COLLECTIVE INVESTMENT SCHEMES IN OECD COUNTRIES

1. 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. ThompsonSenior Financial Sector Expert, OECD MENA-OECD Investment Programme

2. 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 • Small investors cannot afford diversified portfolios • Small investors cannot make informed portfolio selection MENA-OECD Investment Programme

3. Collective Investment Schemes (CIS) • Pooling of Savings by many small investors • Many opportunities in capital markets • Small investors cannot afford diversified portfolios • Small investors cannot trade efficiently • Access to professional management • Selection of strategy MENA-OECD Investment Programme

4. Characteristics of CIS • Defined legal and governance structure • Special laws • Diversity of legal structure • Regulatory systems • Disclosure • Professional management • Investment policy • Low cost execution • Safeguards for investors MENA-OECD Investment Programme

5. Growth of CIS Products, 1992-2003 OECD Europe United States Japan (right hand scale) Billions of US$ Sources: FEFSI, ICI and the Investment Trusts Association, Japan MENA-OECD Investment Programme

6. Worldwide Investment Fund Assets 2003-2005(Trillions of euros, end of quarter) MENA-OECD Investment Programme

7. Geographical Trends in Investment Fund Assets in 2004-2005 (Billions of euro, end of period) MENA-OECD Investment Programme

8. 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 MENA-OECD Investment Programme

9. ‘First Generation’ Legislative Reforms • Outright abuses of agency relationship • Theft • Fraud • Misrepresentation of portfolio • Improper valuation Solution: National and international laws, regulation and standards • 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 MENA-OECD Investment Programme

10. Typology of Conflicts of Interest • Investment Manager vs. Investor • Affiliated Financial and Non-Financial Companies • Non-Affiliated Financial Companies MENA-OECD Investment Programme

11. 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 MENA-OECD Investment Programme

12. 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’) MENA-OECD Investment Programme

13. 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 MENA-OECD Investment Programme

14. 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

15. Standards for CIS Issues Covered Under Standards • Account segregation • Valuation • Investment restrictions and policies • Periodic disclosure • Prospectus • Depositories MENA-OECD Investment Programme

16. Standards for CIS Domestic Standards • In-house policies • Industry standards • Law and Regulation • Market International Standards • OECD Principles (1971) • EC/EU UCITS Directives 1985, 2000, 2001, 2002 • IOSCO Principles 1994, 1997, 1999, 2000 MENA-OECD Investment Programme

17. 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 MENA-OECD Investment Programme

18. Strengthening Governance • Firm level initiatives • Trust is an asset; firms must protect reputation • Industry Associations • Voluntary Codes and Best Practices • Official Regulation • Reviews of rules and practices • New rules • Sanctions • International Standards • IOSCO • EU MENA-OECD Investment Programme

19. Relevance for MENA Countries • 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