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Abstract: This article discusses an innovative enhanced indexing strategy known as "portable alpha". A portable alpha strategy, in essence, involves overlaying the return from an external fund or internal strategy that has consistently generated alpha with a derivatives-created index exposure. A number of major fund managers in the United States and the United Kingdom have recently launched funds incorporating portable alpha strategies. Steps are also being taken to launch similar products in Australia. The article also considers: the economic rationale for portable alpha strategies; the differences between conventional indexing and enhanced indexing strategies, on the one hand, and portable alpha strategies, on the other; the principal sources of alpha for portable alpha strategies in the United States, United Kingdom and Australia; and the different methods for implementing portable alpha strategies. In addition, the article examines the key issues under Australian law confronting fund managers, pension trustees and other fiduciaries who are considering portable alpha strategies. A typical portable alpha strategy comprises two elements - investing in a discrete source of alpha or implementing an alpha-generating strategy and overlaying that investment with synthetic exposure to an index created by transacting derivatives. Thus, a fiduciary must, first, have the legal capacity authority to invest in the source of alpha and enter into the derivatives. Secondly, the adoption of the portable alpha strategy must be consistent with the duty imposed on fiduciaries, by Australian law, to act prudently when investing the assets entrusted to them.
Portable Alpha Strategies, Indexing, Mutual Funds, Hedge Funds, Prudent Investor Rule
Abstract: This article discusses an innovative enhanced indexing strategy known as "portable alpha". A portable alpha strategy, in essence, involves overlaying the return from an external fund or internal strategy that has consistently generated alpha with a derivatives-created index exposure. A number of major fund managers in the United States and the United Kingdom have recently launched funds incorporating portable alpha strategies. Steps are also being taken to launch similar products in Australia. The article also considers: the economic rationale for portable alpha strategies; the differences between conventional indexing and enhanced indexing strategies, on the one hand, and portable alpha strategies, on the other; the principal sources of alpha for portable alpha strategies in the United States, United Kingdom and Australia; and the different methods for implementing portable alpha strategies. In addition, the article examines the key issues under Australian law confronting fund managers, pension trustees and other fiduciaries who are considering portable alpha strategies. A typical portable alpha strategy comprises two elements -- investing in a discrete source of alpha or implementing an alpha-generating strategy and overlaying that investment with synthetic exposure to an index created by transacting derivatives. Thus, a fiduciary must, first, have the legal capacity authority to invest in the source of alpha and enter into the derivatives. Secondly, the adoption of the portable alpha strategy must be consistent with the duty imposed on fiduciaries, by Australian law, to act prudently when investing the assets entrusted to them.
Abstract: Credit derivatives have, to date, mainly been used to disaggregate and lay-off the static credit risk on loan portfolios (including residential mortgage loans, commercial loans, car loans, credit card receivables, and margin lending receivables), and manage syndication and subparticipation risks. Now, however, with the maturation of the credit derivatives market, new applications for credit derivatives have emerged. This is exemplified by the decisive shift in the global credit derivatives market away from vanilla credit default swaps to more exotic structures. This article discusses the new applications of credit derivatives, namely the use of credit derivatives to: hedge credit risk in M&A transactions; hedge currency convertibility risk; hedge dynamic credit risk; create leveraged positions; enhance investment returns; exploit credit arbitrage opportunities; and create synthetic assets.
Credit derivatives, Securitization
Credit derivatives, securitization
Abstract: This research paper provides a brief introduction to Exchange-Traded Funds (ETFs), and describes the features that distinguish ETFs from other investment instruments (such as index mutual funds, active mutual funds, listed investment companies/trusts and share baskets). The paper explains how ETFs overcome the drawbacks associated with conventional mutual funds and listed pooled investment vehicles. The dual-trading structure of ETFs - whereby investors create or redeem ETF shares - is also discussed. Finally, there is a discussion of the so-called active ETFs that have recently been launched in Germany (by Die Wertpapier Spezialisten) and Australia (by BNP Paribas).
