MENA-OECD Investment Programme
COLLECTIVE INVESTMENT SCHEMES IN OECD COUNTRIES
Sustainable Capital Markets Development in the Gulf,
Middle East and Northern Africa
London. 24 July 2006
John K. Thompson
Senior Financial Sector Expert, OECD
MENA-OECD Investment Programme
Collective Investment Schemes (CIS): Background
• Boom in Capital Markets 1980-2000
• Individuals increasingly prefer institutional investment to
direct investment
• Pooling of savings by many small investors
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Small investors cannot afford diversified portfolios
Small investors cannot make informed portfolio selection
MENA-OECD Investment Programme
Collective Investment Schemes (CIS)
Pooling of Savings by many small investors
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Many opportunities in capital markets
Small investors cannot afford diversified portfolios
Small investors cannot trade efficiently
Access to professional management
Selection of strategy
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Characteristics of CIS
• Defined legal and governance structure
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Special laws
Diversity of legal structure
Regulatory systems
Disclosure
Professional management
Investment policy
Low cost execution
• Safeguards for investors
MENA-OECD Investment Programme
Growth of CIS Products, 1992-2003
Growth of CIS Assets, 1992-2003
OECD Europe
Europe
OECD
United States
Unites
States
Japan(right
(right hand
hand scale)
scale)
Japan
Billions of US$
8,000
600
7,000
500
6,000
400
5,000
4,000
300
3,000
200
2,000
100
1,000
0
0
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Sources: FEFSI, ICI and the Investment Trusts Association, Japan
MENA-OECD Investment Programme
2003
Worldwide Investment Fund Assets 2003-2005
(Trillions of euros, end of quarter)
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Geographical Trends in Investment Fund Assets in 2004-2005
(Billions of euro, end of period)
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Agency Dilemma in CIS
Large pools of assets under control of financial institutions
investors with limited ability to monitor
Asymmetry of Power and Information
– Investors (small, often unsophisticated, dispersed)
– Investment Manager/Operator (control of information,
sophisticated)
– Outright Abuse: fraud / theft / misrepresentation
– Conflict of Interest
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‘First Generation’ Legislative Reforms
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Outright abuses of agency relationship
Theft
Fraud
Misrepresentation of portfolio
Improper valuation
Solution: National and international laws, regulation and standards
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Investment Company Act of 1940 (USA)
OECD Principles 1971
EC/EU UCITS Directives 1985
IOSCO Principles 1994
Issues Covered: Funds segregation, Disclosure, Valuation, Investment
Restrictions And Policies
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Typology of Conflicts of Interest
• Investment Manager vs. Investor
• Affiliated Financial and Non-Financial Companies
• Non-Affiliated Financial Companies
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Abuses of Investor Confidence
• Cross subsidization
• Allocation of costs
• Excessive trading (churning)
• Use of affiliated intermediaries
• Support of securities underwritten by affiliates
• Support of securities of companies with banking
relationships
• Support of affiliated non-finance companies, i.e.
‘captive’ finance
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Use of Ownership Rights
CIS are increasingly important owners of equity
Disinclined to be active investors
• Uncertain demand from final investors (performance not
governance)
• Financial costs of activism
• Hesitant to oppose management
Criticism: CIS represent final owners of capital but have not pushed
hard enough for better corporate governance (‘Asleep at the
wheel’)
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The Ultimate Weapon: Transparency and Disclosure
Investors can liquidate positions at will
Investors now have access to a vast body of information to support
informed decisions
Disclosure:
– Mandatory
– Voluntary
Information increasingly available on a comparable basis, standardized
presentation, ratings for :
– Performance
– Fees and Expenses
– Governance
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Investor Access to Information
• Popular press
• Specialized press (ex: Money magazine)
• Information service providers
– Lipper
– Morningstar
– S&P
• Use of information technology
• Recent innovation ratings of CIS governance (Morningstar)
• Database of companies accused of malfeasance
MENA-OECD Investment Programme
Standards for CIS
Issues Covered Under Standards
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Account segregation
Valuation
Investment restrictions and policies
Periodic disclosure
Prospectus
Depositories
MENA-OECD Investment Programme
Standards for CIS
Domestic Standards
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In-house policies
Industry standards
Law and Regulation
Market
International Standards
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OECD Principles (1971)
EC/EU UCITS Directives 1985, 2000, 2001, 2002
IOSCO Principles 1994, 1997, 1999, 2000
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Case Study: Strengthening Governance in the USA
• Internal firm reviews of practice
– Compensation
– Firewalls
– Compliance
• Enlarged role for independent directors (voluntary and mandatory)
• Stronger requirements for independent and adequacy of time and
information
• Governance information and ratings by Morningstar
• Global settlement (SEC and state attorneys general)
• SEC Requirements for disclosure of voting practices
• Corporate governance policies on websites
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Strengthening Governance
• Firm level initiatives
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Trust is an asset; firms must protect reputation
• Industry Associations
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Voluntary Codes and Best Practices
• Official Regulation
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Reviews of rules and practices
New rules
• Sanctions
• International Standards
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IOSCO
EU
MENA-OECD Investment Programme
Relevance for MENA Countries
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Rapidly Growing Savings
Periodic Instability
Need for Investor Safeguards/ Professional Management
Adaptability to Islamic Finance
Issues:
– Should there be international competition in CIS
– Is there a Need for International Coordination (EU UCITS Directives?)
– Which centers will become market leaders in the CIS sector?
MENA-OECD Investment Programme