A Better Grasp of Non-financial Risks

The European Fund Management Industry Needs a Better Grasp of Non-financial Risks — December 2010

3. Risks and Responsibilities in the Fund Industry

other, since the board could be responsible for ensuring that appropriate service providers are hired and that high standards

of governance and of risk management are met.

Box 2: The main forms of investment funds There are two lines of analysis for the main forms of investment funds. First, corporations and trusts, though legally distinct, are now extremely similar in countries (common-law countries) where the trust form exists. Countries where trusts originated, however, have a different regulatory culture, and convergence with countries where corporate-form investment funds are the traditional form is not yet complete. Second, the temptation to get around regulation by using contractual funds has always existed. The contractual form, after all, eliminates the possibility that unit-holders will participate in the decisions made by the fund. The contractual form is historically typical of civil-law countries such as France and Luxembourg. To some extent, the contractual form recognises the relative unimportance of the board of directors and the fact that the depositary and the investment firm are the two true partners in a fund. It is for this reason that the contractual form has not been accepted by the SEC for US mutual funds. In UCITS, depositaries of contractual funds have greater responsibilities than depositaries of corporate-form investment funds (UCITS III, article 7) and must ensure the correct valuation of units as well as “carry out the instructions of the management company, unless they conflict with the law or the fund rules” (EC 2008), obligations that are not made of depositaries of incorporated funds. In France, where the responsibilities of the board of incorporated funds are limited, the depositary has the same obligations for the two sorts of funds. In Luxembourg, where the board is more important than in France, the depositary has greater responsibilities in contractual funds. Ireland has recently adopted contractual funds as a “convergence move”, and the subject is being discussed in the United Kingdom. Corporations vs. trusts The trust type is the oldest form of investment fund. Trusts were developed in England in the twelfth and thirteenth centuries, when landowners left England to fight in the Crusades and needed someone to run their estates in their absence. In common-law legal systems today, a trust is a relationship whereby property (including real, tangible, and intangible) is managed by one person (or persons, or organisations) for the benefit of another. By contrast, a corporate-form investment fund has the same legal structure as a corporation, but the number of shares is variable: shares can be redeemed or created on a continuous basis, rather than exchanged on the secondary market for corporations. The legal forms of trusts and corporations thus differ as follows (see Rounds and Dehio 2007 for a more technical description): in trusts, title to the underlying assets is with the fund trustees, who hold the underlying assets for the sole benefit of the investor-

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An EDHEC-Risk Institute Publication