Exchange-traded funds, managed funds
Abstract: This article provides an overview of the Australian hedge fund sector and considers whether hedge funds are appropriate investments, under Australian law, for investment fiduciaries. Under Australian law, fund managers, pension trustees and other investment fiduciaries must act prudently when investing the funds entrusted to them. The traditional formulation of this duty accords paramount importance to the preservation of the capital of the fund. On this basis, it is almost certain that fiduciaries would be barred from investing in hedge funds. It is, however, likely that the Australian courts will follow the lead of the English and United States courts in recasting this duty in terms of modern portfolio theory, thus bringing hedge funds within the universe of (potentially) permissible investments for fiduciaries. In addition, this article examines the Australian law on the delegation of investment powers by fiduciaries and discusses whether an investment in a fund of hedge funds is consistent with a fiduciary's duty to act personally.
Hedge Funds, Alternative Investments, Prudent Investor Rule
Abstract: This article explains the nature of hedge funds and, in particular, the main investment strategies followed by hedge funds. It also provides an overview of the Australian hedge fund sector. The article, in contrast to the majority of the legal commentary on hedge funds, examines hedge funds from the "buy-side" perspective - it considers whether hedge funds are appropriate investments, under Australian law, for fund managers, superannuation trustees and other fiduciaries. Under Australian law, fiduciaries must act prudently when investing the funds entrusted to them. On a strict formulation of this duty of prudence, with its insistence on capital preservation, it is almost certain that fiduciaries would be barred from investing in hedge funds. However, it is likely that the Australian courts will follow the lead of the English and United States courts in recasting the prudent investor rule in terms of modern portfolio theory, thus bringing hedge funds within the universe of (potentially) permissible investments for fiduciaries. Moreover, where a fiduciary invests in a "fund of hedge funds", as opposed to directly investing in a hedge fund, a further issue arises - whether the fiduciary has breached its duty to act personally, since, in a fund of hedge funds, the fiduciary plays no part in the selection and monitoring of the underlying hedge funds. This article examines the Australian law on the delegation of investment powers by fiduciaries and considers the statutory modifications to the common law strictures on delegation.
Abstract: This paper reviews 'Building the Global Market: A 4000 Year History of Derivatives' by E J Swan (published in 2000). 'Building the Global Market' focuses on the use of derivatives in the ancient Middle East (Chapter 2), ancient Greece and Rome (Chapter 3), Bruges and the Italian city states during the Middle Ages (Chapters 4 and 5), Antwerp during the 16th Century, and Amsterdam and England during the 17th Century (Chapter 6), England during the 18th Century (Chapter 7), and England and America from the 19th Century to the present (Chapters 8 and 9). This book is a useful starting point for law and finance academics - as well as derivatives practitioners - interested in the antecedents of modern derivatives transactions. It, however, falls short of providing a comprehensive account of the history of derivatives.
Derivatives, History
Abstract: This article provides an overview of the on-line platforms for trading credit derivatives. The article also discusses the key issue facing parties intending to establish similar platforms in Australia, that is whether or not the operation of such a platform constitutes the establishment or conduct of a futures market in Australia. Finally, the article comments on the new market licensing provisions proposed in the Financial Services Reform Bill 2001 (which is expected to be enacted in October 2001). It is likely that the various credit derivatives presently transacted on-line would, if transacted in Australia, constitute "futures contracts" under the Australian Corporations Law. Accordingly, it will therefore be necessary for the operator of an on-line platform to ensure that the credit derivatives transacted via that platform are, in fact, being transacted on an "exempt futures market" (in order to avoid the civil and criminal sanctions imposed for breaches of the futures licensing provisions of the Corporations Law). The Financial Services Reform Bill introduces a new form of license, the "Australian market license". A party that operates a "financial market" in Australia must hold this license. A financial market includes facilities through which offers to acquire or dispose of "financial products" are regularly made. It is likely that credit derivatives would fall within the definition of "financial products" set out in the Bill. However, it remains unclear whether or not an on-line platform for transacting credit derivatives constitutes a "facility". Notwithstanding this, the Australian Securities and Investments Commission is likely to consider a platform through which a substantial volume of business is transacted as constituting a facility for financial products and thus a regulated financial market.
