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    Applying Expertise Beyond Regulatory Guidance

    Posted by Ben Richards on Aug 23, 2022

    Shareholding Disclosure requires investors to aggregate different asset classes and investment types depending on the jurisdictional and regulatory requirements. These requirements can be as simple as saying only include Equities in the calculation to more complex requirements such as include only cash settled derivatives or include only derivatives that settle within 60 days.

    Driven by regulation, Compliance teams will make their interpretation and then ensure their compliance system accurately reflects the requirements and are able to correctly calculate exposure through such investments.

    Getting this wrong, and incorrectly including or excluding an investment from a rule/regime could result in a missed disclosure and subsequent fine and reputational damage for the investment firm.

    “Should a swap on a convertible bond on issued shares be included in the Japanese regulation”?

    “Should a convertible bond on a depositary receipt on a preferred equity be included in the European Short Selling rules”?

    In managing Shareholding Disclosure requirements for over 100 clients, FundApps have seen how complex it can be to interpret whether an investment should or should not be included by a jurisdiction and then correctly calculating exposure through such an investment. FundApps refer to these most complex investments as “multi levelled assets”.

    This blog post will share how FundApps have:

    1. Established a regulatory framework for how an investment should or should not be included in a Shareholding Disclosure check 
    2. Ensured the exposure to an issuer through a given investment is correctly calculated

    Regulatory Framework

    Regulatory guidance doesn't go into specific detail on which multi-levelled assets should or should not be included in shareholding disclosure rules. It is here, where FundApps’ expertise can add value beyond legal information providers in determining which derivative constructs should or should not be included by the regulation.

    When deciding whether a multi-levelled asset is in scope for a given rule/regime, FundApps will generally employ the following heuristic: it will be considered in-scope if the asset classes of all instruments in the multi-levelled asset construction are in-scope and any conditions related to each asset class are satisfied.

    For example:

    1. Swap > Right > Equity. For a given rule, this construction will be in-scope if the legal information indicates that Swaps, Subscription Rights, and Equity are individually in scope. If a rule excludes Rights, then this multi-levelled asset will be out of scope.
    2. Option > Convertible Bond > Issued Equity. For a given rule, this construction will be in-scope if the legal information indicates that Options, (Covered) Convertible Bonds, and Equity are in-scope. If a rule excludes uncovered convertibles then this asset will be out of scope.

    In certain cases, FundApps might deviate from this rule but will include an explanation when this is done. We remain open to input from our client community if one can provide explanatory arguments to the contrary based on wording from, in order of preference: 1) the legal memorandum we use, or 2) other official or legal sources. Whether your compliance team chooses to go into such detail when interpreting regulation, the FundApps team have taken this as an opportunity to deliver value to our clients beyond legal information providers and make interpretive calls based on our experience in the shareholding disclosure regulation.

    To implement such a regulatory framework requires having a system that can check criteria on instruments at any level of a derivative. FundApps are able to support these requirements by as an example, being able to include a Swap -> Convertible Bond -> Issued Equity in a jurisdictional rule but exclude a Swap -> Convertible Bond -> Unissued Equity in the same rule.

    Calculations

    Having established:

    1. A regulatory framework on how to determine which multi levelled assets must be included or excluded from Shareholding Disclosure rules
    2. A system capable of implementing such a framework. 

    The final piece in the puzzle requires being able to correctly calculate exposure to the underlying issuer through such investments and ensuring that these calculations remain correct.

    FundApps’ approach to this challenge is by applying test driven development approach to creating automated rule tests which run each time a change is made to a regulatory rule, validating that calculations have not changed and the expected results from a given input is still correct.

    How FundApps help?

    If your firm is trading complex derivative products and any financial product with more than one reference instrument, having a service that is able to support the regulatory checks against these and accurately calculate exposure via such holdings has to be a key part of your compliance process.

    FundApps’ Regulatory Content team are experts in Shareholding Disclosure regulation and reduce the risk of investment managers missing disclosures by implementing a regulatory framework that determines which assets should and should not be included in rules/regimes so clients don’t have to. With over 100 clients approving every change in a rule, any regulatory interpretation is validated by the community of FundApps users, reducing the risk of a missed disclosure due to regulatory interpretation. Get in touch now.