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The Bank of New York Mellon Corporation
European Fund Focus
Summer 2007
17 July 2007
A Newsletter produced by BNY Mellon Trust & Depositary Services
© 2007 The Bank of New York Mellon Corporation. All rights reserved

European Exposure Draft

Best Execution - MiFID

Eligible Assets for Investments of UCITS

Belgian Funds for Institutional Investors

Hedged Currency Classes - A Tool for Product Enhancement

A New Alternative Fund Regime in Luxembourg

IFRS 7 and its Application in the Funds Industry

Contacts

Foreword

It is a pleasure to introduce the inaugural edition of European Fund Focus, a newsletter developed by our Trustee and Depositary services for practitioners within the European Fund Management Industry. We strive to keep fund managers informed of new compliance and industry developments, seeing this as a key part of our role. With the exponential growth in cross border distribution and administration we believe that there has never been a greater need for a geographically broader view of fiduciary issues. We are therefore looking to expand our coverage of pan-European topics and best practice.

The Bank of New York Mellon has a broad interest in fiduciary and other activities for the Fund Management Industry. We are proud of our level of involvement and the influence which stems from our leadership role supporting product development for both fund sponsors and regulatory bodies in the various jurisdictions in which we operate. The merging of The Bank of New York and Mellon Corporation has created the world's largest custodian and a global market leader in servicing fund managers. Whilst size alone is no indication of influence in the market, we are excited about our increased resources and coverage, particularly across Europe, enabling us to provide even greater choice and support to fund managers in the future.

With the move to Principle Based Regulation across Europe we believe our role as fiduciary for Collective Investment Schemes has become increasingly important; not only as a champion for underlying investors but also in working with fund managers, helping them gain a comprehensive understanding of the options available to them.

The purpose of this newsletter is to provide you with a selection of relevant and timely articles sourced from leading practitioners and industry figures from across Europe. We hope these will answer some of your questions and stimulate thought and debate.

Your feedback is important to us and we welcome your comments, ideas and suggestions for future editions.

BNY MELLON | ASSET SERVICING

but four years is an extraordinarily short time in Europe.

In 2003 there was quite a lot of frustration around managers of UCITS funds. The UCITS directive had been around for many years, and had been subject to some considerable (and sometimes painful) negotiation to produce UCITS III. It held out some great promises about the creation of a single market for funds in Europe and managers were increasingly looking to use it to develop their pan-European business. Yet the reality was far from the promise. Managers discovered that they had a passport but a multitude of visa requirements were imposed on them as they sought to enter new markets. At IMA we all decided that we needed to vent that frustration in a constructive, coherent way and so we commissioned Dr Heinemann from Mannheim to produce a report outlining where the real barriers to cross border business lay and what might be done about them.

agenda of areas where change was required to achieve the efficiencies and economies of scale which we believed could and should be achieved if we had a more efficient single market for funds in Europe.

Four years on it is now no longer just an industry agenda, but all the main issues which he identified have now been picked up by the European Commission. By the end of the year, they will make formal proposals for focused, targeted changes to the UCITS directive. They are at the moment analysing comments they have received on an Exposure Draft of possible legislative measures which contains almost everything that the industry has been asking for.

The Commission propose that the process for registering funds for cross-border distribution should be vastly simplified, with communication taking place between regulators. A fund would be capable of being marketed in a host of receipt of notification from the home Member State.

Provisions would be included in EU law to facilitate cross-border mergers of funds. Here the Commission have responded to complaints from the industry that the size of European funds is sub-optimal and that some jurisdictions put unreasonable constraints on funds moving outside their jurisdiction.

Similarly, master-feeder fund structures would be permitted, with a complementary aim of allowing administration to be centralised but this time allowing local funds to be offered to local investors.

While we may have some disagreement with one or two of the details of the proposals (we think the Commission have gone into far too much detail on master-feeder fund arrangements, and we think they must do something about ensuring that fund mergers do not create a tax event for investors) we think that the Commission has done a very good job.

This makes it all the more disappointing that there is one area on which we have significant disagreement. The Commission suggest the new legislation should allow only for a "partial" passport for the cross-border operation of funds.

