American Enterprise Institute

May 18, 2006

[Edited transcript from audio tapes]

9:15 a.m.	Registration
9:30	Introduction:	Peter J. Wallison, AEI
9:45	Collective Investment Structures outside the U.S.
	Discussants:	Pierre Bollon, Association Française de la Gestion financière AFG (France)
		Rebecca A. Cowdery, Borden Ladner Gervais LLP (Canada)
		Robert Hoffmann, Association of the Luxembourg Fund Industry (Luxembourg)
		Richard Saunders, Investment Management Association (UK)
	Moderators:	Robert E. Litan, Brookings Institution
		Peter J. Wallison, AEI
11:30	Adjournment

Proceedings:

Peter Wallison:  Okay, I think we will probably get started.  If everyone can take his or her seat.  People will probably straggle in as they normally do, and we will just ignore them.  In any event, I am Peter Wallison.  I'm a resident fellow here at the American Enterprise Institute.  I want to thank all of you for attending what is likely to be an extremely informative conference today. 

We have four distinguished panelists, who I will introduce before they talk, but they represent several different ways that mutual funds or collective investments are regulated and structured outside the United States.  This, as you probably know, some of your faces are very, very familiar.  This is the tenth conference that Bob and I have organized under the general rubric “Is there a better way to regulate mutual funds?”

The conference today will focus on how collective investment vehicles are structured and regulated in a few developed countries outside the United States — Canada, the UK, France and Luxembourg.  It turns out that the United States is unusual in the sense that it permits only one basic structure for managed collective investment — a corporate structure, which can be either a corporation or a business trust.  In that structure, the corporation or trust holds the assets of the fund, and a board of directors or trustees has responsibility for the management of the corporation’s assets and the carrying out of its administrative functions.  Almost all mutual funds outsource these management and administrative functions through a contract with an investment manager. 

This structure is said to give rise to a conflict of interest — the adviser wants to make as much profit as possible from the relationship to the fund, and is thus in a position to take advantage of the relationship to the detriment of the shareholders.  The board of the fund — acting for the shareholders — is supposed to make sure that the fund is fairly treated.  However, there is nothing particularly unusual about this conflict of interest; all corporate managements, whether they are internal or external, have interests that diverge from those of the shareholders.  Economists call this the “agency problem” — the difficulty of making sure that an agent acts in the interests of the principle and not in his own interests.

One of the principal duties of the board of directors of any corporation is to control the consequences of these conflicts of interest by supervising management on behalf of the shareholders.  Under standard U.S. corporate law, the board of directors of a corporation has a fiduciary duty, in general, to assure that management’s compensation is fair and reasonable, that it is not imposing unreasonable or unnecessary costs on the corporation, and that the corporation is performing well as a profit-making entity.  The boards of directors of U.S. mutual funds are no different and they have all the same responsibilities — to assure that the investment manager charges a reasonable fee, does not impose excessive costs on the corporation, and manages the fund’s portfolio well. 

In general, foreign collective investment vehicles are not limited to this corporate structure.  In many countries they are in something that might be called a “contract form.”  That is, the investor contracts directly with the adviser to manage the investor’s funds collectively with those of others.  In the contract form, the investment manager seems to have a more direct relationship to the investor, not to an intervening corporation as is true in the United States, where, as we just saw, the investor is in a sense an indirect beneficiary of a contract between the fund and the investment manager.  In some structures, the investment manager owes duties formally to a trust or corporation that actually holds the assets that are managed, but that entity—that is, the trust or depository—does not have authority to determine the fee of the investment manager or perhaps even the costs that are charged to the fund as the board of directors in a U.S. corporation has under U.S. corporate law. 

Does the contract form really make any difference in reality?  Yes, to some extent, because when the relationship is between the investor and the investment manager, it is thought of as a contractual relationship rather than an investment relationship, and there is no need or reason for an intervening body such as a corporate board to concern itself with the fairness of the advisory fee and or maybe even the expenses of the fund.  The investor can decide for himself whether he wants to accept the adviser’s terms for the contract relationship, including the fee that the adviser sets for managing the assets and the costs — in addition to the advisory fee — that the fund manager may charge to the fund. 

This is very much like the contractual relationships we see in other areas of our daily lives in which we pay a fee for a service.  In each case, the same conflict of interest exists; the seller of the service wants to maximize his profit, and the buyer wants to get the lowest price.  The buyer simply decides whether the service is worth the all-in cost.  We don’t normally require a board of directors to intercede for us and protect us when we engage in these everyday transactions.  Thus, other developed countries have adopted structures in which the process of collective investment can be treated as something like an everyday fee-for-services transaction, while we in the United States treat it as a special case, in which investors need special assistance and protection.  This does not necessarily mean that investors in other countries are not adequately protected against conflicts of interest on the part of the manager. 

In most other countries there are a variety of forms — from government regulation to independent depositories acting like trustees managing a trust corpus — that are supposed to prevent overreaching by investment advisers and control their conflicts of interest.  These may or may not be as effective as a board of directors in addressing conflicts of interest and holding down costs.  That’s one of the things we will try to determine in today’s conference.  Interposing a board of directors is probably the most expensive way of protecting investors, but it may be that these additional costs produce necessary additional protection for U.S. investors.  On the other hand, the contractual structures used elsewhere, ultimately, may do just as well. 

Today’s conference will give us an opportunity to assess this question.  I once again thank you.  We will have now a full discussion, and if you are going to have any questions, I hope you will note them down so when we get to the question period after the discussion among the panelists, you will have an opportunity to ask your question.  Thank you.

Robert Litan:  Not in particular except to say that I welcome you all here.  We are grateful that you have all showed up to talk about your countries’ respective models.  And just to reiterate what Peter said, we are intensely interested in the cost savings, if any, that you believe arise from the so-called contract model relative to a board of directors.  If you can shed any light on that question and, of course, we are intensely interested in how your models control conflicts of interest.  Those are our two central inquiries that we would like you to focus on and we are anxious for the answers.

Peter Wallison:  Thank you.  Oh yes, that is working.  Okay, our first panelist.  Our first speaker today will be Dick Saunders.  He has been the chief executive of the Investment Management Association in the UK since its formation in February of 2002.  That was through the merger of two other associations, the Association of Unit Trusts and Investment Funds and the Fund Managers Association.  He had formerly been a director of the Association of Unit Trusts and Investment Funds and he had been that since May of 2001.  He spent two years as head of the Economic Department at the British Embassy in Washington, D.C. before getting to the Association of Unit Trust, and he had left the Treasury Department for the private sector in 1995, working at United News and Media and later as a director of the Financial Media Consultancy at Cardew & Co. 

I might add that the full bios of everybody are in your packages and you might have a chance to read those.  I'm just going to pick out various elements of those bios when I make the introductions.  Dick, you’re on.

Richard Saunders:  Okay.  Thank you very much, Peter.  What I thought I would do today, Peter's opening remarks have raised quite a lot of issues which I could try and address, but I think what is going to be most helpful is if I simply give a very straightforward presentation of the structure of the UK mutual funds and then perhaps during the discussion period, we can then try and pick out any themes that you find sort of particularly interesting and want to probe further.  Okay, I'm just going to go very slowly, I'm afraid. 

I’ll start with a few introductory slides, then talk about how the internal relationships work within the different players within the structure.  Talk about the role of the fund manager.  Talk about the role of the depository and then very briefly the other players in this structure.  So the traditional model of mutual funds in the UK has been the Unit Trust which, as Peter says, is a contractual model.  And up until 1997, that was the only open-ended structure in the UK.  We have had closed-ended funds for quite some time but the Unit Trust was the only open-ended model. 

In 1997 we introduced a second parallel model which is actually a corporate model of the open-ended investment company.  Why did we do that?  Well, the basic reason was that asset management is an international business and particularly asset management in Europe is a Europe-wide business and the Unit Trust as a legal structure was very difficult if not impossible to sell in other European jurisdictions simply because of differently legal traditions.  So the open-ended investment company, which is incorporated under company law effectively, a modified form of company law, was introduced so that was a structure, which was recognizable in Continental Europe. 

And then the other thing that was done at the same time was that the OEIC incorporated a number of innovations relative to the Unit Trust.  What those innovations were, the first had a company structure, which was better suited to the European market.  It introduced single pricing.  In other words, one single bid and offer price with an explicit charge.  Up until that point, Unit Trust had been dual priced.  They were based on a bid-and-offer price. 

The next thing they did, an OEIC requires an authorized corporate director, which is effectively the fund manager but it also allows independent directors on the board, but there has been no case since 1997 that I can think of where actually a fund has been set up with any independent directors.  All the funds that I know are structured so there is one member of the board and that is the fund manager. 

The other innovation which the OEIC structure allowed was the umbrella so that you had subclasses instead of having a whole series of Unit Trust making up your fund range, so you had a UK Unit Trust, you had a European Equity Unit Trust, a North American Unit Trust, you have a range of bond Unit Trusts, you had a single OEIC with sub-funds underneath and that is a more convenient structure in many ways.  So what is the difference?  Let us look a little bit closer to compare and contrast the way these two structures work. 

First the Unit Trust, and as I say is the traditional structure in the UK.  The basic idea of the Unit Trust, as Peter says in his opening remarks, is that it is entered into via a contract between the investor and the manager, and that contract is made under Trust Law.  And what happens is that the assets of the investor are held in a separate trust by a trustee who is appointed by the manager.  This independent trustee holds the assets and part of the trustee's responsibility then is to issue and redeem units in the fund and it is those units which the investor owns.  In effect, they are like a share in a corporate structure, but there is a difference of unique structure of the Unit Trust units which is an entity which is issued by the trustee. 

