Undertakings for the Collective Investment of Transferable Securities

Speech by Chris Huhne MEP delivered to the European Parliament on Thu 17th Feb 2000

Mr President, our objective in setting a framework for unit trusts and other UCTIS is to secure the highest possible safe return for our savers, which is why I want to address the issue of derivatives in my remarks today.

I firmly believe that the prudent use of derivatives can help fund secure, safer, higher returns. Despite their image of danger, derivatives are usually used by asset managers as insurance. A contract that, for example, pays a substantial sum if, say, the NASDAQ or the CAC 40 share index falls, causes an extra payment by the investor if the NASDAQ or the CAC 40 share index rises. Is this speculative? Not at all. Imagine you have spent some months building up a portfolio of shares in companies in which you are confident: they have good management, good prospects and they are good investments. Then you become worried that the whole stock market is going to collapse, as it did in 1987. You have the option of selling off everything and getting into cash, but that would be to waste your research into the winners. It would also incur all the transaction costs of selling your shares and then buying them again after the fall. The solution is to take out a derivative which pays off if the NASDAQ or CAC 40 falls.

But even with a tailor-made derivative or OTC derivative which would be cheaper, perhaps insuring you against a relative fall in your portfolio against the index, you would still have the portfolio and the shares, but you would have protected yourself against the risks of a collapse. In exchange, you might also have given up some of the upside of the markets. In this case, which is perhaps the most common use of derivatives by asset managers, you reduce your potential reward but you also reduce your potential risk. That is a desirable development in a soundly managed fund. History demonstrates that investors benefit from a liberal and light-handed approach to regulation. Heavy-handedness - a prescription of how private sector managers should invest and where they should invest - will merely reduce returns to savers.

Pension funds which suffered from rules on where they could and could not invest, as required by of our government bonds, made returns of 5.2% a year, barely half the 9.5% annual returns made by free funds between 1984 and 1996. These are of course the returns after deducting all losses. Do not confuse a real concern for the interests of investors with a populist fear of the new and the innovative and liberal approach that pays off. This is what we should be concerned about here today.