We at IMA (and, indeed, the FSA) believe that the existing UCITS directive allows for a corporate fund in one Member State to be operated by a management company in another Member State, but most regulators or legislators from elsewhere in Europe have disagreed. If anything, UCITS III has caused more onerous requirements to be imposed on management companies than existed under UCITS I. This has increased costs for managers who have ranges of funds in more than one Member State. The Commission have recognised that there is a problem. In our view, however, they have been unnecessarily timid in seeking to tackle it. They suggest that certain activities have to take place "physically" in the same Member State as the fund, indeed, the fund would take on the nationality of the country in which those activities take place. The activities which it has chosen are the calculation of the net asset value of the fund and the maintenance of the unitholder register.

We have told Commission officials in no uncertain terms that we think they have this wrong and, indeed, this would be a backward step and against the aim of achieving a single market. First, a number of UK funds are already administered outside the UK, notably in Dublin. If the proposals were adopted as drafted, such funds would either have to change their domicile and become domiciled in Dublin, or the administration would have to be brought back to the UK; this would add to costs rather than reduce them. Second, we think the proposals would militate against the development of centres of excellence and expertise around Europe. The FSA is at the moment consulting on the establishment of amortised accounting for UK based funds. The valuation of such funds is complex and at present the main European expertise in this area lies with the administrators in Dublin and, to a lesser extent, Luxembourg. It would seem perverse not to allow the administration of such funds by the recognised experts. Our third objection is to the suggestion that something like the NAV calculation or maintenance of the register takes place "physically" somewhere when it is, in fact, done electronically and can both take place and be monitored from anywhere in the world.

There are, of course, counter arguments, which we would acknowledge but to which we think there are robust responses. Regulators have a natural concern about their ability to oversee what is going on in the fund and wonder how they can do this when the manager is not in their jurisdiction. We point out that we fully accept that the depositary or trustee must be in the same Member State as the fund, and it has a vital oversight role. We also point out that the Commission is proposing enhanced cooperation between regulators. This is a concept which is well accepted in other financial services sectors so why not UCITS?

That is by no means the end of the story, since it is not only the Commission which has a say: it is the Council of Member States and the European Parliament who formally decide on EU legislation and negotiations will take place in earnest in 2008. We will all be aiming by 2009 to have in place rules which should really make a difference in reducing costs and increasing efficiencies for firms who are already operating around Europe. Firms who have aspirations to increase their business by moving into other European markets should find it much easier to do so. Investors should benefit from greater competition and lower costs.

Deputy Chief Executive
Investment Management Association

Best Execution - MiFID

An Outline of CESR's Consultation Paper by Joseph Beashel

The best execution obligations under the Market in Financial Instruments Directive (2004/39/EC, as amended, 2006/73/EC) ("MiFID") form an important cornerstone in the regulatory architecture of MiFID which seeks to achieve an efficient market that protects investors, by fostering competition between trading venues and increasing investor confidence. Given the important role which best execution will play in the achievement of MiFID's goals, The Committee of European Securities Regulators ("CESR") issued a consultation paper (the "Consultation Paper") in February seeking to identify and propose solutions to a number of issues that had arisen in respect of this requirement.

The Consultation Paper does not address the scope of application of the best execution requirements, which will be the subject of a future consultation paper, but does seek to identify the requirements, similarities and differences under Article 21, which applies to investment firms that execute client orders ("Article 21 Firms"), and Article 45, which applies to portfolio managers and entities that receive and transmit orders to third parties ("Article 45 Firms").

Despite the differences in language, the Consultation Paper confirms that both Article 21 and Article 45 require investment firms to take all reasonable steps to obtain the best possible result for the execution of client orders, taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order (the "Factors").

Article 21 Firms are required to establish an execution policy, provide details of the policy to clients who must consent to the use of the policy and be able to demonstrate to clients that the policy has been followed. Article 45 Firms are subject to the same requirements however they are not required to obtain consent or demonstrate to clients compliance with the policy. The Consultation Paper provides that the policy will only detail the most important and relevant parts of the Article 21 Firm or Article 45 Firm's execution arrangements.

The Consultation Paper identifies a number of Factors that should be considered and prioritised when executing an order for clients and which should be included in the policy. The priority given to each Factor, will depend on the characteristics of the client, the order itself, the financial instrument and the potential execution venues. In the case of retail clients, the "total consideration" should be given a high priority and the Consultation Paper seeks to extend this to professional clients by requiring that price and cost should merit a high relative importance. Total consideration represents "…the price of the financial instrument and the costs related to execution, which shall include all expenses incurred by the client which are directly related to the execution of the order…"

In identifying venues that will be included in a firms policy, the Consultation Paper provides that the reliability and quality of the venue should take precedence, followed by the costs of that venue and it also provides that in some circumstances it will be permissible to have only one execution venue or only use one entity where this is monitored and reviewed and any deficiencies corrected.

