Circular 1/2012 of the National Securities Market Commission modifying Circulars 6/2010, 4/2008, and 3/2006 regarding collective investment institutions

OFFICIAL STATE GAZETTE No. 186 Saturday, August 4, 2012 Sec. I. Page 55789 I. GENERAL PROVISIONS NATIONAL SECURITIES MARKET COMMISSION 10479 Circular 1/2012, of July 26, of the National Securities Market Commission, amending Circular 6/2010, of December 21, on operations with derivative instruments and other operational aspects of collective investment institutions; Circular 4/2008, of September 11, on the content of the quarterly, semi-annual and annual reports of collective investment institutions and the position statement; and Circular 3/2006, of October 26, on explanatory prospectuses of collective investment institutions. Circular 1/2012, of July 26, of the National Securities Market Commission, amending Circular 6/2010, of December 21, on operations with derivative instruments and other operational aspects of collective investment institutions; Circular 4/2008, of September 11, on the content of the quarterly, semi-annual and annual reports of collective investment institutions and the position statement; and Circular 3/2006, of October 26, on explanatory prospectuses of collective investment institutions. On December 21, 2010, Circular 6/2010 of the CNMV was approved, regulating the operation of financial derivatives by CIIs. Its content not only incorporates developments already existing in the repealed Circular 3/1998 of the CNMV but is also in line with those approved up to that moment at the European level, specifically Directive 2010/43/EU on organizational requirements, conflicts of interest, conduct rules, risk management, and content of the manager-depositary agreement, as well as a Level 3 document on risk measures and calculation of global exposure and counterparty risk for UCITS («Guidelines on Risk Measurement and the Calculation of Global Exposure and Counterparty Risk for UCITS-CESR/10-788:»). This is of special relevance as it develops valid methodologies for measuring the limit on global exposure through operations with derivatives of UCITS, specifically: The standard commitment methodology (or «commitment approach», Relative VaR or Absolute VaR). In the preamble of these Guidelines, it was highlighted that the industry demanded the ability to apply additional global exposure methodologies for Structured UCITS, which is a type of institution that in Spanish regulation falls under the category of CIIs with a specific return objective. The problem concentrates primarily on the launch of certain structures incorporating exotic options (especially those incorporating «barriers» or «digital» options), which would make their launch impossible if existing counting methods under the commitment methodology were applied (which are based on the use of delta to convert derivative exposure into its cash equivalent). At the time of the approval of Circular 6/2010 of the CNMV, no development had been issued at the European level, until on March 28, 2012, ESMA published the «Guidelines on Risk Measurement and Estimation of Global Exposure of Certain Types of Structured UCITS», in which additional criteria are defined for the application of the commitment methodology to the aforementioned institutions. Therefore, the first objective of this Circular is to incorporate these developments into the regulation. Secondly, other modifications are introduced in Circular 6/2010 with the aim of adapting and updating the regulatory framework to the new requirements and circumstances of the markets as well as to the nature of certain CIIs. Thus, modifications are introduced in the counterparty solvency analysis established in rule 20 of Circular 6/2010, with the objective of incorporating recommendations and initiatives that have emerged at the European level regarding «over-reliance» on credit ratings, as well as to seek greater alignment with the content of the UCITS Directive. This modification is carried out under the provisions of the new wording of article 48.1.g) 2nd of the Regulation developing Law 35/2003 on CIIs, which establishes that counterparties, to be eligible, must comply with what is established by the CNMV. Specifically, counterparties presenting sufficient solvency at the judgment of the manager to meet their obligations will be valid. To this end, the manager must perform a credit risk analysis of the counterparty, using appropriate methodologies and considering different indicators or parameters commonly used in the market. Additionally, an exception to these solvency requirements is included for those counterparties that settle operations through the direct intervention of a central counterparty clearing house, as for these operations the regulation exempts the counting of their counterparty risk. On the other hand, this new approach in the solvency analysis affects the wording of certain provisions of Circular 6/2010 that refer to the requirement of a specific credit rating; specifically, certain sections of rules 4th and 22nd of said Circular are modified. Thirdly, modifications are introduced in both rule 22nd and rule 21st with the objective of complying with the requirements for eligibility, counting, and reinvestment of collateral received in CII operations (both of derivative instruments and temporary acquisitions, simultaneous purchases, securities lending, etc.) required at the