UCITS funds, marketed in Europe as relatively safe and transparent vehicles, could be made far more risky than investors realise if new international proposals take effect, according to EM Applications, a risk management firm.

The Committee of European Securities Regulators is proposing, as one option for change, to let funds use a “relative value at risk” measure, which would have the effect that a fund could have a maximum VAR ratio of two compared with its reference portfolio. According to EM Applications, this is dangerously high and recent market shifts would have seen big swings in fund values. (Value at risk is at the maximum loss that can be caused by an adverse market movement).

“Controlling risk and communicating the magnitude of potential losses to investors are crucial for the future success of the UCITS brand. If the rules allow a fund to be twice as risky as a high-risk index, it is certain that somebody will launch such a fund. It is equally certain that, at some point, investors will suffer catastrophic losses,” Peter Ainsworth, managing director of EM Applications, said.

The CESR is trying to create a standardised way of measuring risk in such funds and curb potentially excessive leverage. Its consultation on the matter, which closed on 31 May, lays out a number of proposed changes.

These cross-border funds, which have gone through several versions – the industry is now braced for UCITS 4 – can be purchased by retail investors. In their UCITS 3 guise, they can use derivatives to take short, as well as long, positions in markets. Many investment firms now sell hedge fund “lite” products in UCITS structures.

However, the EM Applications comments suggest that some proposed reforms, if enacted, could cause problems for the UCITS (Undertakings for Collective Investment in Transferable Securities) brand.

EM Applications report says that under the CESR’s proposals, the range of value at risk calculated during a year will be at odds with the risk figure published in the “Key Information Document” on a UCITS fund, which it says is confusing and potentially misleading.

“In recent weeks even mainstream developed market indices have seen daily moves of the order of five per cent, implying a UCITS fund with a relative VAR of two would be changing in value by as much as 10 per cent in one day. Clearly, a fund where the investor could lose 10 per cent of their capital in one day is not a safe investment,” the EM Applications report said.