Credit Derivatives, Internet
Abstract: This article provides an overview of the on-line platforms for trading credit derivatives. The article also discusses the key issue facing parties intending to establish similar platforms in Australia, that is whether or not the operation of such a platform constitutes the establishment or conduct of a futures market in Australia. Finally, the article comments on the new market licensing provisions proposed in the Financial Services Reform Bill 2001 (which is expected to be enacted in October 2001). It is likely that the various credit derivatives presently transacted on-line would, if transacted in Australia, constitute "futures contracts" under the Australian Corporations Law. Accordingly, it will therefore be necessary for the operator of an on-line platform to ensure that the credit derivatives transacted via that platform are, in fact, being transacted on an "exempt futures market" (in order to avoid the civil and criminal sanctions imposed for breaches of the futures licensing provisions of the Corporations Law). The Financial Services Reform Bill, introduces a new form of licence, the "Australian market licence". A party that operates a "financial market" in Australia must hold this licence. A financial market includes facilities through which offers to acquire or dispose of "financial products" are regularly made. It is likely that credit derivatives would fall within the definition of "financial products" set out in the Bill. However, it remains unclear whether or not an on-line platform for transacting credit derivatives constitutes a "facility". Notwithstanding this, the Australian Securities and Investments Commission is likely to consider a platform through which a substantial volume of business is transacted as constituting a facility for financial products and thus a regulated financial market.
Credit derivatives, Internet
Abstract: This article discusses new index-based investments known as "geared beta" strategies. These strategies employ derivative instruments to achieve dramatic outperformance of market returns. Mutual funds which use enhanced indexing strategies can be classified as follows: those that employ securities-based enhancement and those that employ derivatives-based enhancement. Geared beta strategies fall within the second category. The article also briefly explains the other types of derivatives-based index enhancement, including derivatives arbitrage, option overwriting and portable alpha strategies. Geared beta strategies are distinguished from other index enhancement techniques as they have specific objectives that are generally quantified according to index sensitivity (beta). In addition, the article examines geared beta strategies in the context of the over-arching duty of fiduciaries to act prudently when investing the assets entrusted to them. In particular, fiduciaries need to be aware of the compounding nature of the returns generated by geared beta strategies (which typically seek to exceed the daily performance or inverse daily performance of a benchmark index).
Geared Beta Strategies, Indexing, Mutual Funds, Prudent Investor Rule
Abstract: This book provides a practitioner-oriented guide to the key legal and structuring issues that arise in innovative securitisation transactions, under Anglo-Australian law. The transactions on which the book focuses are (i) the securitisation of non-traditional assets and (ii) the disaggregation of financial assets into their component risks and the synthetic securitisation of discrete risks. Chapters: (1) Securitisation - An Introduction; (2) Credit Derivatives - The Gateway to Synthetic Securitisation; (3) Synthetic Securitisation - Should Every Bank have One?; (4) Synthetic Arbitrage - Merger of Credit Derivatives, Securitisation and Asset Management; (5) Insurance Securitisation - Convergence of the Insurance and Capital Markets; (6) Hedge Fund Securitisation - Repackaging Funds of Hedge Funds; (7) Intellectual Property Securitisation - Crystallising the Value of Brand Names and Ideas; (8) Whole of Business Securitisation - Unlocking the Wealth Within
Credit Derivatives, Securitisation, Synthetic Securitisation,
Abstract: This article is concerned with the key legal issue facing institutional investors that have made or are considering hedge fund investments, namely the legal duty to invest the funds entrusted to them prudently. These investors do not, in general, invest for their own account but, instead, undertake investments for the benefit of others. The article is divided into two parts. The first part explains the nature of hedge funds and the chief hedge fund investment strategies. The second part examines the "prudent investor rule" and provides a practical checklist for institutional investors.