In effect, it is the trustee's liabilities.  It is the liabilities of the trust offsetting the assets, the investments on the other side of the account.  And those units then are legally owned by the investor and they reflect through the pricing mechanisms the extent of their investment, their interest in the underlying assets. 

The trustee is responsible for custody the assets and he is also responsible for oversight of the manager.  This potentially creates a conflict.  The conflict in this structure is that on the one hand the manager appoints the trustee and on the other hand, the trustee has a responsibility to oversee the manager. 

So there is clearly a potential conflict and it is one that is resolved by regulation in the UK because what we have in this structure is that there are three regulated entities.  The manager is regulated, the trustee is regulated, and the fund is authorized.  So there are three separate authorizations by the regulator in this structure. 

The OEIC, in contrast, is set up under company law.  Not company law but it is modified.  There are special regulations for the OEIC.  The company itself owns the assets and there, I think, is the parallel with the U.S. case and it issues and redeems shares just as any company does except that it does so obviously in an open-ended rather than a closed-ended way.  What the investor owns is shares in the company.  So his relationship is a much more straightforward one, if you like.  It is that of a very familiar ownership of shares in the company.  And those again, through the pricing mechanism, they reflect the value of the underlying assets and the investors’ interest in them. 

Like any company, the OEIC has got a board, but as I said earlier, while it must have an authorized corporate director, who is, generally speaking, the manager, that function can be the only director.  There is no need to have other directors.  In addition, there exists a depository who has the same responsibilities for custody and oversight that the trustee has in the Unit Trust.  The one difference is that the trustee does not own the assets.  The company owns the assets in case of the OEIC. 

In other respects, the role of the trustee and the depository are identical.  What this means, however, for the investor, these differences are well nigh invisible to the investor.  As far as they are concerned they do not see a difference between shares in an OEIC and city unit trust.  The role of the depository trustee is effectively the same, and indeed the firms who provide that service will fulfill either function, they will be depositories to OEICs, there will be trustees to Unit Trusts, and it is effectively the same function.  Both have an independent trustee which is the key selling point, if you like, of the mutual fund is the existence, is the separation of the assets from the manager that is the same in both instances.  And there is a clear fiduciary duty which is set out not just in company law, but in regulation.  Clearly there is a fiduciary duty which the board of directors of an OEIC owes to its shareholders.  But that is not the primary safeguard in the UK. 

The primary fiduciary safeguards are in the FSA regulations.  The schemes themselves, the funds have to be authorized before they can be sold, and there is a whole set of FSA regulations about systems controls, risk controls and so on.  All those are the same for Unit Trusts and for OEICs. 

There has been a further modification to the scheme in 2004.  A new regime was introduced with a rather bizarre name of COLL, where COLL means is it is short for Collective Investment Scheme.  The previous regime was called the CIS regime, an acronym meaning Collective Investment Scheme.  The new regime, which is still the regime governing Collective Investment Schemes, in order to distinguish itself is now like known as COLL.  The principal changes there were taking out some of the detailed regulation.  I think the number of pages in the rule book was halved roughly.  Introducing harmonization with the most recent use of its directive, use of its three directives and of most interest to remove the remaining regulatory differences between Unit Trust and OEICs. 

So that it is now possible for Unit Trusts and OEICs to be either single priced or dual priced.  It is possible for Unit Trust to have sub-share classes in the way that OEICs do so that the distinction between Unit Trust and OEICs in practical terms is pretty much vanished.  And this is being shown, I think, in the drastic slowing down of the rate of conversion of funds from Unit Trust to OEICs. 

In the early years, a number of Unit Trust managers converted their funds from Unit Trust to OEICs in order, one, to be able to sell those funds in Continental Europe; two, to take advantage of the new regulations.  The second reason has now fallen away for conversion so you can get the same regulatory freedoms as a Unit Trust on OEIC.  As the first reason, as it has turned out, only a relatively small number of UK managers have used the UK authorized OEICs for selling in Europe.  Most have preferred to set up fund ranges based in Dublin or Luxembourg for selling across Continental Europe. 

So neither of those reasons is any longer a very compelling reason for converting from Unit Trust to OEIC with the result that the industry has now settled down at about 50-50 Unit Trust and OEICs.  And there is no longer a compelling reason to convert your Unit Trust range to OEICs and as I say from the point of view of the investor, there is really very little difference.

Robert Litan:  Question.  You just said that recently people who are new in the business or whatever, they went to Dublin or they went to Luxembourg to open their collective accounts.

Richard Saunders:  It is…

Robert Litan:  And what I want to know is why?  Why do they go there and what form do they use?

Richard Saunders:  Well, the forms will either be Dublin OEICs or Luxembourg SICAVs and the reasons behind going to Dublin or Luxembourg rather than the UK are many and complex but they include regulatory…

Robert Litan:  [Indiscernible].

Robert Hoffman:  I will try to explain it.

Richard Saunders:  Robert will give you…

Robert Hoffman:  I will try to explain.

Richard Saunders:  Robert will give you a very good…

Pierre Bollon:  It is because Robert is a lot more efficient than Dick and I.

Richard Saunders:  Absolutely.  But very briefly, there are regulatory differences which may make it more attractive.  There may be tax differences which make it more attractive.  There may be marketing reasons and certainly for many continental distributors, simply feel more comfortable with the Luxembourg SICAV than with the UK OEIC.  And what happens is, it is not just newcomers to the market.  You have Fidelity for example, has a range of Luxembourg SICAVs.  They have a range of UK OEICs and they various Dublin funds as well. 

Pierre Bollon:  And the French [indiscernible].

Richard Saunders:  And the French also.  So many fund managers in Europe will have multiple ranges and they see that as just one of the costs of doing business in Europe, and it is something that they accept.

Peter Wallison:  Dick, I have a question and that is you talked before about single price.

Richard Saunders:  Yes.

Peter Wallison:  And dual priced.

Richard Saunders:  Yes.

Peter Wallison:  What is that?

Richard Saunders:  If you look in the Financial Times, you would need a UK edition of the Financial Times to do this.  At the fund prices, you will see that some fund prices give a bid and offer price.  There is a spread which is about five percent, and that is called dual pricing.  It is the bid-offer spread that we are all familiar with from the equity markets.  Some funds you will see there is no bid-offer spread, there is just a single price, and that is the price at which you buy units, and it is also the price at which you sell units. 

Robert Hoffman:  It is the NAV [phonetic].

Richard Saunders:  It is the net asset value, right.

Peter Wallison:  Right.

Richard Saunders:  Again, it is not as simple as that because the problem with single-priced funds is that they are potentially vulnerable to market timing, of course.  A dual priced fund is much less susceptible to market timing because of that five percent spread makes it much less attractive for a market timer to trade in and out.  The single-price fund has no cost in trading in and out.  So the manager has two options at his disposal to deter timers. 

One is by charging the so-called dilution levy, which is a charge to any large transaction in the fund.  Second, he actually has a range which he can swing that single price according to whether there are more buyers and sellers of the units around.  The idea is to equalize the burden of trading costs between those who exit the fund and those who stay in the fund.  That is the point of these mechanisms.

Peter Wallison:  Let me just interrupt for a moment.  When the fund is sold, though, let us say we are talking about a single-price fund…

Richard Saunders:  Yes.

Peter Wallison:  …which is more analogous to what we have in the United States.  When the fund is sold, does the manager offer a… is he saying to the buyer, this is what it will cost you to invest…

Richard Saunders:  No.

Peter Wallison:  In my fund over a year?

Richard Saunders:  No, because the…

Peter Wallison:  That is to say, fees and everything else.

Richard Saunders:  No, no, sorry, I mean obviously, there is disclosure of fees.

Peter Wallison:  Well, that is what I mean.  Is it a fixed amount, a single amount, or are there a whole series of different fees?

Richard Saunders:  No, the fee is a fixed amount, yes.  The annual management charge is the annual management charges.

Peter Wallison:  So it is disclosed in the document.

Richard Saunders:  It is disclosed in the document.

Peter Wallison:  Is it fixed in the sense that it…

Richard Saunders:  It is taken out through the price.

Peter Wallison:  It is perspective, though?  Is it perspective or are they saying this is what our cost were last year, next year we do not know exactly what they will be but they will probably be something like this, or are they saying this is the fixed amount that we will charge?

Richard Saunders:  There are two elements of cost here.  There is the management fee, the charge that the manager makes, which is fixed and that is perspective and cannot be changed and there are rules governing the certain procedures you have to go in order to change your annual management charge.  There are other charges which are charged the fund, which are allowed by regulation to be charged to the fund and do not go through the manager.  And what is done there is that those are reported retrospectively. 

So, when the total expense ratio for the fund is disclosed, that is a backward looking number because it is exactly as you say.  It is because we do not exactly know what these charges are going to be in basis point terms in the coming year but this is what we were last year.  And there is no reason to expect they are going to be radically different in the coming year because they are mostly pretty small.  I mean the trustee depository fee, which is one of the components that goes into the total expense ratio over and above the manager’s charge, for example, is about two or three basis points.