In reviewing the policy, the Consultation Paper provides that it is not necessary to review every transaction to ensure that best execution was achieved but that appropriate sampling, based on a cross section of typical transactions would suffice. In addition, it states that different firms along the execution chain may need to take different approaches to the way they review their policy based on the role they play in the chain.

The Consultation Paper is helpful in a number of respects. In others, such as language used to describe the differences between firms that execute client orders (Article 21 Firms) and those that receive and transmit orders to other firms (Article 45 Firms) requires some clarification. It is likely the final guidance paper will address these issues though unfortunately, like all things related to MiFID, it will not deal with every possible issue. This inevitable fact should not take from the helpful guidance that is being provided and the final paper will be a significant source of clarification on this important topic.

Joseph Beashel
Partner Banking & Financial Services Dept
Matheson Ormsby Prentice Dublin
www.mop.ie

Eligible Assets for Investments of UCITS

By Gabrielle Jaminon

Almost immediately after the amending UCITS III Directive was passed, the European Commission became aware of the necessity to clarify the meaning and scope of the definitions included in the Directive on the assets that are eligible for investment by UCITS, namely transferable securities, money market instruments and other liquid financial assets as well as how these definitions would apply to certain types of financial instruments.

The onerous job performed by the Committee of European Securities Regulators (CESR), appointed in 2004 by the Commission to help develop a technical implementing piece of legislation, resulted in the final vote by the Commission on 19 March 2007 of an implementing Directive as well as the publication of final Level 3 guidelines by CESR on the same date. Member States have a period of 12 months to transpose the implementing Directive and no grandfathering clauses have been foreseen. This reflects the Commission's view that the clarifications contained in this Directive will not impose any new behavioural or operational obligations for competent authorities or market participants.

In order to ensure that the legislation is applicable to existing financial instruments and also to any forthcoming financial innovations, the clarifications described in the implementing Directive are mainly in the form of a "toolkit" rather than a list of eligible assets. This "toolkit" provides the general principles and criteria to be considered when assessing the eligibility of any investment.

The practical implementation of the "toolkit" will require careful consideration and planning. In some instances, the criteria to be complied with are numerous and may necessitate lengthy analysis and information gathering. This is the case for money market instruments. Structured financial instruments embedding derivatives will also require a detailed analysis.

Market participants should review their processes in order to ensure that they are in line with the requirements and in particular:

· The pricing of transferable securities for which market price is not available, money market instruments priced in accordance with amortised costs and OTC derivatives pricing;

· The compliance monitoring of the criteria applicable to transferable securities and money market instruments (decision tree), identification and measurement of embedded derivatives;

· The risk monitoring of embedded derivatives, credit derivatives and other techniques and instruments.

Although the clarification on eligible assets may lead to an increased amount of analysis in order to confirm the eligibility of an instrument, it should materially reduce the scope for divergence in interpretation and implementation of the definitions within the UCITS Directive. This will help to improve the functioning of the product passport. The implementing Directive also contains some positive news for market participants.

Clarification on the Eligibility of Closed-End Funds

Under certain conditions as detailed in the implementing Directive, units of closed end funds may be considered as transferable securities.

CESR is of the view that UCITS are allowed to invest in real estate and private equity funds, provided that they fulfil the transferable securities criteria.

Clarification on the Eligibility of Credit Derivatives and of Derivatives on Property or Commodity Indices

The implementing Directive clarifies the categories of eligible underlying assets for derivatives instruments with the particularly welcomed eligibility of credit derivatives provided that they meet the eligibility criteria applicable to OTC derivatives, are settled in cash or by the delivery of eligible assets and their particular risks (asymmetry of information) are captured by the risk management process.

CESR also takes the view that indices based on financial derivatives on commodities and property indices may be eligible.