Hedge Funds, Alternative Investments, Prudent Investor Rule Governance, Pension Funds
Abstract: Transporting the alpha generated from an active strategy to an index-tracking fund is gaining global acceptance. It is a concept that challenges the conventional notion that the bulk of portfolio returns are derived fom asset allocation. In this article published by the Securities Institute of Australia, the authors examine the evolution of these strategies in the face of converging market portfolios and competitive fee pressures. The article provides a practical example of how a portable alpha strategy can be structured by overlaying an alpha generating Australian equity fund with a strategy that tracks a US equity benchmark using synthetic exposure. The article also discusses portable alpha strategies in the context of the legal duties owed by superannuation fund trustees and other investment fiduciaries.
portable alpha strategies, fiduciary investments, enhanced indexing, synthetic exposure
Abstract: This book is concerned with the corporate governance aspects of managed investment funds, in particular the role and legal obligations of institutional investors in corporate governance and the legal duty of prudence imposed on fund managers and other market participants that have been entrusted with the management of funds by investors. The chapter titles are as follows: 1. Introduction 2. The Responsibilities of Institutional Investors as Shareholders 3. Legal Limits on Institutional Investors engaged in Corporate Governance 4. The Prudent Investor Rule and Index Investing 5. Hedge Funds 6. Innovative Investment Products 7. Socially Responsible Investments.
Corporate Governance, Institutional Investors, Indexing, Mutual Funds, Hedge Funds, Prudent Investor Rule, Credit Derivatives, Securitization, Ethical Investment, Socially Responsible Investment
Abstract: SRI investments in Australia now exceed AUD1.9 billion. A number of high profile superannuation funds have recently embraced SRI strategies, and strong growth is forecast. This momentum, however, has not been matched with a robust legal framework for appraising SRI strategies. The Report addresses the central proposition of SRI - whether it is possible to "invest for good" without any financial sacrifice. Using a unique methodology, the Report tests the effect of removing shares in companies that operate in the so-called "sinful industries" from the market portfolio - these are principally companies in the alcohol, armaments, gaming, pornography or tobacco sectors. Over a seven year period, the analysis concludes that, in the Australian context, investors avoiding shares in the "sinful industries" sacrificed returns of approximately 0.70% per annum. This Report reveals significant differences between the approaches used by different Australian fund managers to construct SRI portfolios. For example, some Australian funds do not exclude undesirable companies; instead, they downweight the shares of those companies relative to the company's market capitalisation. Thus, notwithstanding a fund's "environmentally-aware" or ethical labelling, that fund's investment portfolio may, in fact, include "polluters" and "shooters" (that is, chemical, mining and petroleum companies, and armaments manufacturers).
Ethical Investment, Socially Responsible Investment, Mutual Funds, Prudent Investor Rule
Abstract: This article discusses the legal design and regulatory status under Australian law of the low-value equity derivatives available to retail investors over the internet. These "equity mini-derivatives" comprise equity contracts for differences (which are structured in a similar manner to retail margin lending products), equity spread bets and fixed odds equity bets (both of which are modelled on conventional sports bets). The article examines the three regulatory issues confronting the parties to equity mini-derivatives in Australia, namely (1) are equity mini-derivatives offered on-line "financial products" for the purposes of the Financial Services Reform Act 2001 (which came into force in Australia on 11 March 2002)? Consequently, will the contracting parties be taken to be dealing in financial products or making a market for such products and therefore subject to the licensing provisions of the Act? (2) do equity mini-derivatives contravene the strictures imposed by Australian law on gaming and wagering contracts? (3) do the on-line trading facilities for equity mini-derivatives contravene the strictures imposed by Australian law on internet gambling?
Equity Derivatives, Mini-Derivatives, Equity Bets, On-line Investing, Internet Gambling
Abstract: This book examines the juridical nature and regulation of security interests created by companies over personal property, under the laws of England and Wales, Australia, Canada and New Zealand. The book also considers recent international initiatives relating to cross-border secured transactions and makes reference to the treatment of corporate security interests in Hong Kong, India, Malaysia and Singapore. The chapter titles are as follows: 1. Introduction 2. Explaining Security Interests 3. Attachment of Security Interests 4. Juridical Nature of Liens, Pledges, Mortgages and Charges 5. Perfection of Security Interests 6. Overview of Quasi-Security Interests 7. Rules of Priority 8. Enforcement of Security Interests 9. Charge-Backs and Fixed Charges over Receivables 10. Cross-Border Security Interests.
