30.4.20 04 Official Journal of the European Union L 144/33 EN 
COMMI SSION  RECOMMEN DATIO N 
of 27 April 2004 
on the use of financial deri vative instruments for undertakings for coll ective investment 
in transferable securities (UCITS) 
(notifi ed under document number C(2004) 1541/1) 
(Text with EEA relevance) 
(2004/383/EC) 
THE COMM ISSIO N OF THE EU ROPEAN  COMMU NITIES, 
Having regard to the Treaty establishing the European Communit y, and in particular Article 
211, second indent, thereof, 
Whereas 
(1) One of the aims of the amendm ents to Counci l Direct ive 85/611/ EEC of 20 Decembe r 
1985 on the coordination of laws, regulations and administrat ive provisions relating to 
undertakings for collecti ve investment  in transferable securities (UCITS)1, introduced 
by Directive 2001/108/EC, was to widen the scope of financial instruments in which a 
UCITS can invest and to enable UCITS to make use of modern investment  techniques. 
This extension of permissible investments does not only include money market 
instruments, bank deposits, units of UCITS and other collective investments 
undertaki ngs: UCITS are now also permit ted to employ financia l derivati ve 
instruments as part of their general investment policy, and not only for the purposes of 
hedging pos itions. 
(2) Another aim of those amendments was to ensure investor protection. Directive 
85/611/E EC, as amended, therefore establi shes an extensive system of risk-lim itation: 
In order to ensure that the risks related to the new classes of financial instruments, in 
particularly regarding derivatives, are duly and accurately monitored, measured and 
managed, management companies or investment companies are required to apply 
sound risk measurement processes  under the supervision of the competent authoriti es. 
In particular, these risk measurement processes should enable them to monitor, 
measure  and manage at any time the risks of the positions and their contributi on to the 
overall risk-pr ofile of the portfolio. Management or investment companies have also to 
employ process es for the accurate and independent assess ment of the value of over-
the-counter (OTC)- derivative instruments. These requirements of Directive 
1 OJ L 375, 31.12.1985, p. 3; Directiv e as last amended by Directiv e 2001/108/E C of the European Parliam ent 
and of the Council(  OJ L 41, 13.2.2002, p.  35).  
L 144/34 Official Journal of the European Union 30.4.2004 EN 
85/611/ EEC call for the establishment  of an adequat e framework for the risk-
measurement and -management of a UCITS by Member States. In order to facilitat e 
the development of such a framework and to ensure a harmonised approach, it is 
desirable to recommend some com mon basic principles for risk-measurement. 
(3) Agreement was reached in the UCITS Contact Committ ee on the benefits of 
formulating basic principles, which should be taken into account by Member States. 
Those princi ples should help Member State s to ensure an equival ent and effecti ve 
protection of investors throughout the Community and level the playing field for 
UCITS operators and products reg ulated under different jurisdict ions. 
(4) With regard to the limit to global exposure relating to derivat ives set out in the first 
subparagraph of Articl e 21(3) of Directi ve 85/611/ EEC and the maxim um limit to 
borrowing transactions laid down in Article 36(2) of that Directive, it should be made 
clear which maximum exposure in total  may be incurred by a UCITS. 
(5) The total exposure of a UCITS needs to be assessed on the basis of both default risk of 
the UCITS and leverage produced by the use of financial derivative instruments. It 
should therefore be ensured that the market risk of a UCITS is adequately measured. It 
is therefore necessary to recommend possible approaches of market risk measurement, 
by clarifying the conditions for the use of the following types of methodologies: the 
commitm ent approach; the Value-at-risk approach (VaR-approach) and stress tests. 
(6) For the same reasons it is useful to recommend some elements for the method of 
assessing the leverage of a UCITS portfolio produced by the use of financial 
derivat ive in strument s. 
