Critical accounting policies

UBS sponsors the formation of Special Purpose Entities (SPEs) primarily to allow clients to hold investments in separate legal entities, to allow clients to jointly invest in alternative assets, for asset securitization transactions and for buying or selling credit protection. In accordance with IFRS, UBS does not consolidate SPEs that it does not control. In order to determine whether UBS control an SPE or not, UBS has to make judgments about risks and rewards and assess the ability to make operational decisions for the SPE in question. In many instances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when considered together make it difficult to reach a clear conclusion. When assessing whether UBS has to consolidate an SPE it evaluates a range of factors, including whether (a) the activities of the SPE are being conducted on UBS’s behalf according to its specific business needs so that UBS obtains the benefits from the SPE’s operations, or (b) UBS has decision-making powers to obtain the majority of the benefits of the activities of the SPE, or UBS has delegated these decision-making powers by setting up an autopilot mechanism, or (c) UBS has the rights to obtain the majority of the benefits of the activities of an SPE and therefore may be exposed to risks arising from the activities of the SPE, or (d) UBS retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain the benefits from its activities. UBS consolidates a SPE if its assessment of the relevant factors indicates that UBS controls the SPE.

SPEs used to allow clients to hold investments are structures that allow one or more clients to invest in an asset or set of assets, which are generally purchased by the SPE in the open market and not transferred from UBS. The risks and rewards of the assets held by the SPE reside with the clients. Typically, UBS will receive service and commission fees for creation of the SPE, or because it acts as investment manager, custodian or in some other function. Many of these SPEs are single-investor or family trusts while others allow a broad number of investors to invest in a diversified asset base through a single share or certificate. These latter SPEs range from mutual funds to trusts investing in real estate. The majority of UBS’s SPEs are created for client investment purposes and are not consolidated. However, UBS consolidates investment funds in cases where it provides or have a moral obligation to provide financial support to a fund. In these instances UBS generally assumes the majority or a significant portion of the risks of the fund, which, combined with UBS’s role as investment manager, makes the party that can exercise control over the entity.

SPEs used to allow clients to jointly invest in alternative assets, e. g. feeder funds, for which generally no active markets exist, are often in the form of limited partnerships. Investors are the limited partners and contribute all or the majority of the capital, whereas UBS serves as the general partner. In that capacity, UBS is the investment manager and 249 Financial information have sole discretion over investment and other administrative decisions, but have no or only a nominal amount of capital invested. UBS typically receives service and commission fees for UBS’s services as general partner but do not, or only to a minor extent, participate in the risks and rewards of the vehicle, which reside with the limited partners. In most instances, limited partnerships are not consolidated under IFRS because UBS’s legal and contractual rights and obligations indicate that UBS does not have the power to govern the financial and operating policies of these entities and concurrently do not have the objective of obtaining benefits from its activities through such power.

SPEs used for securitization. SPEs for securitization are created when UBS has assets (for example, a portfolio of loans) which it sells to an SPE, and the SPE in turn sells interests in the assets as securities to investors. Consolidation of these SPEs depends mainly on whether UBS retains the majority of the benefits or risks of the assets in the SPE.

UBS does not consolidate SPEs for securitization if it has no control over the assets and no longer retain any significant exposure (for gain or loss) to the income or investment returns on the assets sold to the SPE or the proceeds of their liquidation. This type of SPE is a bankruptcy remote entity – if UBS were to go bankrupt the holders of the securities would clearly be owners of the asset, while if the SPE were to go bankrupt the securities holders would have no recourse to UBS. SPEs for credit protection are set up to allow UBS to sell the credit risk on portfolios, which may or may not be held by UBS, to investors. They exist primarily to allow UBS to have a single counterparty (the SPE), which sells credit protection to it. The SPE in turn has investors who provide it with capital and participate in the risks and rewards of the credit events that it insures. UBS generally consolidates SPEs used for credit protection.

Source: Annual report 2008, section Financial information