Charges, Liens, Mortgages, Pledges, Secured Credit, Securities, Security Interests
Abstract: This book examines the equitable doctrine of marshalling as it applies to secured transactions, under the laws of England and Wales, Australia, Canada, Ireland and New Zealand. Reference is also made to selected United States authorities. The chapter titles are as follows: 1. Introduction 2. The History of the Equitable Doctrine of Marshalling of Securities 3. How does Marshalling work? 4. Marshalling of Securities and the Law of Subrogation 5. Marshalling of Securities and other Equitable Doctrines and Remedies 6. The Rationale for Marshalling of Securities 7. Marshalling of Securities and the Common Debtor Rule 8. Exception to the Common Debtor Rule 9. Marshalling of Securities and the Requirement of Proprietary Securities 10. Marshalling of Securities and the Rights of Unsecured Creditors 11. Marshalling of Securities and Third Parties 12. Covenants against Marshalling and other Contractual Constraints.
Exchange-Traded Funds, Managed Funds
Abstract: This article discusses the use by banks of synthetic CLOs (Collateralised Loan Obligations) to manage the credit risk on their loan portfolios and free up the risk capital allocated to such portfolios. The article compares synthetic CLOs with conventional CLOs (in essence, a synthetic CLO involves the issuance of debt securities backed by credit derivatives referable to a pool of loans whereas a conventional CLO involves the issuance of debt securities against the actual pool of loans) and outlines the key advantages of the former over the latter. In addition, the article explains the legal structure of the three main types of synthetic CLO, viz: where the sponsoring bank transfers the credit risk on the entire pool of loans; where the sponsoring bank retains the first loss position in respect of the pool; and where the sponsoring bank retains a super-senior risk position, in conjunction with the first loss position, in respect of the pool of loans.
Credit derivatives, securitization, collateralized loan obligations
Abstract: The current debate on internet gambling has focused on the on-line delivery of conventional betting products, such as lotteries, bets on horse races and bets on sporting events. This article examines a new class of internet betting products, namely products that enable bets to be placed on the future values of individual shares, stock market indices and exchange-traded equity derivatives. The article explains the different types of equity bets that may currently be placed on-line - "spread" bets (which are contracts for differences) and "fixed odds" bets (which are digital options) - and considers the regulatory issues arising out of the provision of on-line equity betting services in Australia. The article discusses the regulatory status of internet equity bets under the Australian gaming and wagering legislation and the Australian Corporations Law. An equity bet will, if it can be characterised as a contract by way of gaming or wagering, be void under the former legislation. However, the Corporations Law creates a safe-harbour from the gaming and wagering legislation for "futures contracts" (a safe-harbour that will be extended to all "financial products" by the amendments to the Corporations Law set out in the Financial Services Reform Bill which is expected to be enacted in October 2001). In addition, a party intending to provide on-line equity betting services in an Australian jurisdiction may need to be comply with the licensing provisions of the Corporations Law governing futures contracts (and, following the enactment of the above Bill, the separate licensing regimes governing dealings in financial products and the operation of financial markets). Finally, the Australian federal government has recently announced plans to impose a blanket prohibition on the provision of internet gambling services in Australia. It is, however, unclear whether this prohibition would extend to internet equity betting services.
Equity Derivatives, Equity Bets, Internet Gambling
Abstract: The vast majority of senior executive remuneration packages in Australia contain share options issued under an Executive Share Option Plan ("ESOP"). It is common for these option entitlements, particularly at the chief executive and chief operating officer levels, to dwarf the cash component of the package. ESOP options perform the important economic function of aligning executive self-interest with the interests of shareholders. This alignment endures only for so long as the options are retained by the executives. Accordingly, an ESOP will invariably prescribe a vesting period during which the participating executives are not permitted to exercise or transfer their options. This article examines how options, in particular option strategies known as "fences" and "zero-cost collars", can be used by executives to extract value or lock-in gains in respect of ESOP option entitlements during a vesting period. The article also considers the regulatory constraints on the use of these strategies. The authors conclude that the substantive disclosure rules of the Australian Corporations Law do not apply to cash-settled fences/zero-cost collars. In addition, the prohibitions against insider trading can be avoided by an appropriately structured fence/zero-cost collar. Finally, the article discusses the corporate governance concerns arising out of the use by executives of fences and zero-cost collars. These option strategies effectively decouple the interests of executives from those of shareholders and consequently destroy the economic rationale for the grant of ESOP options to executives.