More details on eligible assets, the implementing Directive and of the CESR level 3 advice can be found in the KPMG brochure entitled "Clarification of Definitions concerning Eligible Assets for Investments of UCITS" available from the KPMG website: www.kpmg.lu

Gabrielle Jaminon
Senior Manager
KPMG Regulatory & Compliance Services
Luxembourg

Belgian Funds (UCI) for Institutional Investors

The Belgian legal framework already defines the concept of institutional investors [Law of 16 June 2006 (art. 10 §1), law of 20 July 2004 (art.5 §3) and Royal Decree of 26 September 2006]. In addition Belgian funds for institutional investors are already addressed by the law of 20 July 2004 (art.97 to 111) but an executive Royal Decree is still missing. This executive Royal Decree is expected to be published and made effective in the coming weeks.

Currently some classes of funds are already dedicated to institutional investors and benefit from a reduced annual tax. With the Royal Decree it will be possible to fully dedicate funds to institutional investors. These funds would benefit from a reduced annual tax and from a much more flexible framework both in term of administration constraints and investment restrictions.

More information will be provided once the Royal Decree is published.

Jean-Louis Dutranoit
Head of Fund Services
BNY Mellon Asset Servicing
Brussels

Hedged Currency Classes

A Tool for Product Enhancement by Juliette Home

Early in 2006, the IMA asked the FSA to consider the possibility of UK Collective Investment Schemes being permitted to use currency hedging techniques in relation to a particular unit/share.

There were no provisions in the UCITS Directive which prevented the creation of a hedged currency class and we believed that it should be permissible under COLL. Such hedging techniques were permitted in other European jurisdictions including Germany, Ireland and Luxembourg where authorised fund managers (AFMs) operated such techniques in accordance with regulatory guidelines allowable under UCITS. The IMA and many of its members were concerned that the inability to operate hedged currency classes in the UK was resulting in firms launching their funds offshore, putting the UK at a competitive disadvantage.

The FSA, sympathetic to this problem, issued CP06/18 Quarterly Consultation (No. 10) and included hedged currency classes. All respondents who commented on this CP supported the principle of allowing class-specific currency hedging so the FSA amended COLL accordingly. This took effect from the 6 March 2007 (Handbook 63).

The amendment of "Rights of Unit Classes" - COLL 3.3.5 R allows AFMs to launch hedged currency classes for UK authorised unit trusts (AUTs) and open-ended investment companies (OEICs). This enables AFMs to use currency hedging transactions for the purpose of reducing the effect of fluctuations in the rate of exchange between the currency of a class unit and either (a) the base currency of the fund or (b) any currency in which all or part of the fund's assets are denominated or valued. The benefit and cost will accrue solely to the investors who have chosen to invest in that class. The ability for the AFM to hedge can potentially reduce or eliminate a currency risk to investment returns.

However there are a number of issues that we recommend the AFM considers prior to commencing the legal, regulatory and operational work required to launch a new class. Firstly the AFM should contact the FSA CIS Authorisations Team (either directly or via legal advisers) to discuss any queries about the documentation changes as this will help avoid potential delays and difficulties when the formal request is submitted.

It is imperative that the AFM engages the key parties to the fund, in particular the Depositary and Auditor in early discussions, in a similar manner to a new fund launch. For example, the AFM will need to discuss and agree the accounting procedures with the Auditor and the Depositary will need to sign off the Prospectus and agree ongoing reporting. The AFM also needs to ensure that the Risk Management Process (RMP) is in place ahead of launching this type of share class.

Regulatory and Constitutional

A hedged currency class cannot be created unless it has specifically been provided for in the constitutional documents for the fund. COLL 3.2.6 R (9) requires that a statement be included:

"(1) specifying the classes of unit that may be issued, and for a scheme which is an umbrella, the classes that may be issued in respect of each sub-fund;

(2) if the rights of any class of unit differ, a statement describing those differences in relation to the differing classes."

Assuming this disclosure is not included, the scheme instrument will need to be amended and submitted for approval under S.251/ Reg 21. If the instrument contains detailed provisions for valuation and pricing of units, these may also require modification.

In the case of a hedged currency class, the Prospectus must disclose the implications of the hedging policy. Examples of such disclosure include:

· The Prospectus must clearly describe the general currency hedging strategies;

· Where the fund intends to invest in assets denominated in currencies other than the base currency, the Prospectus should disclose whether it is the intention of the fund to hedge the resulting currency, and if so, to what extent;

· A statement indicating the extent to which the fund intends to hedge against currency fluctuations, making it clear that the 100% hedging will not be a perfect hedge. We recommend that a buffer or cushion is applied to the hedge and this is disclosed in the RMP document.