European level with the approval of the «Guidelines on ETF and other UCITS issues». Fourthly, rule 25 section 4 of Circular 6/2010 is modified in order to clarify scenarios for maintaining certain subsequent non-compliances in funds with a specific return objective, when their resolution would harm the achievement of said objective, specifying actions in these scenarios for investor protection. Fifthly, the wording of rule 26.5 of Circular 6/2010 is modified, which requires (as did the already repealed Circular 3/1998) that entities guaranteeing CIIs with a specific guaranteed return objective to the CII by a third party (commonly known as «internal guarantee funds») must meet the same solvency requirement that the regulation demands of counterparties in derivative instrument operations. The requirement of this credit rating criterion is intimately linked to the fact that internal guarantee funds are exempt from complying with most of the limits of current regulation. Specifically: global exposure limit in derivatives and diversification limit in underlying instruments of derivatives (points 3 and 4 of article 52 of the RIIC), as well as counterparty limits for operations with derivative instruments. However, the regulation demands the credit rating requirement for all guarantors of internal guarantee funds, causing situations of legal arbitrage with those CIIs where the guarantee is provided to the participants (commonly known as «external guarantee funds») for which the regulation does not demand a solvency requirement from the guarantor entities. For all these reasons, the aforementioned rule is modified with the objective of specifying that the minimum credit rating requirement (specifically, not lower than that of the Kingdom of Spain at any given moment) will only be demanded from guarantors of internal guarantee funds that are going to exceed the limits established by the regulation regarding operations with derivatives. In addition to this requirement, it is also demanded that said guarantors present sufficient solvency at the judgment of the manager, to meet their obligations. cve: BOE-A-2012-10479

OFFICIAL STATE GAZETTE No. 186 Saturday, August 4, 2012 Sec. I. Page 55790 This proposal will allow a significant number of entities not to be forced, as the only resource, to the granting of an external guarantee, which, compared to internal guarantees, presents a more unfavorable tax treatment, is not applicable to all investors, and also implies that management entities bear higher administrative and operational costs (having to incur, if necessary, individual payments to each of the fund's participants versus a single payment to the fund in internal guarantee funds upon maturity of the guarantee). Sixthly, it has been clarified in Rule 13th of Circular 6/2010, on determination of commitment in other CIIs, that this rule does not apply to CIIs of free-investment CIIs regulated in article 74 of the CII Regulation with regard to their investments in free-investment CIIs or similar foreign CIIs, as otherwise the investment universe of these CIIs would be restricted. Seventhly, with the objective of promoting the electronic processing of documents before the CNMV, as well as facilitating the availability of information to the public, the modification of Circular 4/2008 on the content of the quarterly, semi-annual and annual reports of CIIs and the position statement is proposed, in order that the annual report of CIIs and SGIICs, which comprises the annual accounts, the management report, and the audit report, be submitted to the CNMV through the CIFRADOC/CNMV service, in the CNMV Electronic Registry as a standardized electronic document, in accordance with what is established in the Resolution of the President of the National Securities Market Commission of November 16, 2011, by which the CNMV Electronic Registry is created and regulated, instead of through the physical presentation of documents in the CNMV registry, as is currently the case. Additionally, an Additional Provision 1st is included demanding that ESI and their consolidatable groups remit to the CNMV the financial information to which they are obliged and the internal control and capital self-assessment reports, through the CIFRADOC electronic service, with the objective of promoting the electronic processing of financial reports before the CNMV, as well as, if applicable, facilitating the availability of information to the public. Eighth and finally, letter e) of section 2 of rule fourth of Circular 3/2006, on explanatory prospectuses of Collective Investment Institutions, is modified, specifying that modifications in the credit quality of fixed-income assets will not be considered essential elements of the prospectus as long as, at minimum, the rating of the Kingdom of Spain is maintained and the purpose of the fund is not distorted. With this, it is intended to facilitate managers' capacity to adapt quickly to market conditions in the event of changes in credit ratings without prejudice to transparency with investors, as this would require the prior publication of a relevant fact to that effect. On the other hand, section 2 of rule sixth is modified to specify that modifications granting the right of withdrawal are those of an essential nature. Rule 1st. Adaptation of the content of rules 4, 20 and 22 of Circular 6/2010 regarding solvency requirements and others approved at the European level.

