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Article by Darren Burrows, Funds-Axis Limited Tuesday 9th February 2010	Ireland Focus: Derivatives
http://www.financialregulator.ie/in...

A fund can have multiple share classes and those share classes can be differentiated on the basis of currency, distribution policies or charging structures.  Currency hedging at share class level is also available - whereby the costs/benefits of the hedge transaction is allocated to the share class, rather than to the pool of assets as a whole.

In Ireland, Guidance Note 3/99 – “Share classes – hedging against exchange rate movements” sets out the requirements of the Financial Regulator in relation to the creation of hedged share classes.

Now the Financial Regulator has issued Policy Note 1/2010 which sets out new arrangements which will be acceptable going forward, particularly as regards the use of derivatives at a shareclass level.

The Financial Regulator will permit financial derivative instruments at share class level where their purpose is to effect currency and interest rate hedging (subject to the principles set out in Guidance Note 3/99) and different distribution policies or fee structures at share class level.

The Financial Regulator will also consider proposals where financial derivative instruments may be used at share class level to provide:

• a different level of participation in the performance of the underlying portfolio; or
• different levels of capital protection.

In such cases, the financial derivative instrument for each share class must be based on the same underlying portfolio or index.

Moreover, the transactions cannot result in a leveraged return per share class, i.e. the  participation rate can be up to but not exceeding 100% of the relevant share class’s performance of the underlying portfolio.

The Regulator acknowledges that there is a very significant issue to be dealt with as regards the issue of segregated liability – it would be wrong for one share class to enjoy the benefits of the derivatives usage but for all share classes to assume the risk, in terms of the possibility of liabilities arising greater than the assets of the shareclass.

Where there are financial derivative instruments per share class, other than for the purposes of currency/interest rate hedging are proposed, the Financial Regulator will require:

• A legal opinion that the over-the-counter counterpartys recourse to the CIS is limited to the relevant share class’s participation in the CIS‟s assets; and
• Confirmation from the board of the CIS/management company that they have reviewed and are satisfied that the proposal will, as a result of the agreement between the CIS and the over-the-counter counterparty, not result in any prejudice for investors in one class over another. The board must also confirm that there will be no cross liability between share classes.

Other arrangements will be considered on a case-by-case basis.