(7) Pursuant to the second subparagraph of Article 21(3) of Directive 85/611/EEC, the 
exposure of a UCITS must be calculated taking into account not only the current value 
of the underlying assets, but also the counterparty risk, future market movements and 
the time avail able to liquidate the positi ons. As regards counterp arty risk related to 
OTC-derivatives, specific requirements are laid down in the second subparagraph of 
Article 22(1) of that Directive. In view of these requirements it is desirable to clarify 
the metho d of calcul ating the counterp arty risk associat ed with financi al derivat ive 
instruments and the way in which it relates to the methods and criteria provided for in 
Directi ve 2000/12/ EC of the European Parlia ment and of the Council  of 20 March 
2000 relating to the taki ng up and pursuit of the business of credit institutions2. 
(8) Pursuant to the third subparagraph of Article 21(3) of Directive 85/611/EEC, the 
exposure to the underlyi ng of the financ ial deriva tive instrument has to be included 
into the calculat ion of the issuer concentration limits laid down in Article 22 of that 
Directive. According  to that same provision, Member States may allow that, when a 
UCITS invests in index-based derivatives, these investment s do not have to be 
combi ned to the issuer concent ration limits laid down in Article 22. It is therefore 
appropriate to recommend standards for the applicati on of issuer concentration limits 
with regard to financial derivat ive instrument s. 
2 OJ L 126, 26.5.2000, p.1 
30.4.20 04 Official Journal of the European Union L 144/35 EN 
(9) Uncovered sales are all transactions in which the UCITS is exposed to the risk of 
having to buy securit ies at a higher price than the price at which the securit ies are 
delivered and thus making a loss and the risk of not being able to deliver the 
underlyi ng financ ial instrum ent for settlement  at the time of the maturity  of the 
transaction. These risks are always relevant for those operations in which the UCITS is 
forced to buy securities in the market to meet its obligations. In those cases the UCITS 
is exposed to the risk that it cannot meet  all or a part of its commitments  under the 
terms of a financial derivatives operation. Article 42 of Directive 85/611/EEC 
therefore generally  prohibit s the executi on of uncovered sales in order to avoid heavy 
losses for UCITS. However, in the context  of an operati on with financi al derivat ive 
instrum ents having the financi al profile  of an uncovered sale, the risks typical ly 
associat ed with uncovered sales may not always have the same relevan ce. It is 
therefore  appropriate to clarify the concept of uncovered sales with regard to financial 
deriva tive instruments and to recommend criteria applicable  to the cover of a 
derivatives transact ion in order to facili tate compl iance with Article  42. 
(10) This Recommendation is a first step towards  a uniform understanding of risk 
measurement methodologies in the UCITS area. However, risk-measurement 
methodologies are submitted to a permanent progress. Further steps may therefore be 
necessary taking into account further developments such as the Basle Capital  Accord 
(Basel II) and the future corresponding  Communit y Directive on capital requirements 
for banks and investment firm s. 
(11) This Recom mendat ion provide s some basic elem ents which should be taken  into 
consideration by Member States for their implem entation of Directive 85/611/EEC as 
amended by Directive 2001/108/EC. It should be noted that this Recommendat ion is 
not intended to provide exhaustive guidelines on the use of financial derivative 
instruments for UCITS but to outline some principles which can be considered as an 
essential basis  of a common r isk-measur ement approach for U CITS, 
HEREBY RECOMMEN DS: 
In the framewor k of implementing Directive 85/611/EEC Member States should apply the 
following: 
1. Risk-m easurem ent systems  adapted to the relevant ris k-prof ile of the UCI TS
In applying Article 21(1) of Directive 85/611/EEC, Member States are recommended to 
ensure that management or investment  companies employ risk measurement systems which 
are adapted to the relevant risk-pr ofile of a UCITS in order to make sure that they accurately 
measure all material  risks related to the UCITS under the supervision of the competent 
authorities .
2. A harmonised interpretation of l imitati ons to the UCITS’ risk- exposure
2.1 Limitation t o a UCITS’ global exposure on derivatives and overall  risk exposure
Member State s are recomm ended to ensure that the global exposure relating to financial 
derivative instruments may not exceed 100% of the UCITS’ net asset value (NAV ), and hence 
that the UCITS’ overall risk exposu re may not exceed 200% of the NAV  on a permanent 
basis. 