1. Rule 4th section 1 letter c) of Circular 6/2010 is modified, which will have the following wording: «c) When the entity carries out management strategies with derivative instruments in which no additional exposure is generated as it would be equivalent to that obtained through cash investments. In any case, the management entity must ensure, through the analysis of their characteristics, that the cash investments held cannot expose the CII to additional risks, among others interest rate and credit risks, so they must correspond, among others, to investments from issuers regulated under article 50.2 letter b) of the Regulation of Law 35/2003 or temporary acquisitions of said assets, in both cases with maturity terms less than 3 months and presenting high quality.» cve: BOE-A-2012-10479

OFFICIAL STATE GAZETTE No. 186 Saturday, August 4, 2012 Sec. I. Page 55791 2. Rule 20th section 1 and 2 of Circular 6/2010 is modified, which will have the following wording: «1. As established in article 48.1.g) 2nd of the Regulation of Law 35/2003, a CII may carry out operations with counterparties presenting sufficient solvency at the judgment of the manager to meet their obligations. To this end, the manager must perform a credit risk analysis of the counterparty, using appropriate methodologies and considering different indicators or parameters commonly used in the market. The above requirements will not be applicable to counterparties of financial instruments not traded on organized derivatives markets, provided they are settled through central counterparty clearing houses that require the deposit of collateral based on quotations, record the operations carried out, and intervene between the contracting parties acting as buyer to the seller and as seller to the buyer. 2. The solvency requirement will be understood as equally met when the operation is jointly guaranteed or secured by another entity that complies with the indications in point 1 above and the rest of the requirements of article 48.1.g) 2nd» 3. Rule 21st section 4 of Circular 6/2010 is modified, which will have the following wording: «4. Regardless of what is established in article 2.7 of OM EHA/888/2008, in operations of temporary acquisition of assets, simultaneous spot purchase and forward sale operations, and securities lending operations, the counterparty risk that might arise must be measured for the purpose of complying with the limit established in article 51.3 of the Royal Decree developing Law 35/2003. Said risk must be counted by the total agreed amount of the operation, which may be reduced by the market value of the temporarily acquired assets or collateral received, provided they meet the requirements established in rule 22nd» 4. Rule 22nd section 1 letters d) and g) and section 2 of Circular 6/2010 is modified, which will have the following wording: «d) In the determination of the margin of collateral (or «hair-cuts») on the market value of the collateralized risk, market practices and the nature and characteristics of the values received as collateral will be attended to. These collateral margins must be established prudently, through the analysis of the characteristics of the assets, among other cases, when the issuer of the received assets does not have high quality.» «g) Regardless of the fact that the CNMV may expand the list of assets in which collateral may be materialized, the following are considered valid: – Cash. – Deposits in credit institutions that are at sight or can be made liquid, with a maturity not exceeding 12 months, provided that the credit institution has its headquarters in a Member State of the European Union or in any Member State of the OECD subject to prudential supervision. – Shares and participations of CIIs whose investment vocation is «money market» as established in Circular 1/2009 of the CNMV on categories of CIIs based on their investment vocation. – Investments from issuers regulated under article 50.2 letter b) of the Regulation of Law 35/2003. cve: BOE-A-2012-10479

OFFICIAL STATE GAZETTE No. 186 Saturday, August 4, 2012 Sec. I. Page 55792 – Shares admitted to trading on a regulated market, when they are components of an index that meets the conditions provided in article 50.2 d) of the Regulation developing Law 35/2003. – Non-subordinated private debt admitted to trading on a regulated market.» «2. The CII may reinvest the cash obtained as collateral, provided that: a) It concerns liquid assets, for which the management entity must establish controls that allow ensuring their valuation under market conditions and adequate liquidity in terms of usual trading and crossed volumes. b) In no case can the issuer of the assets in which the collateral is reinvested belong to the same economic group as the counterparty. c) The reinvestment of cash must respect the investment policy contained in the prospectus as well as the other investment rules and limits established in articles 50 and 51 and points 3 and 4 of article 52 of the Regulation of Law 35/2003. d) The following assets are considered valid for reinvestment: – Deposits in credit institutions that are at sight or can be made liquid, provided that the credit institution has its headquarters in a Member State of the European Union or in any Member State of the OECD