Pierre Bollon:  In France, trustee fee and depository fee is included in the management fee.  The only thing that is not included are transaction fees which we can only know afterwards, but all the other fees are included.  So it is one of the differences…

Richard Saunders:  Yes.

Pierre Bollon:  …that we are fighting to have a common definition in Europe, and if you prefer total expense ratios it would help.

Richard Saunders:  Yes, absolutely.  We have always been strong supporters of total expense ratios because they give the full picture to the client.

Peter Wallison:  Now, the trustee’s fee or the depository’s fee is the same both for the OEIC and for the Unit Trust.

Richard Saunders:  Correct.

Peter Wallison:  And their function, if I understand this correctly, is to have some sort of oversight over the way.

Richard Saunders:  I will come to that.

Peter Wallison:  Oh, you are going to come to that? 

Richard Saunders:  Sorry, I'm going to come…

Peter Wallison:  But they do this, whatever you are going to say.  I do not know what you are going to say, but whatever you are going to say, they do for two or three basis points?

Richard Saunders:  Yes.

Peter Wallison:  Okay.

Male Voice:  Can I ask you a verification question.

Peter Wallison:  Yes, sure.

Male Voice:  Just the definition of unit investment trust.  My understanding…

Richard Saunders:  Unit Trust. 

Male Voice:  Okay.

Richard Saunders:  In the UK, investment trust is a closed-ended fund which is actually is quoted on the stock market listed investment.

Male Voice:  Okay, so in the U.S., my understanding is a unit, in what we call a unit investment trust is an open-end instrument but is not managed if they invested it in full securities and that pool holds the securities in fixed proportions throughout its existence.

Richard Saunders:  Yes.

Male Voice:  They may issue and redeem, but that is it.

Richard Saunders:  Yes.

Male Voice:  Because that is not what you are talking about. 

Richard Saunders:  This is not what I’m talking about.  What I’m talking about is what you would regard as an investment company.

Male Voice:  In a managed investment?

Richard Saunders:  Yes.

Male Voice:  Okay.

Richard Saunders:  Absolutely.  Okay.  So these are the players.  At the top there you have got the investors and the investor’s basic relationship is with the registrar.  The registrar holds his details, holds the record of how many shares or units he owns and is the point of contact for investors, although in the investor’s mind, the investor does not see all this.  The investor only really sees that one down the bottom, which is the fund management.  The investor thinks he is buying, giving his money to Fidelity or Schroder's or whoever to manage for him.  But there are actually all these other players in there.  The registrar deals with the depository trustee who, as I see in both cases, is responsible for managing the issue of units or shares. 

In turn, there is a relationship between the trustee, depository and the fund manager.  Sorry, just before I leave the trustee.  One of the trustee’s responsibilities is custody, which he will frequently delegate to obviously one of the global custodians.  He has a relationship with the manager and both those are regulated by the FSA.  So there is a relationship between two regulated entities going on there.  So ultimately, all of that relationship is overseen by the regulator. 

On the other side, many of the regulatory duties of the fund manager, he may well delegate, particularly pricing and fund accounting will be delegated to a fund accountant and that then in turn will be overseen by the auditor of the fund.  So those are the sort of main players in this.  Say, the two key ones are the fund manager and the trustee or depository.  The fund manager, he takes the day-to-day investment.  He does the portfolio management just as we were saying around here.  He is managing the investments. 

Most funds are done in-house, for some of them it is not, it is delegated, maybe in a multi-manager operation, maybe in a fund-to-fund operation.  Sometimes there have been cases where retailers have introduced their own range of funds which have been, well, obviously they use a portfolio manager to manage the investments.  But generally speaking, it is in-house.  The fund manager is responsible for dealing in the units of the scheme. 

An important point to make about this is that the fund manager does actually deal as a principal in the units.  So he holds units on his own balance sheet which are created by the trustee, they go to the manager, the manager holds the units in a pool, and issues them, and takes them back in as investor's buy or redeem units. 

The manager is responsible for pricing the daily pricing of the assets, though of course this is frequently delegated, and is responsible for maintaining the financial records.  Of course, wherever he delegates the function, he remains accountable forward to the regulator for them. 

The depository, what does a depository do?  Well, he safeguards the assets of the scheme, a very important function.  As I say, it is what, in my view, distinguishes mutual funds from any other kind of retail investment and it is what makes the potential conflict that Peter talks about at the beginning, much less in the case of funds than it is for bank deposits or for life insurance contracts.  They oversee all the activities in relation.  So they have a general duty there.  Anything the manager does in the operation of the scheme, he has got to oversee and check that the manager is carrying out procedures and risk controls in the proper fashion and complying with all the rules and regulations and also doing what the fund is doing what it says on the tin that the scheme documentation, what it says will be done in the scheme, documentation is in fact being done. 

The depository is a function that is set out in the use of its directive.  We are very proud of being super equivalent.  This is a very unusual thing for the British to say.  The British complain a lot about when our authorities [indiscernible].  We are actually super equivalent in a couple of respects.  One is the depository has to be independent of the manager.  They cannot be both within the same group.  And secondly, it has got to look at all the aspects of the fund manager’s activities.  No responsibility performance. 

Now, Peter is telling me to finish quickly, so let me do that, just very quickly.  The registrar is also there, the transfer agent settling deals, handling the interface with investors, pricing fund accounting, obviously we talked about, and independent audit.  I think just very quickly, I will finally say that a couple of years ago we carried - and this was in the wake of the market timing affair - we carried out our own internal review of this structure focusing particularly on some of the potential conflicts of interest that arose between these different parties. 

We published a report, which I think was certainly well received by the regulator.  Our conclusion was that we felt that the structure worked well in the UK.  We did not want to propose radical change.  We proposed a number of minor improvements to it to improve transparency and accountability, and I believe that, that report is available if anyone is interested.  Thank you very much.

Peter Wallison:  Thank you, Dick.  It is a fine report actually, and I certainly would recommend it to anyone who wants to know a lot more about how the UK system works.  We will have, I’m sure Bob, and I will have more questions when we get into the question period, but that was very stimulating.  Thank you. 

Our next speaker will be Rebecca Cowdery who is a partner with the investment management group of Borden Ladner and  Gervais - I hope I'm pronouncing that properly - which is a Canadian Law Firm.  For the past 20 years she has worked in the investment management industry as a lawyer and a regulator.  Her work at Borden Ladner focuses on regulatory, compliance and governance issues facing participants in the investment management industry.  She joined Borden Ladner in November 2003 after nine years as a senior investment funds regulator with the Ontario Securities Commission.  She is a current member of the Manager Issues Committee of the Investment Funds Institute of Canada and speaks and writes frequently on topics of interest to the investment management industry.  Rebecca?

Rebecca Cowdery:  Thank you very much, Peter, and thanks to Bob and to Peter for inviting me to be part of this presentation and to meet the Europeans on this panel.  I think what I'm going to do is to give you a little bit of an overview of the Canadian mutual fund industry and here we are talking about managed mutual funds sold to the public.  I'm not going to be talking about the growth of closed-end funds and structured products which they certainly are coming up in Canada.  I'm not going to be talking about the growth in managed accounts in Canada and the growth of private pooled funds, which certainly is a growing element in Canada particularly due to some of our tax law changes.  We have got quite a few, especially from Luxembourg, from the United States, funds coming up into Canada to be sold privately.  But I'm not going to be talking about that. 

I think as a Canadian sitting with Americans, sitting with Europeans, I would like to say that I guess we feel ourselves a little bit simpler.  We have followed, I think, being so close to the U.S. markets, the U.S. regulation.  We have mostly followed what has happened in the United States and what we have got is a system of regulation and an industry structure that has been developed in parallel with the United States but without some of the baggage that you have.  So that is going to be my message today. 

Certainly, I think more and more we are looking to especially the UK, sometimes to Europe but also to Australia - you do not have an Australian on this panel but they have a very, a long trip from Australia.  I'm just an hour away on a good day.  So we are more and more looking at what is happening in the other countries but I just as I say sort of a bit of a history lesson, Canada has evolved very close to the United States and has taken many elements from that. 

So I will start off by giving a little bit of an overview of the industry and I'm a little unusual, I'm not an industry association person but have worked a lot with the industry so bear with me.  I'm going to give you some statistics, which is not something a lawyer generally does.  I will talk a little bit about the structure of Canadian mutual funds, a bit of a parallel to what Dick has taken us through.  And as a former regulator, my main focus now is looking at regulation and some of the reforms that are coming out in the United States, and a bit of a contrast to what is happening in the U.S. right now. 

So today's mutual fund industry, $600 billion Canadian in these retail mutual funds, there is close to 2000 of them.  There used to be more but with the recent tax changes there has been a lot of mergers in the industry and it is now down to just a little up to 2000 funds.  There used to be more fund managers but as you will see as I will get to, there has been a lot of consolidation in the industry, so we are down to about 60 public fund managers. 

Again, a bit of a history lesson, the Canadian mutual fund industry really did start in the 1950s.  There was a fabulous report that was written in about 1969 talking about the Canadian mutual fund industry and really developing the regulation of Canadian mutual funds, and that report is actually out of print but I happened to have a copy of it, and it is a great little report.  But there really has, and I think again this is parallel around the world likely, but significant growth in the 1980s and increasing sophistication in the marketplace and of course the growing importance and the recognition of the growing importance of mutual funds for Canadians in their retirement. 