L 144/36 Official Journal of the European Union 30.4.2004 EN 
2.2 Limitation t o possible temporary borrowing
Member States are recommended to ensure that the UCITS’ overall risk exposure may not be 
increased by more than 10% by means of temporary borrowing, so that the UCITS’ overall 
risk exposure may not exceed 210% of the NAV under any circumstances. 
2.3 Joi nt appl ication of  point s 3 and 4
For the appli cation of the 100% global  exposu re limit relating to derivatives, Mem ber States 
are re comm ended  to ensure  that both points 3 an d 4 a re resp ected. 
3. Ap propri ately cal ibrat ed st andards to me asure ma rket risk
3.1 A dapta tion of risk- measureme nt me thodologies to the risk -profi le of a UCITS
In conform ity with the overarching principle mentioned under point 1 and established in 
Article 21(1) of Directive 85/611/EEC, Member States are recommended to allow a 
differentiate d methodological  approach for the respective categories of “non-sophisticated 
UCITS”, which have overall less and simpler derivative positions by using e.g. a few plain 
vanil la optio ns, and “sophist icated UCITS”. The distinction between , and exact defini tion of, 
these categories requires further work in accordance with point 3.4. Pending completi on of 
such work, Member States should move towards a more calibrated approach for measuring 
market risk in acc ordance with points 3.2 and 3.3. 
3.2 Non-sophisticated UCITS
3.2.1 Use of t he com mitment  approach
Member State s are recomm ended to request their compet ent authori ties to ensure that, in the 
case of non-sophisticated UCITS, they are satisfied that market risk is adequately assessed by 
using the commit ment approach, whereby the derivative positions of a UCITS are converted 
into the equiva lent position in the underlying assets embedded in those derivatives. For the 
applicati on of the commit ment approach, Member States’ competent authoriti es should also 
take into account criteria such as the UCITS’ overall exposu re deriving from the employment 
of financial derivative instruments, the nature, aim, number and frequency  of the contrac ts 
entered  into by the UCIT S and the  managem ent techniqu es adopte d.  
3.2.2  Technical precisions
In the case of options, Memb er States are recom mend ed to allow the application of the delta 
approach, which is derived from the sensiti vity of the change in the option 's price to marginal  
changes in the price of the underlyin g financi al instrum ents. The conversion  of forwards, 
futures and swaps positi ons should depend on the precise nature of the underlyin g contrac ts. 
In the case of simp le contracts, the mark ed-to-ma rket value of the contracts will usually be 
relevant. 
3.2.3 Invitation to cons ider fu rther a dditional s afegu ards
Member States are require d to conside r whether  additional  safeguards  are requested  in the 
context  of the use of the commi tment  approach, such as an appropriate cap to the global 
exposu re relating to financial derivative instruments below 100% of NAV  for non-
sophisticated UCITS. 
30.4.20 04 Official Journal of the European Union L 144/37 EN 
3.3 Sophisticate d UCITS
3.3.1 Standard use of Value-at-Risk (VaR) approach with stress tests
In the case of “sophisticated UCITS”, Member States are recommended to require 
management or investment  companies to apply regularly VaR approaches. In the VaR-
approach es, the maxim um potent ial loss that a UCITS portfolio could suffer within a certain 
time horizon and a certain degree of confidence is estimated. Member States are 
recommen ded to requir e manage ment or investmen t companies  also to apply  stress tests in 
order to help manage risks related to possible abnormal market movements. Stress tests 
measure how extreme financia l or economi c events affect the value of the portfoli o at a 
specific poi nt of tim e. 