Abstract: Institutional investors and traders are beginning to view volatility as a distinct asset class, capable of being invested in and traded in the same manner as other asset classes. This article provides an overview of the use of options to trade volatility (on their own, or embedded in securities such as reverse convertibles) and the new derivative instruments for the trading of volatility (volatility swaps and variance swaps). Volatility derivatives reveal significant anomalies in the regulation of financial markets transactions in Australia. The Australian Corporations Law distinguishes between "securities" and "futures contracts". Volatility derivatives are clearly not securities and, depending on the manner in which they have been structured, may also fall outside the definition of futures contracts. Despite this, where a volatility derivative relates to the price volatility of a security (including shares, bonds and equity options), a dealing in that security by one of the transaction parties will also subject its counterparty to the provisions of the Corporations Law regulating securities. This article examines the application of the Corporations Law prohibitions against unlawful market activity in securities to volatility swaps.
Volatility, volatility swaps, unlawful market activity, false trading, market manipulation
Abstract: During 1999, a number of major Australian insurance companies reported substantial losses flowing from the re-insurance of earthquake, hurricane and tornado risk. This article explains the structure of catastrophe-risk securitisations and other capital market alternatives to the reinsurance of catastrophe risk. The article also considers the major legal issue facing the implementation of these "alternative risk transfer" products in Australia. One of the key features of these products is the assumption of catastrophe risk by parties that will not normally be licensed as insurers in Australia (for example, special purpose vehicles in catastrophe-risk securitisations and the providers of OTC catastrophe swaps). This assumption of risk may constitute the carrying on of an insurance business in Australia. In that situation, the party assuming the risk must be formally authorised to conduct an insurance business by the Australian Prudential Regulation Authority. Failure to obtain the requisite authorisation may lead to the imposition of criminal penalties. In addition, the arrangements under which catastrophe risk has been transferred are likely to be unenforceable in Australia.
Catastrophe Risk, Catastrophe-Linked Securities, Alternative Risk Transfer, Securitization, Insurance
Abstract: This article explains the various types of Collateralised Debt Obligation (CDO) securitisations and provides an overview of "CONDOR" (Collateralised Originated Notes Diversified Obligor Revenues), a CDO securitisation programme established by Citibank in Australia, in late 1999. The article also discusses one of the major legal issues confronting securitisations in Australia: whether or not there has been a "true sale" of the securitised assets to the securitisation vehicle. CONDOR has the ability to issue differentially-rated series of debt instruments against Australian government and corporate debt securities (including asset-backed securities), corporate loans, project finance loans, infrastructure finance loans, housing loans, trade receivables, auto receivables and other receivables. It is also authorised to implement synthetic securitisations of loans and other receivables. Establishing that there has been a true sale of the assets being securitised to the securitisation vehicle is a necessary pre-condition to obtaining off-balance sheet treatment for those assets. In addition, where the securitised assets include loans, a true sale is required to ensure that the risk capital held against the loans is freed-up. This article examines the legal mechanisms for the sale of securitised assets in Australia, stamp duty-efficient sale structures, and the issue of whether notice of the sale must be given to the underlying obligors.