· A statement confirming that the AFM will review the hedging position on each day that there is a valuation point or dealing date, adjusting the hedge when there is a material change to the dealing volume.

· A statement confirming whether the total return is being hedged or just the capital;

· A disclosure that the costs and gains/losses of the hedging transactions will accrue only to the relevant class;

· An additional risk disclosure should be included for the hedged currency share class. For example, AFM's attempts to mitigate the effects of exchange rate fluctuations between the currency of the hedged currency class and the fund but the AFM cannot guarantee that this strategy will be successful in completely eliminating the effects of adverse changes in exchange rates; and

· An explanation of any potential risk of contagion in other classes (as described below).

The Simplified Prospectus will need to reflect, in summary form, any relevant changes to the Prospectus, especially the risk section.

Unitholder Communication

The AFM will need to decide, in conjunction with their Depositary, whether the introduction of the new class is a fundamental, significant or notifiable change. A number of factors are relevant here:

1. Whether the AFM needs to adopt new investment and borrowing powers (likely to be fundamental), or to begin using powers already provided for in the Prospectus but not used in practice (likely to be significant).

2. What potential the hedged class has to affect unitholders in other classes (e.g. the contagion issue). Assuming the AFM will rely on a systems and controls approach to risk mitigation and will not indemnify unitholders of unhedged classes against any hedging loss, the introduction of the hedged class is, in the FSA's view, likely to be significant as it represents a risk which may cause existing unitholders to reconsider their participation in the scheme. A contrary view might be argued that a very large fund is unlikely to be impacted significantly by an extremely small hedged class - but where the AFM's intention is to attract substantial new investment to the fund through this class in the medium/long-term, it should notify investors on that basis.

Operational and Accounting Issues

The AFM needs to ensure that the appropriate methodology and systems are in place to support the hedged currency class. We recommend that as part of the fund set up procedures ("operating memorandum"), the AFM seeks sign off from the key parties to the scheme (e.g. auditor, depositary, administrator) and that appropriate pricing methodology, procedures and systems are in place, both for the initial launch and the ongoing operation of the hedged currency class.

Before the hedged currency class is launched, the AFM must discuss and agree with the Depositary and Auditor whether (1) the total return will be hedged or (2) just the capital. A cost benefit analysis may need to be undertaken to justify which route is followed.

If the total return is hedged, the AFM will have to capture additional data e.g. daily profit and loss, review the yield and adjust the tax treatment to the fund. Essentially, split the gain or loss on the hedging instrument between capital and income which will also require system/procedural enhancements.

If only capital is to be hedged, one proposal is for the AFM to calculate this by netting off the yield in order to determine the amount to be hedged.

Whichever route is taken, the Prospectus needs to make clear whether the share class is hedging on a total return basis or just capital and that it fits into the policy of the fund.

In respect of SORP 2.28 and the treatment of derivatives on the balance sheet, both the motive and circumstances in the use of derivatives are important in establishing whether items should be treated as income or capital and will be determined on a fund by fund basis. It would be fair, however, to say that in most circumstances the share class currency hedge would, primarily, relate to the capital portion of a fund. Such derivative transactions would, from an operational stance, need to be clearly segregated so that they can be directly related to the hedged currency class to ensure appropriate valuation of shares/units in the class. This needs to be reflected in the Operating Memorandum.

The ability to offer hedged currency classes in the UK, is welcomed not only because it brings the UK into line with other European jurisdictions but it also provides additional flexibility to our products and most importantly, gives more choice to the investor. 

Juliette Home
Senior Adviser - Product Regulation
Investment Management Association London

A New Alternative Fund Regime in Luxembourg

The new law on Specialized Investment Funds (SIFs) should help make Luxembourg a prime location for alternative investment structures by John Parkhouse

The law that came into force on February 13, 2007 in Luxembourg is designed, amongst other things, to facilitate relationships between sophisticated investors and alternative investment houses. By extending the scope of eligible investors and eligible assets, the law provides a useful tool to fund providers and product developers everywhere within a jurisdiction well known for both its innovation and investor protection.