3.3.2 Invitation to develop common reference standar ds as a fur ther step
For the application of VaR-approaches , Member States are recommended to require the use of 
appropriate standards in conformity with point 3.1. For this purpose, Member States should 
consider, as a possible reference the following parameters: a 99% confidence interval, a 
holding period of one month and “recent” volati lities, i.e. no more than one year from the 
calcul ation date without prejudice  to further testing by the competent authoriti es. Once 
common standards  have been developed by further work undertaken by Member States in 
accordance with point 3.4, Member States should allow management  or investm ent 
companies to deviate from these standards only on a case-by-case basis, subject to the 
appropria te examina tion of the compet ent authori ties in accordanc e with what is provided for 
in point 3.3.3. 
3.3.3 Inte rnal risk-m easureme nt mode ls
Member State s are recomm ended to accept  only those internal risk-measurement models 
propose d by a management or investment company which are subject to appropriate 
safegu ards, including those set out in this recommendation. The models concerned should be 
subject to appropriate examination by the competent national authoriti es. Member States are 
also recommended to disclose a list of models recognised by the competent national 
authoriti es, and make them publi cly available  by appropriate means. 
3.4 Recom mendation to c arry ou t further wor k
Considering that these risk-measure ment methodologies need further refinement, Member 
States are recommended to encourage their competent authorities to undertake further work 
with a view to elaborating more advanced and elaborated methods of risk-measure ment and 
thus develop a con vergent Community-w ide approach. This concerns in p articular: 
/g190 a) the criteria to identify sophis ticated and non-sop histicated UCITS; 
/g190 b) the conversion of financial  derivative instruments into equivalent underlying assets
and the netting of positions underlying the financial derivative instruments in case of
the application of the commitment approach; 
/g190 c) best pr actices in  the ar ea of VaR an d stre ss tes ts; 
/g190 d) the stan dards  which  internal models mu st meet in order  to be u sed b y UCITS. 
4. App ropriately calibr ated sta ndard s to a ssess lever age
L 144/38 Official Journal of the European Union 30.4.2004 EN 
4.1 Use of the commitment approach
In the absence of the advanced methodologies mentioned under point 4.2, Member States are 
recommended to request the use of the commit ment approach to assess a UCITS’ leverage, in 
combinati on with the VaR-approaches and the stress-tests required for the purpose of 
measuring market risk exposure of sophisticat ed UCITS under point 3.3.  
Member State s are also recomm ended to allow managem ent or invest ment  companies which 
use the commit ment approach according to point 3.2 to also employ the commit ment 
approach f or the ass essment of leverage. 
4.2 Invitation t o allow the use of further advanced methodol ogies
In the case of sophisticated UCITS under point 3.3, provided that the supervis ory authorities 
are fully convinced that a given management or investment company has already developed 
and tested an appropriate method of assess ing leverage by the means of VaR-appr oaches and 
stress tests and provided that this method is duly documented by the management or 
investment company, Member States should consider recognis ing it for the assess ment of 
leverage. For this purpose , Member States are specifically recommended to consider 
approaches  relying on a standard of comparison such as the VaR/stress test value of an 
appropriate reference portfolio which complies with the investment policy of a UCITS or the 
VaR/stress test value of  an adequate benchmark.  
4.3 Recommend ation to carry out further wor k
Membe r States are recom mende d to take into account that the methods for assessing the 
leverage of a UCITS need further refinement, in particular with respect to the maximum 
VaR/stres s-test value corresp onding to a total exposu re of 200% of a UCITS’ NAV . 
Therefore they should encourag e their competent national authorities to undertake further 
work to develop more advanced and sophisticated methods of assess ing leverag e aiming at the 
development of a convergent Comm unity-wide approach.
5. Applying appropr iate standard s and recognise d risk-mitigation techniques to limit
counterpar ty risk
5.1 Criteria for the li mitation of count erparty risk exposure to OTC derivatives
Member States are recommended to ensure that all the derivatives transactions which are 
deemed to be free of counterparty  risk are performed  on an exchange where the clearinghouse 
meets the following conditions: it is backed by an appropriate performance guarantee, and is 
charact erised by a daily mark-t o-marke t valuat ion of the deriva tive positions and an at least 
daily margining .  
