INTERNATIONAL: IOSCO publishes report on Governance for Collective Investment Schemes

Monday July 10 2006

The Technical Committee of the International Organization of Securities Commissions (IOSCO) has published a report, entitled `Examination of Governance for Collective Investment Schemes`, as part of its mandate to develop broad principles for governance of collective investment schemes (CIS).

The background to this is the perspective that CIS Governance must reflect the unique nature and purpose of CIS. As explained in the IOSCO report, “the purpose of a CIS is to successfully invest the pooled assets for the primary benefit of CIS Investors. As a consequence, a robust CIS Governance Framework should seek to protect, through oversight and review, the CIS assets from loss due to malfeasance or negligence on the part of those that organize or operate the CIS and should strive to ensure that investors are adequately informed of the risks involved in their investment and the rewards they can obtain, and above all that the CIS is operated in the investors’ best interests at all times.”

The report also identifies some examples of where the CIS operator could possible use the CIS’s assets for their own gain to the detriment of CIS Investors. These include:

*Operators could rid themselves of unattractive securities that they own by dumping them into the CIS ;

*Operators could obtain rebates from third parties in connection with transactions for the CIS;

*Operators could inaccurately value or inflate their assets on order to avoid showing poor performances.

Hence, IOSCO define CIS Governance as “a framework for the organisation and operation of CIS that seeks to ensure that CIS are organised and operated efficiently and exclusively in the interests of CIS Investors, and not in the interests of CIS insiders.”

The report is in two parts. Both parts can be found at the above link, together with the feedback received by IOSCO to their consultation.

Part 1 of the report includes a detailed description of the approach of each Member jurisdiction to the governance of CIS. This includes a review of the models in operation in UK and Luxembourg. The report notes that as a result of the structural differences between the various CIS models within the Member jurisdictions, both the scope of the duties that are subject to oversight, and the entity or entities that provide independent review and oversight, vary between the jurisdictions.

Part 2 of the report seeks to identify one primary general principle of independent review and oversight of CIS Operators to be applied in all IOSCO-jurisdictions, regardless of the structural form of the CIS in question.

As regards the concept of independence, it is most interesting that the IOSCO report acknowledges that independence of the oversight function can be secured through a variety of different means. This is of particular interest perhaps in the UK which is the perhaps the only UCITS jurisdiction which does not permit the Manager and the Depositary of the scheme to both be members of the same group of companies. This separation has been seen in the UK as a fundamental element of investor protection, but it is super-equivalent to the UCITS Directive and could be a subject for renewed debate following upon the IOSCO report.

Part 2 of the report also sets out a range of functions to be performed by the Independent Oversight Entities. These include:

*overseeing potential conflicts of interest with regard to transactions concluded with related parties or with regard to the outsourcing of functions of the CIS or the CIS Operator to related parties ;

*overseeing decisions of the CIS Operator involving potential conflicts of interest between the CIS and CIS Operator ;

*checking the compliance of the CIS portfolio with the applicable borrowing and investment limits and restrictions;

*controlling the appropriateness of the valuation process of the CIS assets the proper calculation and disclosure of the CIS NAV and of the CIS unit price ;

*assessing the accuracy of the calculation of the CIS Total Expense Ratio (TER); and

*checking the correct application of the principles and procedures for the exercise of shareholder `s rights attached to the securities portfolio;

*ensuring the segregation of CIS assets from the CIS Operator;

*ensuring that fees, expenses and other costs are charged in accordance to the regulatory regime or with the specific rules of the CIS;

*verifying that any income received by the CIS Operator is reflected in the CIS portfolio, on a timely and fair basis ;

*where required by the regulatory regime, checking that the CIS Operator is exercising appropriate judgment about the use of ‘soft’ and ‘hard’ commissions or otherwise that information is properly passed on to investors about the CIS policy on this matter; and

*ensuring that investors are equally treated, within each class of unit shares, most particularly regarding subscription and redemption conditions.