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CAIA Level II > Ethics, Regulation and ESG > Flashcards

Ethics, Regulation and ESG Flashcards

1
Q

What is prudence in the investment process?

A

Prudence is acting in a like capacity of a person that is familiar with the investments being made. When thinking of a portfolio, it requires following the investment parameters set forth by the client

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2
Q

What is transaction-based market manipulation?

A

Transactions done with the purpose of distorting prices or volumes or securing a large position to exploit and manipulate the price of an asset.

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3
Q

What is information-based market manipulation?

A

Spreading knowingly false rumors to induce trading or pressuring sell-side analysts to rate or recommend a security to get benefits

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4
Q

May managers use third party research?

A

Yes, as long as the manager has considered the assumptions, thoroughness of analysis, timeliness of information, objectivity and independence of source.

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5
Q

How often must Investment Policy Statements be reviewed?

A

At least annually, or whenever ircumstances suggest chances may be needed.

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6
Q

If no local law states otherwise, how long should managers keep documents?

A

Seven years.

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7
Q

How should performance be reported, and how often?

A

Performance should be reported gross and net and at least on a quarterly basis within 30 days of the quarter.

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8
Q

How must fees and other investment costs be disclosed?

A

Fees must be clearly explained, detailing the methodes for determining all fixed and contingent fees, as well as costs that will be borne by investors

For prospective clients, the average expected expenses or fees must be disclosed.

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9
Q

Is a code-compliant manager required to meet suitability provisions for large, sophisticated asset owners or for asset owners working through a third-party consultant?

A

When working for an institutional investor, the manager is required to take actions that are consistent with the mandate, but does not require a suitability assessment of the mandate itself. This may be documented through the investment policy statement or through the management contract.

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10
Q

v. If a client directs the manager to operate with a broker that does not offer best execution is the manager compliant with Provision C.4. – Best Execution?

A

Yes, but the manager must alert the client of the potential impact of his directed brokerage on execution prices.

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11
Q

When the manager feels that market quotations no longer reflects the current value of a security, is the manager prohibited from using alternative methods for calculating the holding value?

A

No, the manager may treat such investments like other investments without market quotation for valuation purposes and may use other accepted valuation methods or turn to independent third party for securities valuations.

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12
Q

Do all clients have to receive the same information (full prospectus, for instance) to meet disclosure requirements?

A

No, the code allows for managers to determine how to best communicate with their clients as long as the required information is available to all.

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13
Q

Does the Code require the manager to disclose all elements of a proprietary quantitative model to clients under the investment process provision?

A

No, the manager must provide clients and prospective clients with sufficient information to make an informed decision about the investment method used in the portfolio, thus requiring some detail, but not full transparency.

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14
Q

What are the two theories of Regulation?

A

Public Interest Theory of Regulation and Private Interest Theory of Regulation.

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15
Q

What are the three principles of securities economic regulation.

A
  • Transparency
  • Market Integrity or fundamental fairness
  • Government protection of social and economic systems through law
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16
Q

What are the 4 main U.S. Regulatory Bodies

A

SEC - Regulates Securities Markets
FINRA - Self-Regulatory for broker-dealers
Commodities Futures Trading Commision - CFTC - Regulates Derivative markets
National Futures Association - NFA - SRO for derivatives markets

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17
Q

What are blue sky laws?

A

Blue sky laws are state laws regulating securities markets within each state. There are State SECs, which share oversight with the federal SEC.

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18
Q

What does the CFTC oversee?

A

The CFTC oversees the commodities derivative markets.

Individuals and organizations, including commodity pool operatiors and futures commision merchants are object of CFTC regulation.

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19
Q

What is an investment adviser unter the Investment Advisers Act of 1930?

A

An investment adviser is an person or ferm that, for compensation, is engaged in the business of providing advice to others or issuing reports or analysis of securities,

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20
Q

What is the role of the Dodd-Frank Act?

A
  1. To promote financial stability in the US by improving accountability and transparency in the financial system,
  2. To end “too big to fail”;
  3. To protect the american taxpayer by ending bailouts; and
  4. To protect consumers from abusive practices.
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21
Q

What are the Investment Adviser Act rules on registring before the SEC and State commissions?