5.2 Recom mendation to u se maxim um potential loss
Member States are recommended to require the exposu re per counterparty  on an OTC-
deriva tive transacti on to be measured on the maxim um potent ial loss incurred by the UCITS 
if the counterparty defaults and not on the basis of the notional  value of the OTC contract. 
5.3 Invitation to use the standards laid down in Directi ve 2000/12/EC as a first reference
30.4.20 04 Official Journal of the European Union L 144/39 EN 
In compl iance  with the fixed quantita tive prudential limits alread y impose d by Directive 
2001/108/EC,  Member States are recommended to require the assessment of counterparty risk 
with regard to OTC-derivatives in accordance with the marking-to-market method laid down 
in Directive  2000/12/EC of the European Parliament  and of the Council3, notwithstanding the 
need of appropri ate pricing model s when the market  price is not avail able. Member State s 
should also require the use of the full credit  equivalent approach laid down in Directive 
2000/12/EC, including  an add-o n methodology  to reflect the po tential future exp osure. 
5.4 Recognition of collateral for the purpos e of asses sing a UCITS’  counterparty risk 
exposure
5.4.1 General criteria
Member States are recommended to allow for the recognition of collateral  in order to reduce a 
UCITS’ counterparty risk provided that, in accordance with the prudential rules laid down in 
Direct ive 200 0/12/ EC and t aking i nto acc ount furt her devel opment s, the co llateral:  
/g190 a) is marked-to-market  on a daily basis and exceeds the value  of the amount at  risk; 
/g190 b) is exposed only to negligible risks (e.g. government bonds of first credit rating or
cash) and i s liqui d; 
/g190 c) is held by a third part custodian not related to the provider or is legally secured from 
the consequences of a failure of a rel ated party; 
/g190 d) can be fully enforced by the UCITS at any tim e. 
5.4.2 Ri sk concen tration lim its
In accordance with the general principle of risk-spreading, Member States are recommended 
to ensure that the exposure to counterparty risk on a given entity, respectively group, after 
taking into account any collateral  received from that entity, or group, may not be higher than 
the 20% limit laid down in Directive  85/611/EEC, both at individual  level, under the second 
sub-parag raph o f Article 22(2 ) and at gro up level,  under  Article 22(5)  of tha t Direc tive. 
5.5 Recognition of netting
Member States are recommend ed to allow UCITS  to net their OTC-derivative positions vis-à-
vis the same counterparty, provided that the netting procedures comply with the conditions 
laid down in Directi ve 2000/12/EC and t hat they are based on legall y binding agreements. 
6. Using adequate methodologies when appl ying limit ations to issuer risk
6.1 Adaptation of  the risk-measurement methodologies to the de rivatives typol ogy
Considering that the fourth subparagraph of Article 21(3) of Directive 85/611/EEC provides 
that, in order to include financ ial deriva tive instruments into the issuer concentration limits 
foreseen  by Article 22, they should be converted into equivalent underlying positions, 
Member State s are recomm ended to require  the use of methodologies adequate to the type of 
instrument considered.  For example, Member States may allow the use of the delta approach 
for options. In cases where this approach is not relevant or technical ly impossible, due to the 
compl exity of the concerne d financ ial deriva tive instrument, Member States may then allow 
3 OJ L 126, 26.5.2000, p.1 
L 144/40 Official Journal of the European Union 30.4.2004 EN 
the use of an approach  based on the maximum potential loss linked to that derivative as a 
maximum thr eshold asses sment of  the so lvency risk. 
6.2 Ca se of in dex-ba sed d erivatives
Member States are advised , in the use of their discretio nary powers for the applicati on of the 
option foreseen by the third subparagraph of Article 21(3) of Directive 85/611/EEC, to take 
into account  whether the underlying index of a financial derivative instrument meets the 
requirements of Article 22a of that Directive. For the applicati on of Article 21(2) and the third 
subparag raph of Article 21(3) of that Directive, Member States are recommended to consider 
that, a management or investment company should generally be prevented from using 
financial derivative instruments based on a self-composed index with the intent to circumvent 
the issuer concentration limits of Article 22. Member States are also recommended to 
consider that a management or investment company should be prevented from using financial 
derivative instruments based on indices which do not comply with the concentration limits set 
by Ar ticle 22a of D irective 85/611/EEC. 
