UCITS & corporate governance

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Mark Sinsheimer, Director - MS Conseil - France

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UCITS & corporate governance

  1. 1. UCITS & corporate governance TBLI Conference Paris November 10, 2006 Mark Sinsheimer, CFA
  2. 2. UCITS, the leading category of shareholder <ul><li>French company ownership : </li></ul><ul><li>Individual 8% (30 % in 1990) </li></ul><ul><li>UCITS 28 % </li></ul><ul><li>Other institutional 24% </li></ul><ul><li>Foreign (inc. Mutual funds) 40% </li></ul><ul><li>Holding period : </li></ul><ul><li>Non financial companies 10 years </li></ul><ul><li>Individuals 5 years </li></ul><ul><li>Foreign and UCITS 5 months </li></ul><ul><ul><li>>90 % of stock exchange transactions </li></ul></ul>Source: ANSA 2005
  3. 3. <ul><li>Dual nature of UCITS </li></ul><ul><li>The conflicts of interests linked to asset management </li></ul><ul><li>The various control mechanism </li></ul>Who controls UCITS and how do they exercise their duty?
  4. 4. What is the economic reality of UCITS? <ul><li>Company/trust/co-ownership offering </li></ul><ul><ul><li>Access to institutional asset management service </li></ul></ul><ul><ul><li>Cost reductions </li></ul></ul><ul><ul><li>Risk diversification </li></ul></ul><ul><ul><li>> controlled by governance </li></ul></ul><ul><li>Financial product enabling </li></ul><ul><ul><li>Efficient investing on financial markets </li></ul></ul><ul><ul><li>Following a defined investment policy </li></ul></ul><ul><ul><li>With tax advantages possibly </li></ul></ul><ul><ul><li>> Controlled by regulation of product, manager and advisor/distributor </li></ul></ul>
  5. 5. Conflicts of interest linked to asset management <ul><li>Investment process </li></ul><ul><li>Direct costs </li></ul><ul><li>Indirect costs </li></ul><ul><li>Valuation procedure </li></ul><ul><li>Marketing policy </li></ul><ul><li>Performance presentation </li></ul>
  6. 6. The investment process <ul><li>Indexing </li></ul><ul><ul><li>Mostly administrative service </li></ul></ul><ul><ul><li>Cheap / mostly fixed costs </li></ul></ul><ul><li>Active management </li></ul><ul><ul><li>Definition of added value objective (return/risk) </li></ul></ul><ul><ul><li>Costly </li></ul></ul><ul><li>Closet indexing </li></ul><ul><ul><li>Minimize marketing / reputation risk </li></ul></ul><ul><ul><li>Generic UCITS at generic costs </li></ul></ul><ul><li>Formula UCITS (structured) </li></ul><ul><ul><li>Description of promised result </li></ul></ul><ul><ul><li>Comes as a substitute for transparency </li></ul></ul>
  7. 7. From management fees to total expense ratios <ul><li>Management fees (flat + performance) </li></ul><ul><ul><li>Investment management </li></ul></ul><ul><ul><li>Administration (custody, admin, structure) </li></ul></ul><ul><ul><li>Includes marketing expenses (trail commissions) </li></ul></ul><ul><li>Commissions linked to transactions </li></ul><ul><ul><li>Compensates concentration of orders at BO/MO </li></ul></ul><ul><ul><li>Soft dollars </li></ul></ul><ul><ul><li>Custody </li></ul></ul><ul><li>Second level management fees </li></ul><ul><ul><li>Master-feeder: marketing segmentation / yield management </li></ul></ul><ul><ul><li>Fund of funds : manager of managers / fees on fees </li></ul></ul>
  8. 8. Valuation procedure <ul><li>Arbitrage proof UCITS while providing best service </li></ul><ul><li>Fair value pricing may/should be used </li></ul><ul><ul><li>Illiquid securities, OTC derivatives </li></ul></ul><ul><ul><li>Closed markets, stale prices </li></ul></ul><ul><li>Management fees authorizes smoothing </li></ul><ul><li>Control </li></ul><ul><ul><li>Internal pricing model and audit by compliance </li></ul></ul><ul><ul><li>Control by custodian </li></ul></ul><ul><ul><li>Statutory auditors </li></ul></ul><ul><ul><li>Consultants (statistical audit) </li></ul></ul>
  9. 9. Marketing and full disclosure <ul><li>Candid presentation of </li></ul><ul><ul><li>Investment service provided </li></ul></ul><ul><ul><li>Fee structure </li></ul></ul><ul><li>Incentives of advisor / distributor </li></ul><ul><ul><li>Disclosure of trail commissions </li></ul></ul><ul><ul><li>Other promotional agreements </li></ul></ul><ul><ul><li>Soft commissions to brokers </li></ul></ul><ul><ul><li>Bank, insurance networks </li></ul></ul>