A
  1. Companies with under 25MM in AuC are generally exempt.
  2. Companies with 25mm-100mm in AuC in a state that requires registration are exempt from registring before the SEC.
  3. Companies with 25mm-100mm in AuC in a state that does not require registration must register before the SEC.
  4. Companies with over 100mm AuC and managed accounts must register with the SEC
  5. Companies with over 150mm AuC must register with the SEC.
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22
Q

What are the main exemptions to registration on the Investment Adviser Act?

A
  1. Companies with under 25mm AuC
  2. VC Advisers
  3. Advisers of private funds up to 150mm AuC
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23
Q

What is Form ADV

A

Form ADV must be filed by investment advisers before the SEC.

Part 1 has information about the fund, managers and associated persons.

Part 2 is a disclosure document for existing and prospective clients. It must be delivered annually.

24
Q

What is the role of alternative investment regulation in the US

A

Because they are premised on the assumption that tey are designed for wealthy individuals, AI regulations’ role is to monitor and control systemic risk to the U.S. Economy, and not to protect individual investors.

25
Q

What are accredited investors under the 1930 Securities Act

A

Accredited investors are persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves renders the protections of the Securities Act registration process unnecessary.

26
Q

What are the criteria for accredited investors?

A

Net worth (with spouse) of over 1MM (excluding residence)

or

Income over 200k/year (or 300k/year with spouse) in the last 2 years.

or

Certain entities such as trusts.

27
Q

What are the criteria for qualified investors

A

Natural person with at least usd5mm in investments.

Institutional investor with at least usd25mm in investments.

Entity where all beneficial owners are qualified investors.

28
Q

What are the types of SEC inspections

A

Regular inspections: based on Form ADV and promotional materials
Cause Inspections: triggered by tips, complaints and referrals
Sweep Inspections: review thematic issues across multiple firms

29
Q

What is an AIFMD Soverign Exemption?

A

A manager may refuse to cooperate with AIFMD if it understands that it affects the soveregnty of member nation.

30
Q

What are asset stripping rules?

A

Prevent entities that have been bought from taking loans and distributing loan proceeds

31
Q

What are UCITS?

A

UCITS stands for Undertakings for Collective Investments in Transferable Securities (UCTIS) and are the main framework for collective investment schemes.

Must be open-ended and liquid and usually invest in listed securities.

32
Q

What are the differences between UCITS and Alternative Investment Funds

A

UCITS are generally for retail investors with small invesment ammounts, investments are restricted to “safe” and liquid assets and have limitations on leverage.

Alternative Investment Funds are aimed for investors with higher investments, have fewer investment restrictions. All investment types are possible, including private equity and real estate. May be reasonably leveraged.

33
Q

What are three main ESG challenges

A
  1. Fiduciary Duties: Managers refrain from choosing ESG over highest possible returns;
  2. Lack of Standards: Investors feel there is lack of clarity on ESG Incorporation to investments;
  3. Cost: Because of lack of standards, managers have to create their own internal capabilities.
34
Q

What are the main goals of ESG regarding water usage?

A
  1. Conservation of water
  2. Reduce soil erosion
  3. Minimize greenhouse gas emissions
  4. Decommissioning
  5. Maintaining proper permits and licensing
35
Q

What are the main goals of ESG regarding social issues?

A
  1. Health and safety standards
  2. Meeting all labor laws and regulations
  3. Respecting indigenous people’s rights
  4. Provide safety training and certifications
36
Q

What are the main ESG guidances on commodity trading

A
  1. Never take on physical delivery of goods
  2. Only trade liquid contracts to lower volatility
  3. Avoid funds that generate or contribute to commodity volatility
  4. Limit investment in agricultural contracts to avoid volatility that may harm poorer populations.
37
Q

What are the three aspects of ESG in Hedge Fund Investment

A
  1. Take ESG considerations into the investment selection and portfolio construction
  2. Encourage invested companies to follow ESG policies
  3. Don’t allocate in sectors/asset classes with poor ESG records.
38
Q

How may Hedge Funds become more transparent?

