that:

There should be no leverage at an overall portfolio level; AND
That individual derivatives should not be used for leverage.

This would also be relevant where the rule is that derivatives must only be used for EPM purposes.

Example: In the example below, the portfolio as a whole is deleveraged but the Royal Dutch shell CFDs, considered individually, is taking leverage.

	MV	Exposure
BP	100	100
BP CFD	0	-50
Royal Dutch Shell CFD	0	25
Total	100	75

Portfolio Level Rules

A number of rules are written having regard to values uploaded / stored against the Portfolio, rather than calculated by aggregating across the portfolio holdings. These include:

Portfolio_VAR30
Portfolio_Tracking Error
Portfolio_UCITS Global Exposure
Portfolio_Commitment Exposure
Portfolio_Gross_Exposure

Note, the portfolio level values of Portfolio Commitment exposure, Gross Exposure and Notional exposure are not quite the same as the aggregation across different holdings, due to treatment of cash, borrowing, shareclass hedges, forward FX etc.

Visual Overview of Portfolio Elements