Whilst they may appear complicated, the UCITS Derivatives Rules are relatively straight-forward.
These are summarised below.
There is also a range of details training on asset eligibility, leverage counterparty risk etc.
Summary
Asset Eligibility
1. Derivatives must have eligible underlyings
You can have any sort of Financial Derivative Instrument FDI, but it must have an eligible underlying.
2. OTC Derivatives must be with acceptable counterparties
You can enter into OTC Derivatives, but if you do so they must be with acceptable counterparties.
3. OTC Derivatives must be capable of reliable valuation
Where you enter into OTC derivatives, they must be capable of reliable valuation.
Investment Limits
4. For Diversification limits, we need to look through derivatives
We have our diversification rules, for example the 5/10/40 diversification limit.
For the purpose of these diversification rules we need to look through derivatives.
This means we must aggregate together our direct investments with our indirect investments for example through derivatives and aggregate those exposures together whenever we consider whether were complying with the 5/10/40 diversification requirements.
However, as regards the aggregation of the direct and indirect exposures there is an important exemption whereby you do not need to aggregate exposures through derivatives on financial indices.
5. 100% Derivatives Global Exposure
A UCITS can have a maximum global exposure of 100% of its NAV.
This means that it can have either:
- 100% economic exposure through derivatives, measured using the “commitment approach” ; or
- it can be measured using a Value at Risk approach whereby UCITS can have a maximum of 20% absolute VAR or two times the VAR of a relevant and appropriate benchmark.
6. 5% or 10% Counterparty Exposure
A UCITS can have a maximum of 5% exposure to any one OTC derivatives counterparty.
That is increased to 10% in respect of approved counterparties.
7. 20% Aggregated Exposure Rile
There is also a 20% aggregated exposure limit to any single body.
In this case single body means a group of companies.
This rule includes:
- • All exposures to that single group through deposits, transferable securities and money market instruments; AND
- Any indirect exposures through derivatives to that group of companies. AND
- Any counterparty exposure to that group.
8. Cover Requirements
Finally, there is a UCITS derivative cover rule.
This is the requirement for a UCITS to be able to meet all of its obligations, including through derivatives as they fall due.
For cash settled derivatives, this simply means that the UCITS must have sufficient liquid assets in order to meet any unrealised losses.
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