1. The CBI's UCITS and Non-UCITS series of Notices and Guidance Notes prescribe rating requirements for counterparties to:
(a) over-the-counter ("OTC") derivative transactions;
(b) efficient portfolio management techniques including stock lending and repurchase transactions; and
(c) prime brokerage arrangements, with Irish regulated investment funds.
2. The credit ratings referred to in the CBI's Notices are Standard and Poor's short term ratings. An equivalent rating for the purposes of the Notices is one which has been provided by an internationally recognised rating agency and which is deemed equivalent, by the investment fund, to the rating stipulated in the Notice. An implied rating arises, in the normal course, where a decision on an unrated entity is made by the investment fund on the basis of the relationship between an issuer and its rated parent, or where an issuer has a senior debt-long term rating but no short term rating.
3. In light of recent credit rating downgrades it is possible that some regulated funds may inadvertently breach the CBI's requirements. In these circumstances, the directors of the investment company/management company/general partner ("the Directors") and the trustee must consider the issues arising, including their obligations to act in the best interests of the investors. They should, as is required in the case of an inadvertent breach of any regulatory requirement, adopt as a priority objective the remedying of that situation over a reasonable timeframe, taking account of those interests. The Directors or trustee must continue to actively monitor the credit worthiness of the counterparty by conducting internal ratings assessments on behalf of the investment fund. A decision to remain contracted to counterparty inadvertently in breach of the CBI's rating requirements should be supported by an internal rating assessment undertaken on behalf of the investment fund. The CBI expects to be informed of any breach and the remediation plan made necessary by a counterparty downgrade and the rationale for that proposed approach.
4. In a new development for prime brokerage arrangements, without any intention to pre-empt the decision of the directors of the Directors or trustee, the CBI would, in principle, and taking section 3 of Guidance Note 2-11 into account, permit that, in the event of a downgrade of the credit rating to not below A-2, or equivalent, the relationship between the prime broker and the authorised investment fund remain in place where net exposure of the fund to the prime brokers is maintained at less than 40 of net asset value (or 20%/30%) in the event that the Irish regulated investment fund is a professional investor fund).
5. Finally, the CBI points out that Irish regulated investment funds entering into new OTC derivative transactions, efficient portfolio management techniques or prime brokerage arrangements must adhere to the requirement of the CBI's Notices and Guidance Notes.
The new development whereby the CBI will permit a prime broker relationship to remain in place in the event of a credit rating downgrade to not below A-2, or equivalent, (provided the exposure limits outlined above are met), will be of benefit to investment funds with multiple prime broker relationships and may be a useful trigger for directors of the investment company/management company/general partner to consider adding additional prime brokers to mitigate credit rating downgrade risk.
Separately, as at the date hereof, the Irish Stock Exchange ("ISE") credit rating requirements have not currently changed in light of the CBI letter. As long as one of the credit rating agencies rate any prime broker-counterparty at a minimum of: P-1 by Moodys, A-1 by Standard & Poors or F1 by Fitch for short term debt, the ISE will take the higher of the three credit ratings or the credit rating of the parent company if a subsidiary acts as prime broker-counterparty.
It is not currently clear what action the ISE will take if the credit rating falls below these levels or if the short term credit rating falls below P-2 by Moody's, A-2 by Standard & Poor's or F2 by Fitch for funds listed on the ISE with maximum exposure to a prime broker limited to 40% of the net asset value of the fund. It is our understanding that the ISE will view each downgrade on a case by case basis.
This is a welcome albeit small step by the CBI which does not represent a significant development in this area. Credit rating downgrades may still present regulatory issues for Irish regulated funds using prime brokers and OTC counterparties - over and above any commercial factors associated with such downgrades that Irish regulated funds still need to consider.
UCITS V Update
On 3 July 2012, the European Commission published its legislative proposal for UCITS V in the form of a draft directive. The directive sets out proposed changes to the UCITS depositary function and UCITS manager's remuneration and proposes the empowerment of Member States' competent authorities with investigative powers and administrative sanctions.
Whilst the European Commission has not proposed a consultation process in respect of the draft directive, available here, Maples is represented on the UCITS V Taskforce of the IFIA which is charged with responding to the European Commission with industry comments on this legislative proposal. On that basis, please feel free to provide your comments on the draft directive to us.