  10. 10. Performance presentation <ul><li>Survivorship / backfill bias </li></ul><ul><ul><li>Incubator funds </li></ul></ul><ul><ul><li>Funds’ creation and mergers </li></ul></ul><ul><li>Comparison to benchmark or peers </li></ul><ul><ul><li>Style bias </li></ul></ul><ul><ul><li>Bias within category </li></ul></ul><ul><li>Expenses </li></ul><ul><ul><li>Change in total expense ratio </li></ul></ul><ul><ul><li>Front end or Back end load paid to the fund </li></ul></ul><ul><ul><li>Smoothing of risk </li></ul></ul>
  11. 11. The US approach, the board as fiduciary <ul><li>Huge abuses </li></ul><ul><ul><li>Late trading anf market timing </li></ul></ul><ul><ul><li>Soft commissions and distribution by brokers </li></ul></ul><ul><li>Congress answer inspired by SOX </li></ul><ul><ul><li>2/3 of independent directors </li></ul></ul><ul><ul><li>Increased disclosures and audit committees </li></ul></ul><ul><li>Which proves difficult to implement </li></ul><ul><ul><li>Cost and complexity </li></ul></ul><ul><ul><li>Confusion </li></ul></ul><ul><ul><li>Can asset management be outsourced? </li></ul></ul>
  12. 12. SICAV boards in Europe <ul><li>Directors 72% promoter </li></ul><ul><ul><li>19% stakeholders </li></ul></ul><ul><ul><li> 7% independent </li></ul></ul><ul><ul><li> 2% distributors </li></ul></ul><ul><li>Average directorship : 3.9 </li></ul><ul><li>Average board size : 5.7 </li></ul><ul><li>Estimated fees : € 10.000 </li></ul><ul><li>Professional indemnity : 16% letter </li></ul><ul><ul><li>19% Insurance </li></ul></ul><ul><li>Source: CAIS, Fitzrovia and PwC presented by P. Zurstrassen </li></ul>
  13. 13. International centers: Luxemburg, Ireland <ul><li>From fund administration </li></ul><ul><ul><li>Among largest markets (>€ 1.000 Bios) </li></ul></ul><ul><ul><li>>50% of subscriptions in Europe (2004) </li></ul></ul><ul><ul><li>Distribution hub: call center, transfert agent </li></ul></ul><ul><li>To UCITS control (UCITS III: substance requirement of investment companies) </li></ul><ul><ul><li>Control and supervision of risks </li></ul></ul><ul><ul><li>Control and supervision of outsourcing contracts </li></ul></ul><ul><ul><li>Principles of good governance </li></ul></ul><ul><li>Promotion of ‘best practices’ for pan-European distribution aiming the US market </li></ul>
  14. 14. External controls <ul><li>Fund custodian/administrator </li></ul><ul><ul><li>Compliance to regulation and investment strategy </li></ul></ul><ul><ul><li>NAV computation </li></ul></ul><ul><ul><li>Subscription/redemption procedure </li></ul></ul><ul><li>Fiduciary ratings </li></ul><ul><ul><li>Lipper-Fitzrovia computation of Total Expense Ratio </li></ul></ul><ul><ul><li>RCP et Fitch focused on risk in Europe </li></ul></ul><ul><ul><li>Morningstar, S&P in US after scandal </li></ul></ul><ul><ul><li>Third party audit? (California, Pennsylvania) </li></ul></ul>
  15. 15. UCITS in DC plans <ul><li>Good governance principles for FCPE </li></ul><ul><ul><li>Representation of beneficiaries and stakeholders </li></ul></ul><ul><ul><li>Union membership </li></ul></ul><ul><li>But practical difficulties subside </li></ul><ul><ul><li>Large boards </li></ul></ul><ul><ul><li>Limited fiduciary training </li></ul></ul><ul><ul><li>No standard for reporting format </li></ul></ul><ul><ul><li>Specific policies to deal with M&A </li></ul></ul>
  16. 16. Conflicts of interests when voting <ul><li>Business relation with issuer </li></ul><ul><ul><li>Asset management (DC plan) </li></ul></ul><ul><ul><li>Commercial of investment banking </li></ul></ul><ul><li>Sell proxies for what they are worth </li></ul><ul><ul><li>Security lending especially “hot shares” </li></ul></ul><ul><ul><li>Save on proxy research </li></ul></ul><ul><li>Special situations </li></ul><ul><ul><li>House UCITS </li></ul></ul><ul><ul><li>DC plans </li></ul></ul>
  17. 17. The French example <ul><li>AFG provides a service consistent with recommended principles </li></ul><ul><ul><li>Recommended position on resolution of French companies </li></ul></ul><ul><ul><li>Proxinvest / Deminor-ISS </li></ul></ul><ul><li>Then monitors and benchmarks application </li></ul><ul><ul><li>Principles mostly applied (80% quest AFG) </li></ul></ul><ul><ul><li>Compares favorably with most countries </li></ul></ul>

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