Establishment

Establishing a mutual fund follows a similar procedure in all countries. First, a management company determines the investment opportunity for a fund with a particular investment objective and policy, then decides its appropriate type or construction, either the corporate type, as an investment company, or the contractual type, as a unit or investment trust. It is worth noting that, in law, only the corporate type has a’legal personality’.

Usually in conjunction with an independent custodian, depositary or trustee, the fund’s constitutional documents are prepared and executed as legally binding instruments. The officers and agents, such as the investment manager, transfer agent, selling agent, administrator, auditor, are identified and then the terms and conditions upon which the fund will be offered and operated are settled and the charges and tees of the various parties agreed. Application for authorisation is then made to the relevant authority.

FundsDepending on the jurisdiction, authorisation of the management company and the other parties concerned either precedes any application for authorisation of the mutual fund, or it is carried out as a single process when the management company first makes application for authorisation of a fund. Either way, the fund does not become authorised until the regulators are satisfied that it and the parties involved meet certain minimum requirements along the following lines:

  1. the management company must have a minimum capitalisation and ‘free resources‘ sufficient to fund its expenses for, say, three or six months;
  2. except in Australia, the custodian, depository or trustee must be independent of the management company and have a minimum capitalisation, which typically is substantially greater than that required for the management company. In Hong Kong, for example, HK$ million is their management company requirement, but for the custodian/trustee it is HK$10 million;
  3. the management company /and any separate investment manager) must have appropriately qualified and experienced personnel engaged in the fund’s management and administration. In the US and UK, compulsory training and competence schemes have had to be operated by management companies for personnel engaged in portfolio management or administration and in selling or advising on investments for some years and this form of requirement is gradually being imposed throughout the world;
  4. the fund itself must meet certain operational requirements set out in the relevant regulations dealing with matters such as frequency of valuation and dealing, calculation of NAV and unit prices publication of prices and other information, maintenance of shareholder records, and controls over transactions with connected persons;
  5. the fund must also meet various investment requirements applicable to its objectives or fund type, including diversification, concentration, liquidity, limits on the use of derivatives and on borrowing;
  6. to allow investors to make informed decisions, detailed disclosure requirements must be adhered to by the fund;
  7. if the fund has been authorised in another jurisdiction, or the management company is not resident in the country concerned, then it must have a resident licensed representative with whom investors can deal.

The method by which the fund meets these requirements is set out in its prospectus, which, together with the instrument of incorporation (or the trust deed) and appropriate fee, must accompany submission of a completed application form to the central regulator. Other information may be required, such as:

  1. a marketing plan, including sales projections for, say, three years and a statement of how quickly the fund is expected to become viable;
  2. the management company’s latest audited accounts and personal details of its directors and senior officers;
  3. the custodian’s or trustee’s latest audited accounts and consent to appointment;
  4. if the fund has been authorised in another jurisdiction, evidence of authorisation and, if already up and running, its most recent audited report and accounts.

If any of these documents is not in the local language or another acceptable or official language, it may have to be supplied in a translation.

If the regulators are satisfied, an order of authorisation is issued and the fund may commence operations in that country. The process may take between 15 days and six weeks, depending on whether the parties involved are already approved and whether the fund is of a standard type.

Set-up

Set-up involves the putting in place of staff, systems and procedures to deal with the business of operating the fund or enhancing existing resources to deal with an additional fund. A fund in the form of a company may be the owner of these resources itself but a trust typically cannot own ‘fixed assets’ or other physical resources. The company can usually recover the costs of these resources from operation of the fund by writing off the original outlay on set-up, possibly over a number of years (known as ‘amortisation’) but more typically in the first year, and, if an umbrella structure is established, by spreading the write-off over a number of sub-funds. Annual running costs are covered by charges made on the issue of shares and management of the fund.

Where the fund is not self-managed, which is the case usually with the contractual type or trust, then set-up and its costs fall to the management company and its appointed administrators and transfer agents. The management company is entitled to charge fees for its services and, in turn, can contract with its agents to pay for their services, either from its own income or, if the regulations permit, directly from the fund.

Once set-up is complete, marketing can begin. When sufficient shares are sold, the fund can begin its investment programme, the activity generally understood as ‘fund management‘.

Changes

Once the fund is up and running, any changes to the details supplied to the regulators when applying for authorisation must be referred back for approval if they amount to a material change. Extreme examples would be seeking to operate a fund authorised as a bond fund as an equity fund, an America fund as a Japan fund, but ‘material’ also means changes to the maximum rates of fees or charges that can be borne by the fund or charged to investors or changes in the investment objectives, for example, from capital growth to high income.

The approval process typically includes gaining the approval of shareholders in general meeting. This is mandatory for certain proposed changes and otherwise if the trustee/custodian believes it to be necessary. Some changes can be made without such approval, although notice of change is usually required. For example, the maximum rate of a particular charge may be laid down in scheme documents. A proposal to increase this rate requires prior approval, but a proposal to increase the currently applied rate to a rate that does not exceed the maximum could be implemented after giving notice to shareholders. In the UK, for example, the notice period is 90 days.

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Mutual Funds’ Establishment, Set-Up and Changes