Launch Process of a SIF

The SIF law made it far easier to establish alternative investment-type funds. Replacing the existing 1991 law on institutional funds, the new law importantly allows a SIF to be established without prior permission from the "Commission de surveillance du secteur financier (CSSF)". Thus, among other far-reaching changes, the law will significantly reduce time to market for these funds. Other simplifications and changes include:

· The need to file an application for the SIF's approval with the CSSF within only a month following its creation;

· The fact that a promoter is no longer required and that the investment manager will not be subject to CSSF scrutiny. In addition, the depositary bank, while required in Luxembourg, has reduced responsibilities;

· The regulator only requires an annual audited report i.e no semi-annual or other similar reporting is required;

· A minimum requirement exists of one NAV calculation per year;

· The fund may be structured in corporate (SICAV), contractual (FCP) or partnership form and may be open or close-ended;

· The annual tax duty remains at one basis point, calculated on the SIF's net assets.

Note that existing 1991 funds automatically became SIFs when the law was enacted.

Increasing the Scope of Eligible Investors and Eligible Assets

The new law widens the scope of eligible investors to include not only institutional investors but also professional and 'well-informed' investors. The latter includes private individuals who:

· Formally adhere to the status of "well informed" investors (meaning they are able to understand the risks of investing in the SIF).

· Invest a minimum of 125,000 euros in the SIF. This minimum investment may be waived if a credit institution, investment firm or management company endorses an individual's ability to appraise the SIF's risks and opportunities.

The range of eligible assets is unlimited: private equity, alternative strategies, real estate and commodities are just a few examples. The law now allows high net worth individuals and their advisors/managers to launch products tailored to their own needs, while institutional investors can create new alternative vehicles, or repatriate existing funds into a safe, regulated environment. The new law basically permits a higher degree of flexibility at the product set up and client target level phases whilst maintaining the scope of investment strategies available under the old institutional fund regime. This also means that fund providers no longer need to adopt a multi-jurisdictional approach to product development. Risk diversification requirements remain, but the prior law's quantitative limits disappear - it is up to the managers of each SIF to determine quantitative limits subject to the approval of the CSSF.

In addition to the huge success enjoyed by Luxembourg as a centre for mainstream fund products, Luxembourg has also quietly become successful in each of the key alternative asset class fields. The new law serves to boost Luxembourg's positioning in this burgeoning sector. It also caters effectively to the demands of private banking/wealth management firms seeking discreet, low cost and flexible products for their private client base.

The SIF framework is generating a significant amount of interest, not only in the alternative classes, but also, in more traditional mainstream classes, as the SIF can be used to efficiently and effectively incubate new strategies. The SIF's flexibility combined with the established reputation and scale of Luxembourg is a powerful combination and we expect significant growth in this area as a result.

John Parkhouse is an Audit partner and leads the Luxembourg investment management and real estate practice of PricewaterhouseCoopers.
Tel: + 49 48 48 2505
E-mail: john.m.parkhouse@lu.pwc.com

Comparison of selected European vehicles

	Criteria	SIF	Irish QIF	UK LP	Jersey Expert Fund	French Funds	German Spezial Sonder- vermögen
Regulatory	Regulated vehicle?	Yes	Yes	No	Yes	Yes	Yes [Yes for Hedge Funds] /No
	Pre-approval by regulator?	No	Yes	No	No	Yes/No	Yes
	Other than local GAAP?	Yes	Yes	Yes	Yes	No	Yes
	Investment restrictions?	No	No	No	No	Yes	Yes
	Investment in RE, PE, HF?	All	All	RE,PE	RE,HF	RE,PE,HF	RE,HF
	Simplified prospectus regime?	Yes	Yes	N/A	Yes	Yes	N/A
Tax	Subscription tax?	Yes	No	No	No	No	No
	Income tax?	No	No	No	No	No	No
	Access to DTT?	Yes/No	Yes/No	No [Transparent]	No	Yes/No [Depending on legal regime]	Yes
	Withholding tax on dividends paid? (residents/non residents)	No	Yes/No	No	No	No/Yes	Yes
	Standard VAT rate?	15%	21%	17.50%	0%	19.60%	19%
Distribution	Listing possible?	Yes/No	Yes	No	Yes/No	No	No
	Maximum number of investors?	No	No	20	No	No	30
	Minimum investment amount?	Min. €125k	Min. €250k	No	Min. US $100k	Yes/No	No
	Minimum experience required?	Yes	Yes	No	No	Yes/No	Yes
Licensing	Service providers/ persons subject to regulator's approval?	Directors Custodian Auditor	Promoter Investment manager	Manager (not mandatory)	Promoter Investment manager	Custodian Prime broker Auditor	Custodian ManCo

Source: PricewaterhouseCoopers, 2007

IFRS 7 and its Application in the Funds Industry

Garrett O'Neill and Edeona Martin

of the new accounting standard IFRS 7 Financial Instruments: Disclosures by the International Accounting Standards Board (IASB). The standard seeks to bring further clarity to the significance of financial instruments to an entity's financial position and performance and how financial risks are perceived and managed by entities.

