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European asset managers have approached regulators to employ a hedge funds-based model called side-pocketing to safeguard their Russia-linked portfolios from tumbling into losses, reported Bloomberg. 

The model allows asset managers to set up a vehicle to hold assets that are too risky and illiquid to handle.

The Association of the Luxembourg Fund Industry (ALFI) said that side-pocketing may be the most obvious solution to the current market freeze instigated by Russia’s ongoing military attack against Ukraine.

The members of the association, which is considered to be Europe’s main investor hub, are said to together manage $6.5trn in assets.

ALFI deputy director Marc-Andre Bechet in an interview told the publication said: “We think this is the best way of protecting investors’ interests.

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“But a side pocket — for the time being — isn’t something which is accepted across all jurisdictions.”

According to Bechet, ALFI is urging European regulators to consider the practice and lift any regulatory barriers that block asset managers from shielding their portfolios from losses linked to Russian holdings.

A spokesperson for European Securities and Markets Association said that standard rules governing the use of side-pocketing do not exist in Europe as of now.

National regulators will have to decide what is appropriate on a fund-by-fund basis, the spokesperson added.

The practice of side-pocketing is banned by German regulator BaFin, while France allows mutual funds and hedge funds to resort to it under ‘extreme’ circumstances.

Ireland permits only hedge funds to use the side-pocketing model. Similarly, Luxembourg has also limited its use.

Switzerland’s FINMA approves the use of side pockets on a ‘case-by-case’ basis, while other European countries allow only limited to no use of the practice.

The International Organization of Securities Commissions (IOSCO) has signalled ALFI’s recommendation merits consideration.

IOSCO in a statement to Bloomberg said that the use of side pockets is “likely to be appropriate where the fair valuation of part of an investment fund portfolio is temporarily very difficult or impossible, but other parts of the portfolio aren’t in that situation.”