Covered Short Sales By Irish UCITS Funds Financial Regulator Policy Change

Policy Change Highlights

The

Financial Regulator issued a revised policy note on October 5, 2007 in relation

to physical short selling by UCITS.

Under

this revised policy, UCITS will now be permitted to engage in covered

physical short sales where the cover is provided through stock borrowing.†

Additional rules apply as set out below. Going forward, this will mean that

UCITS will be able to pursue long/short strategies without being limited to synthetic

replication through derivatives.

Whilst

of particular relevance for 130/30 type funds (see further below), this revised

policy has broad application for UCITS wishing to short sell.

Background to Policy

Change

Prior

to the release of this revised policy note, UCITS were not permitted to engage

in physical short selling but were able to pursue synthetic shorting strategies

by taking short positions through the use of derivatives, subject to the

overriding requirement that global exposure did not exceed 100% of net assets.

Whilst

that global exposure limit remains, the new policy reflects what is happening

in the market place and the market's understanding of what constitutes ìcoverî

and is clearly a welcome development.

The

key point is the acceptance of a distinction between covered and uncovered

short sales.

The

position in relation to uncovered short sales remains - they are prohibited

under Regulation 72 the UCITS Regulations1.

The Revised Policy

The

revised policy now provides that where stock is borrowed before entering into a

physical short sale of that stock, the stock borrowing arrangement will be

considered to constitute cover for the short sale.

The

new policy is subject to the following parameters:

Short

sales are covered through a stock borrowing at the outset, in

accordance with the UCITS Regulations.

The

stock borrowing arrangement must be in accordance with the CESR guidelines

and the assets used by the fund to support the stock borrowing cannot be

passed to the stocklender (although a charge over such assets may be given

by the fund's trustee/custodian).

General

leverage limits are not exceeded

The

strategy is adequately disclosed in the fund's prospectus and risk

management process.

The prospectus must

disclose a clear description of the covered short sale strategy. A risk

factor must outline the unlimited risk of an increase in the market price

of the security that is the subject of the short position.

The prospectus must

contain an indication of the expected level of...