So there are 10 fund companies that dominate the marketplace.  Canada has very strong bank networks.  There are five strong, dominant, Canadian chartered banks.  They operate four out of the 10 top fund companies.  And just again because we are in the US, two of the top 10 are Fidelity and I'm going to forget the other name, is that not terrible?  The other, what?

Male Voice:  Vanguard?

Rebecca Cowdery:  No, Vanguard is not in Canada.

Pierre Bollon:  Capital?

Rebecca Cowdery:  No, they are small.  I cannot remember the name.  Anyway, two out of the top 10 are…

Male Voice:  [Indiscernible]?

Rebecca Cowdery:  No, they are not in Canada.

Male Voice:  [Indiscernible].

Rebecca Cowdery:  No.

Male Voice:  [Indiscernible]

Rebecca Cowdery:  No.  Most of the Canadian mutual funds are sold to the broker dealer network.  I'm just going to go quickly through this.  One of the first Canadian mutual funds is Investors Group, used to be Investors Syndicate and sort of sold through an old-style, kitchen-table type of salesperson.  They still have that traditional tight selling force but more and more it is being sold through the broker dealer network.  As I mentioned, there has been much industry consolidation over the last few years.  The very top Canadian fund company, which is that Investor's Group, the old-style, kitchen-table type of a fund company, acquired two of the other major Canadian fund companies in the last couple of years.  The third top Canadian fund company swallowed up a number of the other independents, again within the last few years. 

Our structure is, I think, again consistent with the United States.  We have traditional retail classes, most funds are sold in classes or series.  Sales load, deferred sales load, level load, and institutional classes with a much lower or nonexistent management fee, again built for institutional investors, particularly the growing retirement savings plan marketplace.  The fund manager pays for dealer compensation out of its own profits.  There is a traditional fixed management fee, like a two percent management fee, it varies of course whether you are an equity fund or a bond or a money market fund. 

So all of the mutual funds pay to their management company this fixed management fee.  From out of that fixed management fee, the fund manager pays for dealer compensation.

Robert Litan:  Question.  When you say fixed management fee, who fixes it?

Rebecca Cowdery:  The manager does.

Robert Litan:  Is it two percent for everybody?

Rebecca Cowdery:  No, the fund manager decides; when the fund manager is the sponsor of those funds, when they are establishing those funds, they look around to see obviously what the market can bear and they charge that fee.

Robert Litan:  But is it like common, that virtually everybody is around two percent?

Rebecca Cowdery:  That is how it has evolved.  It is really industry practice and competitive market forces.  There is no regulation of the fee.

Peter J. Wallison:  What does it include when you say management fee?  Does it include any other expenses of the firm?

Rebecca Cowdery:  No.  There is a management fee plus, as I put out on the slide here, unspecified operating expenses.  But I think both of them together are disclosed as a management expense ratio, which includes everything for operating the fund other than transaction costs.

Peter J. Wallison:  Okay.  What is that general…

Rebecca Cowdery:  Two-point-five for an equity fund.

Peter J. Wallison:  Two-point-five, so you would say two percent is the management fee, and then there is 0.5 for all these other expenses?

Rebecca Cowdery:  Right.  And again with competitive market forces, fund managers do not want to be out of sync, of course, with their competitors so it is really kept to that level that way.

Peter J. Wallison:  Yes, okay.

Rebecca Cowdery:  All Canadian mutual funds, and I can say this, there are really no concepts of a self-managed mutual fund.  All Canadian mutual funds are a separate thing from their fund manager.  It is a separate entity.  The fund manager is responsible for the business affairs in the mutual fund.  It is generally the fund sponsor, the entity that really established this as a mutual fund.  And again as Dick has explained, the fund manager can outsource all of its services for the funds including portfolio management, fund administration, fund valuation, and accounting.  But again, the fund manager remains ultimately responsible for the investors for what happens to those funds. 

By law, all assets have to be held by a third-party custodian.  They have to be functionally independent but they can be part of the same corporate group.  For example, those bank-owned mutual funds, as I have explained, all of them have as their custodian the parent bank who is sort of the custodian has the assets held in custody.  We do not have very much introspection about funds established as a trust, funds established as a corporation. 

I think bottom line in Canada, most funds are established as trusts, and the reason for that is quite simple, it is tax, income tax considerations.  There is better income tax treatment as a flow-through vehicle when an investor invests in a trust mutual fund versus a corporation.  But more and more, there are some corporate mutual funds established again primarily for tax reasons to allow investors to switch among the various classes without incurring capital gains tax.  But in reality, and I would echo what Dick said but emphasize it, is that there really is no practical difference whether you are a trust or a corporation in Canada. 

From an operational perspective, even from a legal perspective there really is not much difference.  If you are a trust, you have to have a trustee.  But in Canada under our trust legislation, it says you have to be an individual.  The trustee has to be either a group of individuals, one individual or it has to be a qualified or registered trust company, someone who is in the business of acting as a trustee.  Not as a mutual fund trustee, but as a trustee generally or the legislation does allow the fund manager to also be the trustee of the mutual fund.  Yes.

Female Voice:  Is this the same in all the provinces of Canada because I know they have a Provincial Securities Commission?

Rebecca Cowdery:  Yes.

Female Voice:  Are they the ones that differ from province to province?  Is there one province that dominates?

Rebecca Cowdery:  Thank you for asking that question.  Yes indeed, Canada has 13 different provinces.  We have no central securities regulator.  Each province by law has responsibility over securities issued in the province and also has responsibility for trust-type of activities.  Banking is federal so there is a Central Bank Act and a central regulator of Banks but there is no Central Securities Regulator. 

All of what I'm saying is very much across Canada.  Ontario is where most people live and so it has the largest securities commission, for example, and it is the financial center but everything I'm saying is basically the same across Canada.  There are some little nuances but they are not relevant for today's purposes.  But as I say, I think interestingly perhaps for you is, again most mutual funds, the trustee is the manager.  So only a handful use individual trustees and only very few use a registered trust company and there is no real magic as to whether or not you use a trust company or not. 

Other than, I think my experiences as a smaller fund manager just starting out, you may want to use a trust company to be the trustee because they are really outsourcing all of their activities to that same entity.  So you might say that this leads to some conflicts of interest, potential conflicts of interest.  So how Canada has dealt with that?  Because certainly we do not ignore those issues, we have been talking about those issues since this 1969 report that I talked about. 

Governance, this kind of what Peter was talking about at the opening remarks looking at how do you deal with conflicts of interest, it is dealt with at the board of the fund manager.  Some fund managers have independent directors on their fund manager but it is very much not consistent across the industry.  If the mutual fund is a corporation as Dick was explaining, I mean I should say that it is governed by general corporate law and, of course, by general corporate law the fund has to have a board of directors, but generally it is the same people who are the board of directors of the fund managers. 

So that is not where you are going to get sort of any independent oversight of the mutual fund, and I'm going to get to changes in structure so hold your questions on this one.  Some fund managers, because again, we follow what is happening in the United States, we follow what is happening internationally and again because of the importance of mutual funds for Canadian retirements, many fund companies have, on their own hook, established what they call advisory boards, independent advisory boards to help out the fund manager in managing conflicts of interest primarily. 

And just continuing on with the structural business, we have some fund companies that have public shareholders, in which cases I have put on the slide here, the governance of sort of the independent oversight of those funds, but again it is looking at it from the perspective of the shareholders of that public company, not so much for the shareholders or the unit holders in the underlying mutual fund but it is being looked at, at that public company level.  So what I have called today's regulation then as I have mentioned, there is no concept of independent oversight as there is in the United States, as there is with the depository as Dick has explained and is in that very good paper that the UK Trade Association put out. 

However, right from the beginning of the industry, securities regulation and common law, the fund manager is responsible.  They do have fiduciary responsibilities to act in the best interest of those mutual funds.  They have a duty of care associated with it and that is what regulation has principally relied on.  They have relied on fiduciary responsibilities plus disclosure. 

I'm not saying anything new.  I think this is a worldwide phenomenon but certainly the fiduciary responsibilities of the fund manager coupled with disclosure, fund manager accountability for that disclosure, and of course annual audits of the financial statements of the mutual funds.  There is some regulation of the fund itself.  Some aspects of fund management I have mentioned, it is a requirement that the assets be held by a separate custodian.  And how we deal with the most obvious conflicts of interest that come up and arise when the fund manager is doing direct transactions with the fund, for example, is that actually prohibited? 

And again, this is very much, I think, similar to the regulation in the United States.  It comes up mainly with these bank-owned mutual fund companies, again the banks are all very much public companies in Canada.  They are very much the top public companies.  The funds to date have not been allowed to invest in the parent company of the fund manager, basically because there is a prohibition on that.  But increasingly, there is pressure on the regulators to allow those funds to invest in the parent companies.  There is regulation of portfolio managers, people who are in the business of advising in securities so that the actual people who are managing the assets of the fund have to be registered. 

Of course, people who sell securities have to be registered but we do not have a concept of the fund manager, the sponsor, the administrator of the fund being regulated other than in a somewhat indirect way.  Regulation deals with the rights of investors, the right to vote on fundamental changes, the right to redeem and the right to have information and notice of any material change to their fund.  And of course, there is regulatory oversight by all 13 provinces, but generally it is mostly where the fund manager is located and as I have explained, most of the fund managers in Canada are based in Ontario, Vancouver, and Montreal so those are the three principal regulators. 