subject to prudential supervision. – Shares and participations of CIIs whose investment vocation is «short-term money market» as established in Circular 1/2009 of the CNMV on categories of CIIs based on their investment vocation. – Public debt issued or guaranteed by a Member State of the European Union or any Member State of the OECD, provided they present high quality at the judgment of the management entity through the analysis of their characteristics. – Temporary acquisitions agreed with credit institutions that have their headquarters in a Member State of the European Union or in any Member State of the OECD subject to prudential supervision, subject to prudential supervision. The CNMV may expand the list of assets in which collateral may be reinvested.» Rule 2nd. Adaptation of the text of rule 25 of Circular 6/2010 to the scenario analysis method in CIIs with a specific return objective. Rule 25th section 3 of Circular 6/2010 is modified, which will have the following wording: «3. For the purpose of complying with the limits established in points 3 and 4 of article 52 of the Regulation of Law 35/2003, the management entity must be in a position to prove that, after the non-valuation period, said limits will not be exceeded after performing scenario analyses both on the underlying and on the parameters affecting the valuation of the instrument. When performing said scenario analysis under the application of the commitment methodology, the criteria defined in the following paragraph may be applied provided that it concerns a CII: – That is managed passively and structured to reach a specific or predefined return objective (or «pay-off») at maturity, maintaining at all times the assets or instruments necessary to guarantee that such return objective is met. That is, those are excluded for which the achievement of the objective requires the application of active management techniques (among others dynamic management, CPPI…) or that are referenced to underlyings whose evolution depends on active management (among others CIIs, indices, baskets of actively managed assets…). – In which the return objective can be decomposed into scenarios of underlying evolution reduced in number, that are simple and independent, so that it can be ensured that the investor can only be exposed to a single scenario at any given moment. – That the prospectus incorporates requirements aimed at preventing the entry of new investors. – Includes a warning informing in a prominent manner that investors who redeem their investment before maturity will not benefit from the predefined return objective and may experience significant losses. CIIs that meet the requirements indicated in the previous paragraph may: – Apply the commitment method in each of the scenarios, giving adequate compliance to the global exposure limit in each of them, and provided that the maximum loss that can be incurred at the moment when a scenario jumps to another does not exceed 100% of the net asset value at the start of the period. For the purpose of performing this analysis, the scenarios contemplated in letters b) and c) of rule 4th of Circular 6/2010 of derivatives not generating an excess exposure may also be applied to each of these scenarios. – In the case of structures whose underlyings are subject to diversification limits, the impact of the return of a single underlying asset, when the CII passes from one scenario to another, must comply with said limits based on the equity at the start of the specific return objective of the CII. The CNMV may define additional criteria for the performance of said scenario analysis in the case that the commitment methodology is applied for compliance with the global exposure limit established in article 52.3 of the RIIC. Additionally, it must be ensured that at the end of the non-valuation period, the size of operations in derivative instruments must be exclusively the necessary to reach the target return, a requirement that must also be controlled and taken into account throughout the life of the return objective in order to avoid deviations between the evolution of the fund's net asset value and the return objective established in the informative prospectus for this reason.» Rule 3rd. Adaptation of the text of Circular 6/2010 in order to develop investor protection in certain scenarios. Rule 25th section 4 of Circular 6/2010 is modified, which will have the following wording: «4. When, for causes unrelated to the manager, the CII incurs in any of the non-compliances established in current regulation, and its regularization could prevent the achievement of the specific return objective established in its informative prospectus, this situation must be communicated immediately to the CNMV, providing detailed information on the non-compliances in which the CII incurs and, if applicable, the measures that could be adopted to avoid conflicts of interest and protect the interests of the participants, among others: detailed communication of the non-compliance in the Periodic Public Information, establishment of cve: BOE-A-2012-10479

OFFICIAL STATE GAZETTE No. 186 Saturday, August 4, 2012 Sec. I. Page 55793 mechanisms or performance of financial operations that provide stability to the evolution of the net asset value and to the con»