A Better Grasp of Non-financial Risks

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

Appendices

Appendix II: Review of Main Functions in and Parties to the Fund Management Industry Appropriate regulations require the understanding of the many specifics of the fund management industry. This section describes the main roles and functions in the fund management industry in the main European jurisdictions (the specifics of the US industry are detailed in section 3.1.3.1). The elements essential to fund management, such as the creation of the fund, the management of the fund, the custody of assets, and the distribution of the fund, can be defined in linear fashion. The fund industry has separated ownership and control by requiring that assets be safe-kept by depositaries; for assets that cannot be safe-kept (derivatives, non- financial securities, cash, and registered securities 44 ), bookkeeping, along with monitoring and due diligence, would help protect unit-holders. The lack of a European definition of these additional controls is the source of many problems. The control function is assumed first by the investment firm, then by the depositary, the board of directors, and the auditors. Administrative functions are usually the responsibility of the investment firm but tend to be outsourced. The creation of the fund and the sponsor The sponsor is the public face of the fund that contributed to the creation of the fund, generally a bank (which may act as a distributor for this fund or is the shareholder of the investment firm)

or an investment firm, depending on the country. In common-law countries, the sponsor of the mutual fund makes everything happen. It determines the mutual fund’s legal structure, handles branding and promotion, and is usually well capitalised. It does not hold legal title to the fund’s underlying assets. Sponsors in common-law countries have common- law fiduciary duties to investors. In civil- law countries, thus in many continental European countries, sponsors have no fiduciary duty (from the fact of being sponsors) to those who invest in mutual funds, because they have no contracts with end-investors. In these countries, the sponsor usually have responsibilities to investors from their status as distributors or investment firms; in addition, sponsors may be liable in the event of a fraudulent fund (after all, they cannot claim that they are unaware of the nature of the fund, as they helped set it up). In a US incorporated mutual fund, the sponsor and the investment company sign the investment management contract, although Rounds and Dehio (2007) suggest that, in fairness ,it is the directors, as representatives of the investment company, who are actually contracting with the sponsor. The sponsor generally does record-keeping, asset accounting, and interfacing with shareholders. The sponsor is not explicitly mentioned in EU regulations, so its responsibilities differ from one country to another. In the United Kingdom, the sponsor is usually the manager. In France, the creator of the fund is usually the investment manager, and when the investment firm is owned by a parent company, the parent is often the public face of the fund.

44 - Registered securities are those in which the name of the holder of the securities is in the books of the issuer and not in central securities depositories such as Euroclear.

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An EDHEC-Risk Institute Publication