So at present as I have explained there is no concept of mandated independent oversight, so you do have this issue of the fund manager having a conflict of interest, the fund manager's duty or wishes to generate profits for its own shareholders but that is coupled with its fiduciary responsibilities for acting in the best interest of the funds.  Canada, as I have mentioned, has followed the United States for many years.  In about 1995, I mentioned the 1969 report, in 1995 with the growing importance of mutual funds the then-chairman of the Ontario Securities Commission asked one of the commissioners, her name is Glorianne Stromberg.  I do not know if anybody knows her.  She is very familiar - you are telling me to speed up - wrote a report about regulation and that really generated this whole debate about independent oversight of mutual funds. 

You will see in the materials, I have put in some description of where Canada is going on that.  It is borrowing a little bit from all over the world but it is this concept of an independent review committee to look at how the fund manager manages conflicts of interest.  The emphasis is going to be retained that the fund manager is responsible for managing the fund and has the accountability for managing the fund but then it will have to take into account the recommendations of the IRC. 

This rule is coming into force this year is what we have been told.  I think it is a recognition that it is going to be a bit of a bumpy ride.  There are many in the industry that do not see that they have any particular conflicts of interests.  The fund managers see their interest is very much aligned with their investors.  They do not have related party transactions and they just do not see what an IRC is going to do for those fund investors, particularly when you consider the cost of imposing this outside agency to monitor what the fund manager does.  But I think overall there is recognition that additional oversight may be a good thing but again sort of looking at whether the costs actually are more than what the benefits will be to investors. 

There are a number of other things going on where again, looking to the United States and the compliance plan rule.  We think that is what is coming.  There were issues in Canada with market timing.  I will not go into those unless you ask me but we are having a compliance plan rule.  People are always thinking about disclosure to investors.  All of that is always on the agenda, and it is certainly surfacing again and again, looking at what the United States is doing and looking at what the UK is doing. 

And that finishes Canada for you.

Peter Wallison:  There are so many questions but there is one thing I just want to ask you about.

Rebecca Cowdery:  Yes.

Peter Wallison:  That we probably cannot get any other information about and that is this so-called CI case.

Rebecca Cowdery:  Yes.

Peter Wallison:  I think it was a year ago when they said that they were going to offer a special kind of fee arrangement.

Rebecca Cowdery:  Yes.

Peter Wallison:  How has that worked out?  Has it helped them competitively or has it or has it not?

Rebecca Cowdery:  CI is the third largest fund company.  It is proud of being an independent fund company so it is not bank-owned.  It is one of the fund companies that are publicly owned so there is a public CI fund investment.  I do not know where they got the idea.  They are a very innovative fund company.  They decided it was better for investors to have a fixed fee structure, so not this concept of a management fee plus this unspecified operating expenses.  So they came up and they went to their unit holders actually to ask for permission to move to this, to a one-fee structure, an all-in fee structure. 

And they pride themselves on being a low-cost fund manager.  I do not know how successful, I mean they are the third-largest fund company.  I knew you were going to ask me this question so I did look at their public information.  They seemed to be doing very well, Peter, but the interesting aspect is it has not caught on with the rest of the industry.  There has really not been much discussion about it.  There was a little bit of a flurry when they first proposed it but the media died down about it.  Investors do not talk about it.  We have got some strong sort of investor advocate types.  They do not talk about it so I do not know why that is.  It is all very interesting, it sort of goes to the passive nature of mutual fund investing.

Peter Wallison:  Interesting.  Okay.  Well, thank you very much Rebecca, terrific presentation.  Robert Hoffmann is our next speaker.  Robert is the vice-president of Profile.  I would not try to pronounce these things in French for obvious reasons but he has been that since June of 2005.  Since March of 2001 he has been the general manager of the Association of the Luxembourg Fund Industry.  From 1999 to 2001 he was a lawyer and the head of the investment funds department at the law firm of Allen and Overy.  He has represented the Luxembourg funds on the European Fund and Asset Management Associations Board of Directors since March 2005 and has headed that organization’s distribution and marketing project as a member of the management committee, Robert?  Thank you for being here.

Robert Hoffmann:  Peter, thanks for the invitation.  I have been asked to address you in English which is not my mother tongue.  I will promise, for obvious reasons, to also refrain from speaking one of my official languages which are Luxembourgish, German, and French and everybody else in Luxembourg either speaks Portugese or Italian, so I will not do that.  I will do what we all do in the business community in Luxembourg, we speak international English.  It does not serve your language but it facilitates communication but it is not good for the evolution of English, downgrading. 

Luxembourg is a tiny country.  In terms of funds it is huge.  I think the size of the fund business is a result of the success story that needs an explanation so I will elaborate a little bit on the past and the reasons why Luxembourg became in the fund area what it is today.  Luxembourg would not have been anywhere in this fund business without a banking center.  It has been very much driven by a sophisticated banking center.  And why did it become a banking center?  So I will go through the different points of the agenda. 

It has started actually as a banking center as a result of a law that you introduced here in 1963.  That is the introduction of the famous Interest Equalization Tax that was aiming at reducing bond issues from foreigners into your jurisdiction by imposing it by a tax of 15 percent, and as a result that business went away from the States and got located basically in Luxembourg and in London.  It was the beginning of the Euro markets while Luxembourg at that time, because of other reasons also, the Germans could not do it in Germany because of what they, it was [indiscernible].  They had to keep non-interest bearing accounts with the Bundesbank. 

Luxembourg at that time was inexpensive and nearby so that is how it started, thanks to your tax law.  I do not comment on this.  Then later on, the banks developed other activities in Luxembourg because the EU market itself did not justify the setting up of the facilities.  Loan restructuring became very popular, loan restructuring especially after the Mexico problem and the Latin American problems within the loan business.  Again that was done in Luxembourg because that debt, you could deduct it from your taxable revenue so it was tax efficient in Luxembourg, and later on in the 1980s the fund business started and I will tell you why also. 

It started in a very modest manner.  The first fund was also, like in Canada, created in 1950 but there was no fund business.  In the early 1980s there was on the table of the bankers a draft directive, which was the first UCITS directive that all of you most likely know that to the extent that you deal with Europe.  And in 1983 we introduced our first investment fund act based on the European directive that came out in 1985, and that granted European passport to fund management groups based in one jurisdiction in Europe.  And we were, in 1988, the first country in Europe to have transposed into national law the European directive, thanks to the fact that we were small, we could afford not to be protectionist. 

We were quite open.  We did not have to protect national players.  There were not any large players, so that attracted in itself already a number of fund companies.  It grew rapidly, as you see, until the past few years.  There is in a way a stagnation in terms of number because we talked a little about cost, what is important is, and that is a problem in Europe, most funds are too small and funds are generally consolidated, are becoming bigger, so the number hopefully is not going to increase but the assets should increase because cost is very much in relation to critical mass and size. 

So funds must unfortunately be big to be performing, no matter what fee structure you put in place.  There are minimum fees you have to pay for small funds and that will eat up performance.  When we go then to the assets, there you see a rapid growth especially the past few years and in a nutshell we have now 2100 fund legal structures.  We have come back to that. 

We have two kinds of structures, contractual funds and corporate funds.  Funds are set up quite often under the umbrella structure and when you look at the different sub funds units combined, we come to 8,700 sub funds.  Since March 31st this year, we have come up to €1.67 trillion.  Fifteen months ago we were around €1 trillion so the growth has been tremendous over the past 14 or 15 months.  In terms of dollars, it is over $2 trillion, depending on the exchange rate. 

What is very important to understand is that Luxembourg, being very small, does not really have a domestic market for distribution either, although there are some private banking activity going on but obviously those €1.7 trillion are not being invested, not being subscribed by Luxembourg-based investors.  But the funds typically are being distributed throughout Europe and far beyond Europe into the whole world, into 150 countries, including pension fund managers in Chile, Lima, pretty soon in Mexico City.  Institutional investors in the Emirates, Dubai, in Singapore, Taipei, Hong Kong, Seoul, and Tokyo and so on, South Africa, just to name a few. 

It is also interesting to understand where the fund sponsors come from.  This chart has been updated last night.  I did not manage to change the bars but the US is now number one since March 31st.  It is the largest country of origin followed by Switzerland.  It is interesting to know here also that the major regions that set up funds in Luxembourg are non-European jurisdictions because Switzerland is not part of the European Union, as you know, and then we are followed by Germany and so on.

Male voice:  CH is Switzerland?

Robert Hoffmann:  CH is Switzerland.  Sweden.

Pierre Bollon:  CH is Confederation Helvetique.

Robert Hoffmann:  Yes.

Male Voice:  I thought China.

Pierre Bollon:  You could say “Chuisse” but that is not the [indiscernible].

Robert Hoffmann:  So as I have said, Europe is in a way our home market and the rest of the world is our exports market.  I mean we are primarily an exporting country and as such, there is only one really other jurisdiction in Europe that is primarily exporting, that is Ireland, and we have developed a specific model.  This reconfirms this model that is cross-border fund business in terms of market share.  Ireland has roughly 40 percent of the European cross-border market, Luxembourg 77 roughly.  Together, we have over 90 percent of the efficient UCIT business.  “Cross border” means not one but we have three kinds of funds, funds that are being set up in one country and being sold in that country, that is the domestic business. 

Then we have for various reasons a situation where a German fund would set up its business in Luxembourg and sell back only to Germany for a number of reasons because we have different structures that we allow for… that is around three plus.  They are excluded from this chart.  This chart is the fund promoters that really do prosper for the business, generally prosper for the business. 