IFRS 7 builds on the principles contained in the existing financial instruments' standards IAS 32 and IAS 39, and requires additional disclosures surrounding the balance sheet and income statement as well as qualitative and quantitative disclosures not required by the previous standards. IFRS 7 applies to all entities required to prepare IFRS financial statements, including funds, and applies to all risks arising from financial instruments, except those specifically covered in separate standards.

almost two years ago, it only applies for annual periods beginning on or after 1 January 2007. Therefore, its application in practice is yet to be seen. However, we are now midway through the first period to which this standard applies, and in addition, the standard requires comparative information relating to 2006, and therefore, the additional requirements of this standard over and above those already existing within International Financial Reporting Standards are becoming a real issue for the preparers of financial statements.

The purpose of this article is to highlight someofthekeychangeswhichIFRS7will require and briefly consider the specific implications for the fund industry.

Objective

The objective of IFRS 7 is to provide users with enhanced information in order to evaluate:

instruments for the entity's financial position and performance;

· The nature and extent of risk exposures arising from financial instruments (quantitative disclosures); and

· The approach taken in managing these risks (qualitative disclosures).

While IFRS 7 complements IAS 32 and IAS 39, it differs from the current practice contained in these standards and requires amongst other items, the following principal new disclosures:

Balance Sheet Disclosures

· Carrying amounts of financial assets and financial liabilities under each of the categories in IAS 39 (held to maturity, available for sale, loans and receivables, designated at fair value through profit or loss, trading, other liabilities). IAS 32 required such disclosure only for financial assets designated as at fair value through profit or loss.

· Fair value movement on financial liabilities designated as at fair value through profit or loss arising from changes in credit risk.

· Additional information on loans and receivables designated as at fair value through profit or loss.

Income Statement Disclosures

· The net gain or loss for each category of financial assets and liabilities must be disclosed separately.

· Separate disclosure of fee income and expense other than amounts already included in determining the effective interest rate.

Disclosures on Accounting Policies, Hedge Accounting and Fair Value

· Detailed disclosures regarding "day one" profits arising from the use of valuation techniques.

· New disclosure requirements for financial assets that are either past due or impaired.

· Additional disclosures where fair values are determined in whole or in part using valuation techniques which use inputs other than observable market prices. In particular, disclosures are required if changing the assumptions underlying the valuation to reasonable alternative assumptions would have a material effect on the resulting values.

· Additional disclosures regarding hedge accounting.

· Additional requirements on providing sensitivity analysis for market risks and how changes in these risks would have affected profit or loss and equity in the period.

Qualitative Risk Disclosures

IFRS 7 requires the following qualitative disclosures for each type of financial instrument risk, including but not limited to credit risk, liquidity risk and market risk:

· Risk exposures and how they arise.

· Management's objectives, policies, and processes for managing those risks.

· Changes in either of the above from the prior period.

Quantitative Risk Disclosures

The level of detail of quantitative disclosures should be driven by the information delivered to management. Quantitative disclosures should include:

· Summary quantitative data about exposure to each risk at the reporting date.

· Quantitative disclosures about credit risk, liquidity risk, and market risk.

· Concentrations of risk (not just credit risk as previously).

Implications for Financial Statements of Funds Prepared Under IFRS

The implications of IFRS 7 for funds will vary from fund to fund depending on the nature of their activities. However, normally funds will carry all of their financial instruments at fair value, and therefore new disclosures regarding the other categories of financial instruments, permitted under IAS 39, may in most cases be irrelevant for funds. However, this may not be the case in all situations, and some funds may hold certain short term investments at amortised cost in which case additional fair value disclosures may be required.

Additional risk management disclosure is likely to be required in fund financial statements. This is likely to include further detail on disclosures already provided under existing standards relating to risks, how the risks arise, and how the risks are managed. In particular, the new standard requires specific consideration of market risk, liquidity risk, and credit risk, both qualitatively and quantitatively.