6.3 Risk-concentration l imits
Member States are recommended to require management companies or investment  companies 
to cumulate counterparty  risk with issuer risk versus the same entity or group for the 
application of the 20% NAV- limit pursuant to the second subparagr aph of Article 22(2)and 
Article 22(5) of D irective 85/611/EEC. 
7. Applying relevant cover rules to transactions with both listed, and OTC, financial  
derivative i nstruments
7.1 Appro priate cover in the absenc e of cash- settlement
When the financial derivative instrument provides for, either automati cally or at the 
counterpart’s  choice, physical delivery of the underlying financial instrument on maturit y or 
exercise, and provided that physical delivery is common practice on the considered 
instrument, Member States are recommended to require UCITS to hold this underlying 
financ ial instrume nt as cov er in t heir i nvestm ent port folios.  
7.2 Except ional  substituti on with an alternativ e underlying cover in the absence of cash 
settlement
In cases where the risks of the underlying  financia l instrument of a deriv ative can be 
appropria tely represented by anothe r under lying  financia l instrument and the under lying  
finan cial instrument is highly liquid,  Member States should consider allowing UCITS to hold 
exceptionally other liquid assets as cover provided that they can be used at any time to 
purchase the underlying financia l instrumen t to be delivere d and that the additi onal market 
risk which is as sociated with that type of transaction is adequately meas ured. 
7.3 Substit ution wi th an alte rnative unde rlying cove r in the case of c ash-settlement
Where the financia l derivati ve instrumen t is cash-settl ed automat ically or at the UCITS 
discretion, Member States should consider allowing the UCITS not to hold the specific 
underlying instrument as cover. In this case, Member States are recommended to consider the 
following categories  as acceptable cover: 
30.4.20 04 Official Journal of the European Union L 144/41 EN 
– a) Cash; 
– b) Liquid debt instruments (e.g. government bonds of first credit rating) with
appropriate safeguards (in particular, hai rcuts); 
– c) Other highly liquid assets which are recognised by the competent authoriti es
considering their correlation with the underlying of the financial derivative
instruments, subject  to appropriate safeguards (e.g. haircuts where relevant). 
In the context  of the appli cation of Articl e 42 of Direct ive 85/ 611/EE C, Member St ates shoul d 
consider as “liquid” those instruments which can be converted into cash in no more than 
seven business days at a price closely corresponding to the current valuation of the financial 
instrum ent on its own market . Member State s are recomm ended to ensure that the respecti ve 
cash amount be at the UCITS’ disposal at the maturity/expiry or exercise date of the financial 
derivat ive in strument .  
7.4 Calc ulati on of th e level  of cover
Member State s are recomm ended to require the level  of cover to be calcul ated in line with the 
commi tment  approach. 
7.5 Nature  of the  underlyi ng fina ncial  instrument
Member State s are recomm ended to require that the underlyin g financi al instrum ent of 
financial derivative instruments, whether they provide for cash-settlement or physical 
deliv ery, as well as the financi al instrum ents held for cover have to be compl iant with the 
Directi ve and th e indi vidual  investm ent pol icy of the  UCITS.  
7.6 Recommendation to undertake further common work
As regards cover of transactions with financial derivative instruments, Member States are 
recommended to encourage their competent authorities to identify a common typology of 
transact ions with financi al derivat ive instrum ents in which the risk profile  of an uncovered 
sale ma y be ident ified.  
8. The Member States are requested to inform the Commission, insofar as possible, by 30 
September 2004 of any measures they have taken further to this Recommendat ion and to 
inform  it of the first results of its implementa tion, in as far as they are able, no later than 28 
February 2005. 
9. This Recommen datio n is addressed to the Membe r States. 
Done at Brussels, 27 April 2004. 
For the C omm ission 
 F rederik BOLKE STEIN 
Member of t he Commission