This is an interesting list that you may not be able to read very well that is in your handout.  It is a list that ranks fund companies by the number of countries into which they distribute.  It is not the size of the fund, it is not the number of funds but the number of countries.  Then it shows where they are domiciled, and they are domiciled either in Luxembourg or in Dublin.  Franklin Templeton is in terms of number of companies, by far the largest followed, by UBS Fidelity, many names you know.  All the large companies are present. 

Now, yes, we try to compete, that is another point.  I mean the beginning of an answer to the question of fee structures.  Fee structures evolved through competition.  So I think one way of bringing cost down is to ensure competition.  If you have transparent… and transparency is important too.  Competition is definitely the driving force for bringing down cost, including the size and the efficiency of the service providers. 

Our model together with the Irish model is different from yours or the French or the German.  All the specialized tasks are being dedicated to outside companies, outside of the fund complex.  Also, the rest is to a large extent the question of conflict of interest because the separation of functions that is fully enforced and that is supervised by the supervising authority, conflict of interest is not really a big issue, at least not for the funds domiciled in Luxembourg. 

What kind of collective investment schemes are available out of Luxembourg that is pretty similar in all the jurisdictions within Europe?  I do not know why it does this but we have the UCITS, Pierre will talk about UCITS as well.  UCITS are the European funds.  The European funds that abide by the provisions laid down in the directives that transpose international law.  They are the [indiscernible] for collecting investment in transferable securities.  They are eligible for European passport.  That means you set up the fund in one European member country and then you can distribute it throughout Europe without too many problems.  Although this is an issue in itself that we addressed in situ, it is not necessarily of big interest to you but there is a notification procedure in place within Europe that does not always function, depending on the country into which you want to sell your funds. 

Then we have the non-UCITS that all the other collective investment schemes in Luxembourg.  Both are covered by the same law.  There is part one to our UCI law that covers UCITS and part two deals with all the other retail collective schemes. 

Then we have a specific role for institution of funds the units of which are not to be sold to the public, and we have also put in place since June 2004 a specific law for private equity and venture capital funds.  We are currently working on a new legal framework for special funds reserved to qualified investors that would also add further clarification in terms of hedge funds that are pretty active in Luxembourg already. 

We have pretty much like in England two structures, SICAV translated by OEICs.  It is an investment company with variable capital and the FCPs of the common fund.  It is a co-ownership where the investors are co-owners.  They are unit holders and that is being managed by a management company, and the assets are being controlled and supervised by a depository. 

And I will talk a little bit more about the management company now because the SICAVs are either self-managed or they designed a management company that deals with the management of the asset.  But it can be also self-managed.  That means it is a corporate structure with a board of directors that does all and delegates a lot.  This is the typical situation of a unit trust with a management company under the UCITS 3 directive.  The management company what we call limited liability [cross-talking, inaudible] of corporate.  If it is set up as such, then it needs a minimum board of three directors.  The directors must not be Luxembourgers.  They must not be a resident of Luxembourg.

 They must not be independent, although that is a recommendation to have one independent director.  It is not a must.  We have another structure that knows the English translation.  There you need a manager rather than a board of director but beneath you have executive managers, at least two managers.  That is a condition laid down in the UCITS directive.  These two managers, typically at least one should be based in Luxembourg but depending on the control systems put in place by the company that is operating on an international basis.  Either one must be based in Luxembourg.

 And the other different function, as I said, are being delegated--the custodian must be there by law.  It is not a delegation but the distribution takes place outside of Luxembourg in most of the cases so the distribution agreements sample administration must be carried out in Luxembourg.  As the intellectual asset management function is being delegated to investment managers most of the cases outside of Luxembourg, quite often to England.  And in a way, we have a shared approach, England doing much more of the asset management for many of the funds based in Luxembourg and the plumbing in certain way and the distribution issues are being dealt with by our jurisdiction.  That is quite often it is complimentary.  The same company…

Peter Wallison:  Robert, can I interrupt for a moment?  Who establishes the management fee?  It is the Luxembourg management company establishes the fee?

Robert Hoffmann:  We have the notation of sponsor fund, we call it fund promoter.  That is the entity in the interest of which the fund is being set up.

Peter Wallison:  Yes.

Robert Hoffmann:  All right?  That may be Fidelity, that may be an individual asset manager, it may be a bank, it does not matter.  And they decide the fees.

Peter Wallison:  So they establish the fees.  They establish the…

Robert Hoffmann:  When it comes now to the fee or the asset manager gets, that is a negotiation.

Peter Wallison:  Right, but I mean there is no negotiation in other words.  They establish what the fee is and the investors pay it.

Robert Hoffmann:  True, the investors have nothing to say.  It is just being shown.

Peter Wallison:  They make a choice.

Robert Hoffmann:  Yes.

Peter Wallison:  They want that service.

Robert Hoffmann:  It is transparent.  Yes, correct.

Peter Wallison:  Okay.  And the expenses, too, is there any control all over the expenses by any independent body?

Robert Hoffmann:  There is the control by the supervisory authority that looks at the justification of the fees put in place.  It has to be at arms length.  It has to be reasonable.  There are caps that are not official but when you take the all-in approach, it is between three and four percent.  We are only over four percent, unless you justify it.  The custody, the administration fees vary a lot along the size of the fund.  But for a large fund, let’s say €2 or €3 billion, the average would be around 1.5, 1.8 basis points, but more.

Peter Wallison:  For what, 1.5 to 1.8 for all-in or…?

Robert Hoffmann:  For administrative function.

Peter Wallison:  …administrative cost

Robert Hoffmann:  Administrative cost, yes.  That is a transfer agency functions, accounting, calculation of NAV, that will all be covered, but roughly between one and two basis points.

Peter Wallison:  Then these…

Robert Hoffmann:  But it can go up to 9 and 10 basis points, if the fund is more.

Peter Wallison:  And then the fee is on the top of that?

Robert Hoffmann:  And the management fees on top of that.  But quite often, there is an all-in fee and then it is up to the management company to allocate the different parts.

Peter Wallison:  Oh, there is frequently an all-in fee.

Robert Hoffmann:  Yes, that is quite often of case, yes. 

Peter Wallison:  And that would be?

Robert Hoffmann:  The problem is, I mean we do not have really any standard approach to this because each fund promoter brings to Luxembourg its own structures and then we look whether it is at arms length, whether it makes sense, but we have all models in place.

Peter Wallison:  I see.  So the regulator then looks at all these things and approves them for sale.

Robert Hoffmann:  Yes, absolutely.

Peter Wallison:  In Luxembourg and also out of Luxembourg or is there a difference between whether it is approved in Luxembourg or for sale out of Luxembourg?

Robert Hoffmann:  To the extent that the fees occur in Luxembourg, it is being approved in Luxembourg and I will come back to that.  [indiscernible] administration must be carried out in Luxembourg.  The custodian must be in Luxembourg, so all the functions and principles are carried out in Luxembourg. 

Pierre Bollon:  The question was, is there difference between the funds which is sold only on Luxembourg or outside.  No.

Robert Hoffmann:  No, there are huge differences in terms of [audio gets cut off] fees.  The distribution cost is different depending on whether you distribute your fund to China, to Spain, or to Luxembourg, probably banking.

Peter Wallison:  But if you are approved by the Luxembourg authorities, you can sell it, either in Luxembourg or outside, depending.  It does not matter what you sell it for.

Robert Hoffmann:  Typically, what is happening is that you create specific share classes or sub-funds in the umbrella fund for each jurisdiction with different fee structure.

Robert Litan:  Yes, okay.  But for example when sell a Luxembourg fund in France…

Robert Hoffmann:  Yes.

Robert Litan:  The French regulatory authorities, do they do something?  Do they regulate the fees in some sense?

Robert Hoffmann:  They do not regulate the fees, no.  If it is a UCIT, then the fund is being authorized in Luxembourg…

Robert Litan:  With a single password.

Robert Hoffmann:  It is a single password and then the intention to sell the fund into France will be notified to the French regulator, then within two months they have the time to react and that is it.

Pierre Bollon:  What we look at the French but the others also, they look at the marketing material.  Is it understandable, is it in French, or in Czech.  [Cross-talking, inaudible].  But you are not satisfied with it in Europe.  We would like national authorities to have no right to have a look and if the Luxembourg authority regulator is making a mistake, then the French regulator should go at the Luxembourg regulator and complain and not stop the funding.  But that is not the case right now for marketing material.  Every local authority has the right to look [indiscernible].  But it does not entail power on fees and eligible asset or something like that.  It is on marketing material.

Peter Wallison:  Go on, Robert.

Male Voice:  [Inaudible] some clarification for Robert or Pierre.  I think you said that your total expenses of [inaudible] funds tend to be three or four percent.

Robert Hoffmann:  Maximum, maximum.

Male Voice:  That is the maximum 300 and 400 basis points?  You said the administration, though, is only a possible two basis points.  How do you get to the 300 and 400?  What is the general size of the management fees?

Robert Hoffmann:  Yes, I mean a large part is being absorbed by the distribution fee.  Distribution is the bulk of it.  That is included.  Oh, yes.  And plus management fee.

Male Voice:  Yes.