One of the key new requirements for funds relates to the requirement to provide sensitivity analysis in relation to market risk. The financial statement will be required to show how profit or loss and equity would have been affected by changes in the risk variables which were reasonably possible at the balance sheet date. In addition, the methods and assumptions used to prepare the sensitivity analysis are required, and the changes in these methods and assumptions from the prior period also need to be disclosed. However, an exemption which may be of considerable use in the industry is that if the entity prepares an alternative sensitivity analysis such as VAR, it may use that in place of the details specified above. Again, however, an explanation of the method used, main assumptions underlining the calculations, and limitations of the method should be disclosed.

Certain funds will invest in various types of loans and receivables, and in this case there may be significant additional disclosure regarding these credit exposures. These will include disclosures regarding maximum exposure to credit risk, methods used to determine fair values, details regarding collateral or credit enhancements, amounts which are either past due, or impaired, and details regarding defaults and breaches.

In relation to income statement disclosures, some further analysis of gains and losses may be required if a fund uses more than one category of financial instrument. Furthermore, any fee income and expense will require separate disclosure.

For funds which continue to use Irish GAAP, the majority of the requirements of IFRS 7 are being brought into Irish GAAP as Financial Reporting Standard 29 ("FRS 29"). FRS 29 also applies for annual periods beginning on or after 1 January 2007.

Conclusion

To conclude, fund financial statements for 2007 will require revision and additional disclosure to take account of the implications of IFRS 7. The key implications are likely to relate to the provision of sensitivity analysis regarding market risk, further qualitative disclosures regarding each type of risk and how the fund manages these risks, and where relevant, more disclosures regarding credit risk.

Finally, a key challenge will be that this information will also be required for the comparative period. In that regard, entities should at this stage ensure that the data will be available in order to generate this information.

Garrett O'Neill is a partner in the financial services audit division of KPMG in Dublin.
Edeona Martin is a manager in the financial services audit division of KPMG in Dublin

Enquiries Feedback and Points of Contact

Dublin & Cork

Jason Harewood
Head of Trustee Services BNY Trust Company (Ireland) Limited
Tel: +353-1-6428129 E-mail: jason.r.harewood@bankofny.com

Tony O'Brien
New Business Enquiries
Tel: +353-1-6428453 E-mail: tony.w.obrien@bankofny.com

London

David England
CEO of London Trust Companies
Tel: +44 207-964-6715 E-mail: dengland@bankofny.com

Lloyd Dyett
Director of London Trust Companies
Tel: +44 207-964-6741 E-mail: ldyett@bankofny.com

Gavin Mortimer
New Business Enquiries
Tel: +44 207-964-4046 E-mail: gmortimer@bankofny.com

All jurisdictions excluding UK

New Business Enquiries

David Claus
Managing Director
Tel: +322-545-4464 E-mail: dclaus@bankofny.com

Luxembourg

Franck Wassmer
Head Of Depository Bank The Bank of New York (Luxembourg) S.A
Tel: +352 26 34 77 5247 E-mail: fwassmer@bankofny.com

Carlo Montagna
New Business Enquiries
Tel: +352 26 34 77 5450 E-mail: cmontagna@bankofny.com

Belgium

Jean-Louis Dutranoit
Head of Fund Services BNY Mellon Asset Servicing
Tel: +322-545-4300 E-mail: jdutranoit@bankofny.com

To protect the confidential and proprietary information included in this material, it may not be disclosed or provided to any third party without the prior written consent of The Bank of New York. The information included in this material is provided for general information purposes only and does not constitute legal or professional advice. Neither The Bank of New York nor any of its affiliates accept any liability or responsibility for any losses arising or resulting from any reliance on information included in this material. This limitation of liability applies to all claims and losses of any kind, including (without limitation) loss of profits, business, revenue, goodwill or anticipated saving; and/or consequential or indirect loss.

Contents

The Bank of New York Mellon Corporation European Fund Focus Summer 2007 17 July 2007 A Newsletter produced by BNY Mellon Trust & Depositary Services © 2007 The Bank of New York Mellon Corporation. All rights reserved

The Bank of New York Mellon Corporation
European Fund Focus
Summer 2007
17 July 2007
A Newsletter produced by BNY Mellon Trust & Depositary Services
© 2007 The Bank of New York Mellon Corporation. All rights reserved