Securitization, Collateralized Debt Obligations, Collateralized Loan Obligations, True Sale, Assignment
Abstract: This article explains the structure of Exchange-Traded Funds (ETFs), and describes the proposed Australian ETFs, as well as the ETFs that have been launched in the United States, the UK and Europe, and Asia. The article also considers the key issues under Australian law confronting fund managers, pension trustees and other fiduciaries who are considering investing in ETFs. Under Australian law, fiduciaries are required to invest the funds entrusted to them in accordance with the "prudent investor rule". However, an allocation of funds to an ETF raises a more fundamental legal issue: has the fiduciary, by investing funds in an ETF, improperly delegated its investment powers and so breached its legal obligation to act personally? This issue arises each time a fiduciary appoints an external manager to invest fund assets, but is particularly acute in the case of ETFs and other managed strategies where the fund assets are committed to a strategy without the ability for the fiduciary to intercede in the strategy. The law on delegation by fiduciaries in Australia is in an unsatisfactory state. The common law places strict limits on delegation - it is only in cases of "necessity", that a fiduciary can depart from its legal obligation to exercise investment powers personally. This principle has arguably been superseded by the broad statutory powers conferred by the Australian Corporations Law on fiduciaries that are responsible for managed funds. In contrast, despite the introduction of special legislation regulating pension funds, questions remain about the ability of pension trustees to invest pension assets in ETFs and other managed strategies.
Exchange-Traded Funds, Managed Funds, Pension Funds, Investment Powers, Fiduciary Duties
Abstract: The "passport" or "perfect trader" option is a new derivative instrument which enables investment managers and other fiduciaries to renounce the losses that might be incurred on investment portfolios. This article provides an overview of the different types of passport options (barrier, chooser, double stake, magic potion, reset, smooth trader and switch passport options), and considers the use of such options by fiduciaries in the terms of the "prudent investor rule". Under Australian law, investment managers and other fiduciaries entrusted with the investment of assets on behalf of others, are subject to an overarching duty to act prudently when investing those assets. Passport options can make the management of investment portfolios less risky by shielding fiduciaries from trading losses. Nonetheless, a fiduciary considering the use of such options must assess their suitability (including the premium being charged) in terms of the risk profile and return objectives of the trust fund.
Passport Options, Investment Managers, Prudent Investor Rule
Abstract: Weather derivatives are a new risk management tool that enables companies to manage weather-related declines in the demand for the products or services supplied by those companies. This article provides an overview of exchange-traded weather derivatives and the application of securitisation technology to the management of weather risk (including an overview of the Kelvin weather risk securitisation sponsored by Koch Energy, in late 1999). In addition, the article considers whether the directors of a company, whose revenues are subject to weather-related volumetric risk, are obliged under Australian law to employ weather derivatives to reduce weather-related volatility in earnings. There is no specific legal duty - imposed either by statute or principles of common law - requiring the directors of an Australian company to use derivatives to hedge price or volumetric risk. However, in view of the Australian cases on directors' duties of care and skill, there is a risk that an Australian court may find directors to be in breach of such duties, where their company suffers a loss due to the absence of an appropriate hedging programme.
Weather Derivatives, Volumetric Risk, Directors' Duties
Abstract: In collective investment products, ranging from retail managed funds and investor directed portfolio services (usually called "wraps") to funds of funds and hedge funds, one or more fiduciaries is interposed between the investor and the market. The regulatory framework for these products is provided, in Australia, by the Corporations Law but much of the detail is still supplied by the general law of fiduciaries that was developed in England in the 19th Century. Under Anglo-Australian law, the parties involved in the management and administration of collective investment products (such as investment managers, custodians and prime brokers) are considered to be in a fiduciary relationship with the investors in those products. Accordingly, an investment manager or custodian who innocently commits funds to an unauthorised investment or permits such an investment to be placed in an investor's portfolio may face a claim for breach of its fiduciary duties to that investor. This article is concerned with the remedies - and, more particularly, the quantum of compensable loss - available to investors where a fiduciary has allowed an unauthorised investment into their portfolio. The law in Australia and, until very recently, England has approached this problem from a perspective that emphasises the preservation of the investor's capital at all costs. This, however, disregards the fact that, in contrast to the traditional Anglo-Australian trusts for which capital preservation was paramount, the investors in collective investment products have explicitly bargained with the fiduciary for their capital to be exposed to the market. Accordingly, this article argues that it is time that the remedies available to investors under Australian law for unauthorised investments took account of this bargain as US law does. Thus, the appropriate benchmark for compensating an investor for an unauthorised investment under Australian law should be the performance of the authorised alternatives, and not the capital committed to the unauthorised investment.