Pierre Bollon:  We have one tendency to call management fees something which includes distribution cost, and it is no good.  We should call it a total ratio, because the reality is that we, the managers, we keep only a tiny part of it and most of it goes to the distributor that is included.  All marketing fees are included in what we call the only management fee.  We should not, because the clients have the one perception that we earn a lot of money but like very often two-thirds of it or three-fourths of it is going to the distributor.  Requisition to the distributor.

Peter Wallison:  So the buyer, that is to say the investor, the investor does not pay anything for the commission of the distributor or broker, whoever it is he sells it to.

Robert Hoffmann:  There are different structures that are in place.  Typically the buyer pays a subscription or redemption fee that may not necessary go back to the distributor.

Peter Wallison:  Yes. 

Male Voice:  There is an additional sales charge [indiscernible].

Robert Hoffmann:  Yes.

Peter Wallison:  So there is a sales load on top.

Robert Hoffmann:  Yes. 

[cross-talking]

Peter Wallison:  The distributor gets it from both sides.

Robert Hoffmann:  And then the distribution fees as being paid to the distributor, as in that case taken out and charged to the fund.

Peter Wallison:  Okay.

Robert Hoffmann:  So we made the distinction between fees and expenses that are being charged to the fund and those that are being charged outside the fund.  Like the subscription fee that is being paid directly up front by the investor and that goes quite often to the management company.

Male Voice:  Some question for clarification again.  And so are these like load fees or are they like one time, in which case your fees of 300 or 400 basis points would have to impute some kind of amortized load, right?  Or are they 12b-1 fees with recurring charges against them?

Robert Hoffmann:  They are not recurring. 

Male Voice:  But this one time…

[cross-talking].

Pierre Bollon:  No, it is different.  We have entry fees—you could call it load but there is a big question of when to go down, so we are very often are very weak, especially in my country are going down, so the distributor gets it, but the distributor also with recessions coming from what we call [indiscernible] management fees.  No, very often it could be one time but also a kind of year-after-year if the bank keeps her client so it gets, so each time it is small, like 12b1, I guess.

Richard Saunders:  Could I just explain how it works in UK then?  I mean there are slight differences but I think it is probably similar.  The typical charge structure for a UK fund will be a management fee which has an initial load of five percent and then an annual management fee of 1.5 percent.  Out of the five percent load, at least three percent will be paid to the distributor in commission.  Out of the 150 basis point annual charge, 50 basis points will be paid in what we call trail commission or retrocession as an annual ongoing commission to the distributor. 

Other charge structures, just as in France, there is pressure on the load and you are increasingly seeing the load being discounted in various distribution channels.  There is an alternative though, which is to pay fees to your adviser and typically rather than being a financial adviser that will be a private client, stock broker or wealth manager and the way he will work, he will charge a fee on the size of the client's portfolio.  It may be one percent a year or whatever.  But instead of paying those charges, the 500 basis point 150 basis-point charge, the investor will pay an institution rate which strips out the commission.  And that is one of the key uses of share classes in the UK to any rate is to have a retail and an institutional share class, the difference being the cost of the commission.

Robert E. Litan:  I just want to get one clarification that, that 300 to 400 basis points that you are talking about, that is annual, right?

Robert Hoffmann:  That is annual.

Peter Wallison:  Right, okay.

Robert Hoffmann:  Yes.

Peter Wallison:  Okay, Robert would you go on?  I think we are going to continue beyond 11:30, because obviously we did not allot enough time for all of this.  So I hope you all can stay.  This is really fascinating.  Robert, why do you not finish up?

Robert Hoffmann:  Okay, I will just make it then short.  The situation of SICAV, an investment company that has chosen to designate an outside management company and has the choice also of being self managed.  It is pretty much the same situation as the situation of FCP, common fund or a unit trust.  So that is a self-managed SICAV that has a no management company.  That is important to understand. 

It is the board that takes all the decisions.  There have to be at least three board members.  On top of that, they have two executive managers.  Again, they must not necessarily be based in Luxembourg.  They have to appoint an independent auditor.  The auditor plays a very big role in supervision in terms of supervision in the European Fund Industry.  The custodian and all the rest is pretty much the same as for the common fund as we call it. 

So what do they have in common?  For the management company, they must be incorporated in Luxembourg.  They are an inherent part of the fund, except for the self-managed SICAV.  They must be authorized and they are supervised by the CSF.  That is our supervisory prudential authority.  They have to show an activity program.  They have minimum capital requirements actually imposed by the European directive that are being applied in Luxembourg as well as any other European jurisdiction. 

On the top of that, the shareholders of management company must be approved by the CSF then we come close to the promoter concept already, because typically the shareholder of the management companies are the entities, are the people, who represent the entity in the interest of which the fund is being set up.  I will come back to the promoter concept in a second.  We are just typical.  Again, I explained that already to the [indiscernible] that many functions are being delegated to third-party service providers, including distribution and investment advice. 

All those parties are being supervised by the Luxembourg authority, to the extent that they are based in Luxembourg and otherwise, they have to be supervised in a similar manner as in Luxembourg, including IT firms.  IT firms that are specialized in extending services to the Luxembourg fund business are being supervised by the financial authority.  All the rest is actually pretty much in line with the provisions laid down in the UCITS directive and not specific to Luxembourg. 

Let us shortly mention the fact that Luxembourg is not only a location for harmonized passported European UCITS.  It is also a center for specialized funds, for institutional funds, real estate funds.  Many of the US real estate fund promoters for their real estate projects outside of the states have set up structures in Luxembourg.  One is very large, that is the Heitman Group from Chicago.  They have huge funds in Luxembourg with institutional investors from all over the world.  We put in place recently a specific [indiscernible] in terms of financial capital and private equity to provide for a corporate solution very close to the Anglo-Saxon approach of limited partnership for tax reasons. 

We have since 2004 a law in place in terms of securitization that can also be set up as a fund.  And we are working currently on a new law that we hope to come out by the end of the year or the beginning of next year relating to special funds for qualified investors, where we will drop the notion of promoter because there is a lesser need for investor protection.  All the promoter notion goes back to the idea of investor protection, I will come to that in second, and I will also conclude my presentation. 

The promoter, as I said, is the entity that in the interest of which the funds is being set up, and it has to be specifically approved by the CSF that looks not only at the professional qualification and the reputation, but also at the financial situation of the promoter.  The promoter, although it is not a concept that is laid down in Luxembourg law, it is the Lender of Last Resort.  If things go wrong, if investors incur losses on the contractual basis, the management company, the custodian of the [indiscernible] is not in the position to come up with compensation of the promoter and then they will have to pay, otherwise the fund is being deleted from the list of authorized products. 

If the entity and the interest of which the fund is being set up does not have what we call deep pockets, then they need to find and identify a co-promoter that would serve us a lender of last resort.  That typically would be a Luxembourg-based depository bank.

Peter Wallison:  You say if investors incur losses.

Robert Hoffmann:  Yes.

Peter Wallison:  Let us assume that it is an equity fund…

Robert Hoffmann:  No, I will come back to… incur losses, I mean you got two situations.  Incur losses because of miscalculation of NAV or breach of investment policy.  We only looked at the two situations.  It is not a market loss policy. Yes, that will be too easy.

Peter Wallison:  So that is…

Robert Hoffmann:  We have cut the protective fund, that is a different story.  Incurred losses due to wrong behavior of…

Robert Litan:  Wrongdoing.

Robert Hoffmann:  Yes, wrongdoing.

Peter Wallison:  And who establishes the wrongdoing?  Is that done by the regulator?

Robert Hoffmann:  Yes, independent auditor.

Peter Wallison:  The independent auditors.

Robert Hoffmann:  The independent auditors must first inform the management company, the promoter but also the regulator.

Peter Wallison:  So they look at how the fund is actually managed in addition to simply its financial statements?

Robert Hoffmann:  Correct and they have to establish a long form report.  They have to establish relationship if the fund was all third parties, the intermediaries, as we call them.

Peter Wallison:  Yes.

Robert Hoffmann:  They also looked into the professional services from third-party service providers.

Peter Wallison:  Okay.

Robert Hoffmann:  Okay. 

Peter Wallison:  Okay.  Robert, thank you very much.

Robert Hoffmann:  So I think I will stop here because we still have Pierre and we want to have some discussion.

Peter Wallison:  Right.  We want to give Pierre some time and incidentally your English is excellent.

Peter Wallison:  I would not worry about it.

Robert Hoffmann:  I have to come often here and practice.

 Peter Wallison:  Okay.  Pierre Bollon, Monsieur Bollon is the chief executive of AFG.  Again, I will not try to pronounce the Association Francaise et cetera, the French, which is the French Investment Funds and Asset Managers Trade Association.  He is also vice chairman of the French Study Center for Corporate Social Responsibility and a member of the board of the European Funds and Asset Managers Association.  Before joining AFG in September 1997, Monsieur Bollon worked from 1984 to 1989 as a civil servant in the Prime Minister’s Office and then at the Treasury.  And from 1990 to 1997 he was an adviser to the chairman and director of Economic and Financial Affairs of the French Federation of Insurance Companies.  Pierre.

 Pierre Bollon:  Thanks.  It is a pity there is no market for time of speech because I would be rich now, but I was not able to sell it to my friends; hey took it for free.  I’ll try not to be too long in order to make up for some of the time so that you can go back to your office or have a decent lunch.  I will need the small thing, I’m afraid this is left to go away.  Okay.  So the first part is a kind of publicity like my friend from Luxembourg did, and so I will be very quick.  We have a very big country for asset and fund management who have nearly 500 management companies. 