A

Open Protocol Hedge Fund Reporting is a standardized risk reporting that gives a framework of investment process of the Fund without provinding specific asset allocation data.

39
Q

What is an impact to Hedge Funds that have migrated from segregated investor accouts to share classes?

A

Loss in transparency

40
Q

Is short selling ESG appropriate?

A

There is debate on whether short selling is beneficial or harmful to markets.

Some argue that it’s harmful to market sentiment and increases market volatility, while others argue that it allows for the better adjustment of market prices.

41
Q

How may hedge funds incorporate ESG governance to the use of leverage?

A

Hedge funds should have specific conditions and restrictions on leverage use, and have clear rules on how leverage is defined and measured by the fund.

42
Q

How may ESG be integrated into Private Equity funds?

A
  1. Establish a formal commitment to ESG integration
  2. Set ESG objectives and metrics
  3. Engage and communicate with all stakeholders
43
Q

Does ESG investing generate better returns?

A

There is no consolidated understanding regarding ESG investment returns, and some studies outright state that the data does not support the hypothesis that returns are better and state that investors pay a price for ESG investing.

44
Q

Are ESG ratings reliable as credit ratings?

A

No, the main criticism being that ESG Ratings don’t rate anything (don’t assign likelyhood of a future event).

Credit ratings among the big three agencies have a 0.9 correlation, while ESG ratings have a 0.32 correlation.

45
Q

Is it appropriate to financial managers to consider ESG issues beyond their direct financial effect on an investment?

A

Yes, if the manager believes in good faith that ESG investing will bring direct benefit (enhance risk-adjusted returns).

In the US it is becoming more appropriate to use ESG investing.

EU regulations are increasingly supportive of ESG considerations.

Asian markets are not clear, except for Hong Kong, which has the Hong Kong Strategic Framework for Green Finance.

46
Q

What is negative and positive screening?

A

Negative screening is to exlude certain sin stocks involved in sectors that are deemed negative.

Positive screening focuses in specific operations and policies that are exemplar on one and more ESG issue.

47
Q

What are the Global Impact Investing Network three elements?

A

ESG Investing must:

  1. Be intentional;
  2. Seek financial returns, even if below market
  3. Be commited to impact measurement and reporting.
48
Q

What is the difference between Mission-related investments (MRIs) and Program-related investments (PRIs)?

A

The difference is that PRIs seek no specific financial returns, allowing for subcompetitive risk-adjusted returns.

PRIs are abe to qualify for tax advantages.

49
Q

What does the evidence from research on ESG investing show?

A

Barber, Morse and Yasuda show that impact fund IRRs are 4,7% lower than traditional VCs and investors are willing to pay 3,4% in expected IRR.

50
Q

Explain the concept of the Tragedy of the Commons

A

Individuals and entities will overconsume or undervalue natural resources and other assets that are available for common use because the cost is borne by everyone.

51
Q

Explain the Coase Theorem

A

In a competitive and frictionless market, negotiation between parties will reach the most cost efficient solution.

52
Q

Give arguments for and against special consideration for ESG Investments

A

Arguments for:

  1. Single factor models rate ESG returns comparable to or better than non-ESG stocks
  2. Good ESG ratings should equal reduced litigation risks and reputational risks
  3. ESG investments generate non-cash benefits of a better world

Arguments Against:

  1. Multi-factor models rate ESG returns comparable/worse than non-ESG
  2. Fiduciary duty is to maximize returns
  3. Managers may be cherrypicking favourite causes over return.
53
Q

What is the difference between Normative and Positive Models

A

Normative models explain how prices should behave, useful in convergence strategies.

Positive models explain how podels actually behave by explaining the past to predict future behaviour.

54
Q

What is the difference between Theoretical and Empirical models?

A

Theoretical models are based on assumptions about behaviour, and empirical models are based on observed behaviour.

55
Q

What is the difference between Applied and Abstract Models?

A

Applied models address real world problems and abstract models adress hypothetical situations.

CAIA Level II (1 decks)

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