Mutual Funds, Managed Investments, Fiduciaries, Trustees, Investment Managers, Unauthorised Investments, Equitable Compensation
Abstract: Credit derivatives are transforming the ways in which banks and other financial institutions manage credit risk. In contrast to traditional methods of credit risk management, such as loan syndications, risk participations and conventional asset-backed securitisations, credit derivatives permit financial institutions to unbundle and separately lay-off the credit risk on their loan and bond portfolios and trading books. This article explains the legal structure of the main types of credit derivatives (credit default swaps, credit spread products, total rate of return swaps, and credit-linked notes) and examines the key regulatory issues facing credit derivatives in Australia. The first of these issues relates to the status of credit derivatives under the Australian Corporations Law, that is whether such derivatives are "futures contracts". Parties who deal in or advise on futures contracts are subject to licensing requirements. In addition, futures contracts can only, under the Corporations Law, be transacted on a futures exchange or in a specifically exempted futures market. Failure to comply with these requirements attracts both civil and criminal penalties. The question of whether a credit derivative (or any other derivative) is a "futures contract" will, if the reforms proposed in the Financial Services Reform Bill 2000, are enacted be superseded by the question of whether a credit derivative is a "financial product". A party who deals in or advises on financial products will be subject to licensing requirements. In addition, parties who conduct markets in financial products will be required to hold a new financial product market licence. Again, non-compliance with these licensing requirements will attract civil as well as criminal penalties. The status of a credit derivative as a futures contract or a financial product also has significant implications for the application of the Australian gaming and wagering legislation. Futures contracts enjoy the benefit of a statutory safe harbour from that legislation. This protection has also been extended to financial products under the Financial Services Reform Bill. Finally, there is a concern that credit derivatives are contracts of insurance under Australian law and, consequently, that a dealer in credit derivatives will be considered to be conducting an insurance business. Parties, who carry on an insurance business in Australia, must, under the Australian Insurance Act 1973, be formally authorised to do so by the Australian Prudential Regulation Authority. A party that breaches this requirement will be subject to criminal penalties. In addition, it is likely that, in these circumstances, the credit derivatives transacted by the dealer will be unenforceable.
Derivatives, Credit Derivatives, Regulation of Derivatives, Futures Contracts, Insurance, Gaming and Wagering Contracts, Credit Default Swaps, Credit Spread Options, Total Rate of Return Swaps, Credit Linked Notes, Securitisation
Abstract: Equity swaps are routinely used by fund managers and other investors to obtain economic exposure to shares and equity indices, as an alternative to acquiring the shares or index securities. The principal issue facing equity swaps - and other derivatives - in Australia is whether they are "futures contracts" under the Australian Corporations Law. The Corporations Law imposes licensing requirements on parties who deal in or advise on futures contracts, and requires futures contracts to be transacted on a futures exchange or in a specifically exempted futures market. Contravention of these requirements attracts civil as well as criminal penalties. This definitional issue is also critical, in the context of the statutory safe harbour for futures contracts from the Australian gaming and wagering legislation. The regulation of equity swaps in Australia reveals flaws in the "securities/futures contract" dichotomy under the Corporations Law. Dealers in equity swaps typically hedge their exposure via transactions in the underlying shares. The dealer's hedging activities may, however, have unintended consequences for the end-user of the swap. Notwithstanding that equity swaps are likely to be "futures contracts", an end-user, may as a result of the dealer's hedging activities, find itself subject to the provisions of the Corporations Law regulating "securities" (including the takeovers, insider trading and unlawful market conduct provisions). There is thus a real risk that the shares acquired by a swap dealer for hedging purposes will be aggregated with an existing entitlement of the end-user and its related entities, leading to a breach of the takeovers provisions by both the dealer and the end-user. In addition, a recent Australian case has established the jurisdiction of the Corporations and Securities Panel to make declarations of unacceptable conduct in securities, in respect of equity swaps, and consequently issue orders requiring the disposal, or prohibiting the voting, of any of the shares underlying the swap held by the dealer or end-user.
Derivatives, Equity Swaps, Regulation of Derivatives, Futures Contracts, Securities, Gaming and Wagering Contracts
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