Management company--it does not mean funds--it means asset managers.  They are managing around 8,000 funds, UCITS funds - UCITS compliant and 3,000 non-UCITS funds.  It is almost now 1,400 when I speak today, billion euros.  So it is little less than $2,000 billion, so it is about 1/5 of the size of your industry.  So as we have 60 million people, it is a little less than the U.S. by inhabitants but not so far and 20 percent of households’ financial assets, which is not enough.  We are working everyday to make this 20 percent go up. 

These are the figures of the assets under management in France, top parties UCITS or unit of collective investments trust and UCI, and then the lower party’s mandates, and I will come back to that, but I think it is important that all business is asset management for third parties for clients.  There are two ways to do it.  One way is fund regulated or in other ways mandate but for us, at the end of the day, it is the same business.  We are entitled - my members, when I say we, it is my members - we are entitled to manage assets, buy and sell, manage a portfolio for their clients and there are two ways to do it; either pre-organized one which is a fund and the more free one which is the mandate.  But at the end of the day, it is the same business to be in forward, to manage other people’s money.  So to do that you have to be regulated and authorized. 

So this is some comeau baie [sounds like], or we call it cheese.  I guess you call it pie here, so it is a different way of saying round things but it is well done, well done comeau baie is very good one so this is a financial management.  It is a bit different from the slide that the next one is the one that Robert showed you.  It is the domiciliation of UCITS.  So here you see that Luxembourg is way ahead now but when you look at the previous one, it is where the money is managed and the money, well, number one in the financial management of funds and because as Robert told you, most of Luxembourg and Irish funds are managed in their country of origin of the promoter.   

I guess it is quite a bit relevant to what we are saying today so these figures, of course, we could discuss for days and they are McKenzie figures, not ours.  It shows about the total cost of management companies.  It has to be where maybe above we will have to work a little on that because some of these figures are surprising but it shows that a total cost in Europe is 20 basis points on average, and it is an interesting comparison I guess.  I do not know if it is an indication of competition or if it is an indication of the cost of regulation.  It can be both maybe or organizational efficiency.  I do not know, but these figures I guess we should welcome them and try to understand maybe they are wrong, maybe they are right.

 Richard Saunders:  Is it just recommendation has something to do with it?

 Pierre Bollon:  Yes and no.  I said recommendation, yes [cross talking].

 Richard Saunders:  The U.S. and U.K. will be much more equity...

 Pierre Bollon:  Yes, okay.  It is one of the reasons.  Yes.  The more equity you have, the more the cost is expensive of course.  Yes, it is part of the reason, I’m sure.

 Peter Wallison:  Sorry Pierre, what is included in those, in the cost?  Do you know what the underlying data is for that?

 Pierre Bollon:  We discussed that with McKenzie, and it was not so easy to understand but to put into that maybe you have to pay them to understand.

 Robert Litan:  Mckenzie is non-transparent.

 Pierre Bollon:  That is a reason.  Yes, but we did not pay them to show our cost where it was, or it was always low so I’m not sure.  That is all of the operating costs of asset management so that is, I guess, it is the fees and the… I do not have…

 Peter Wallison:  Okay we will try to get that… McKenzie but…

 Pierre Bollon:  It is also a way to see things but as I said, the asset allocation is part of the explanation.  Maybe the cost of regulation is part.  As I said, maybe the level of competition when you have 20 percent of financial assets of household it means like competition is severe and intense.  We are fighting with insurance products, fighting with banking accounts so we have to keep fees low. 

And also another thing is that in France we have a lot of institutional money managed for funds also.  And to relate to what my two panelists have said of course, institutional money is a big chunk of money, and the fees are lower so it is part of the explanation, I guess. 

 Peter Wallison:  Just one more clarification about that to the extent that we can, what are the numbers?  Are the numbers absolute dollars?

 Pierre Bollon:  It is basis points of assets for the management.

 Peter Wallison:  Basis points.  So 27 basis points per dollar?

Pierre Bollon:  Yes, that is what it seems.

Peter Wallison:  Euro or?

 Pierre Bollon:  I must admit I’m not completely comfortable as I see it putting these figures but at the same time, they are from McKenzie.  The idea, because one of the underlined idea of this meeting this morning was also to try to measure the regulatory costs, the costs of all that we are talking about and we have not done so up to now in this panel, so that is why I put these with the help of Stephan.  I have put these figures knowing that it is not so easy to interpret and understand so well.  I immediately said that…

 Peter Wallison:  Yes, thank you.

Pierre Bollon:  Before showing it to you because I do not feel 100 percent comfortable with it.  So we are very regulated and organized in Europe.  I know that you used to say something that United States and U.K. are divided by your common language. Maybe we can say so in Europe, but we are divided by our common regulation on UCITS.  Still, maybe the same effect, but we understand each other well at the end of the day and we can export funds, cross borders even if we wanted.  We would like it to be easier than it is, so this UCITS directive has a lot of merits and it helped us to converge, although it is not 100 percent convergence at the end of the day. 

There are differences between, as we, Robert and I, are quite minor, not insignificant but minor I would say, especially the difference comes in very often because at national level the regulators are kind of competing to protect their, or to appear to protect to their own savers, so they have the tendency of what you call gold plating, I guess, to add on to your open regulation.  Very often, they think they are doing it for good reasons but at the end of the day, it adds costs and also it adds complexity and all of us are paid to fight that, day after day.  We also have a stronger… but in the French, I would say is, if it wanted to appear the champion of [indiscernible] regulation, and that is something that you have to live with. 

It is also a plus because it helps to sell funds to the clients but it is very, very safe but at the same time, my problem is that it might impede innovation and quickness to answer to competition in the market for financial products.  So we have to fight to have what we are trying to call better regulation.  That means not adding a slice after slice regulation. 

And to come to the subject of today, one of our fear, it is less-so now, is that you had this here, this problem of market timing late trading, so the result was a strengthening of holds on independent directors and independent chairman.  It is still pending because the court repelled it, but we were, at that time, fearing but these, the cures you have here to cure your diseases whether they are good or bad, I do not know the cures would come to us even if we did not experience the same problem. 

We can call it a tsunami effect; you are like working along the beach with your and suddenly you have a big wave coming from the other side of the Atlantic and it goes, speeds a wave or something and so we were a bit anxious.  Tsunamis speed up tsunami so we are a bit anxious about that.  It is why you published in England the paper you have in the files but we need, of course, the same kind of paper in France, we need the same in Germany because we do not want to be cured for, to have medicine for disease we do not have. 

 Rebecca Cowdery:  Can I say Pierre, the IOSCO Group, the International Organization of Securities Commissions is run by the French AMS right at the moment, and they look like that tsunami is licking at European’s heels on the governance.

 Pierre Bollon:  Of course.  I know IOSCO SC5, Standing Committee Number 5 by Hubert Reynier from the French IMF but from what I have seen from IOSCO papers they are kind of, is kind of good at changing caps and not exporting too much the French regulatory gold plating or the SEC gold plating that kind of, their paper on governance of collective investments scheme was quite balanced.  I think I do not know if you have the same opinion on it.  It is something that I think you should read and I do not know if you have sent it or you could send it, send your link with IOSCO paper on governance.  Here it is.  But I guess you can also have it from the IOSCO website but it is a very interesting paper and it is quite balanced, and it explains a lot of what we are talking about today so…

 Rebecca Cowdery:  But there is a new one coming? 

 Pierre Bollon:  Yes.

 Rebecca Cowdery:  Right, on specific responsibilities of these government agencies that they talked about.

 Pierre Bollon:  Yes, and I know in this respect you tend to have an idea of independent oversight but not coming from the board of directors of France but independent oversight. 

Also what they are doing in Australia, you were to right to mention Australia, could be examples about what IOSCO might want to put forward.  I know they wanted to do that a lot two years ago but when the Canadian law was so slow to come back, we finally thought it would never come back.  They have just told us a few minutes ago that the Canadian law might come in the summer so that might restart IOSCO thinking on this independent oversight but not on a fund level but on a management company level.  We will see if it becomes a must, and we should also look at all of us.  So I start again my speech. 

Fund simplification is important and a specific thing maybe--I do not know if it is the case in many countries, the code of conduct we do, association level we can be endorsed by the regulator and once we are endorsed by the regulator, my members can be sued if they do not follow the own code.  The good thing about it is that, we have the pen in our hands and we do not let the regulator write the regulation.  It is a bad thing maybe at times but it feeds as a regulator with new ideas of regulation and it is an endless thing.  We put things in a professional code and then it goes into the regulation. 

So we are kind of always thinking twice I would say before writing our own regulation because at the same time, it is good because we write it so it is normally more intelligent or clever or to the fact than what the regulator might write, and it is preemptive and not over reactive regulation but at the same time it feeds the regulator.  So it is a bit of a dilemma we have with this kind of a self-regulation.  But at the end of the day, I would say we are in favor of it, and we are still producing self-regulation. 

Okay, so this is the same thing about what I showed you a few minutes ago.  We also in France, have regulated hedge funds.  I know it is a strange thing here, regulated private equity funds, regulated listed funds now and employee saving funds.  They are non-UCITS but they are a growing part of the market because it is mainly is where the innovation is. 

Next slide.  Same thing as my friend said so I think I do not have to elaborate a lot.   We have two types of funds, corporate funds which are SICAVS and contractual fun