On February 12, 2012 the Technical Committee of the International Organizations of Securities Commissions (“IOSCO”) issued a draft consultation report to expound on its May 1999 final report on principles for valuation of collective investment schemes (“CIS”). The objectives of the May 1999 report were to obtain a greater understanding of the jurisdictional differences and regulator approaches to the valuation of CIS (mutual funds) and pricing of CIS interests; and gain an understanding of the extent and type of enforcement of jurisdictional rules relating to the valuation and pricing of CIS. Also, they recommended some ethical, disclosure and share calculation principles.
The Technical Committee consists of the chairpersons of the SEC and CFTC. And other government directors of securities regulation which include: Spain, UK, Japan, Germany, France, Italy, Mexico, Switzerland, Quebec, Ontario, China, Brazil and Australia.
Comments are due on or before May 18, 2012 and were specifically requested on the following:
- Do these principles adequately address the regulatory issues raised by the valuation of CIS?
- Are potential conflicts of interest appropriately addressed? Do you see a need for more stringent principles in this area?
- In particular, does the principle on the NAV at which the purchase and redemption of CIS interests should be effected, adequately cover the issues.
In the February 2012 report the Committee proposed 13 principles on pricing mutual funds or CIS. Principles 1 to 5 are recommendations for written pricing policies and procedures for the securities or assets held by a CIS. They should identify the methodologies that will be used to value each asset held by the CIS. Structured financial instruments should be based on qualitative and quantitative analyses which have to be conducted both in normal and stress scenarios.
Principle 3 listed the following approaches to address the investment adviser conflicts of interest: (1) the risk management function of the CIS could review the valuation provided by the CIS operator. Under this model, the risk management function would be hierarchically and functionally independent of the CIS portfolio management function. Similarly, an internal auditor or committee that is separate from the CIS portfolio management function could review the valuations; (2) the portfolio management function could be separated from the valuation and/or pricing function, and thus not permit the CIS operator or portfolio manager to determine the valuations, although the CIS operator may be able to provide input, as appropriate. In addition, automating the valuation process, where possible, can help to reduce the possibility of improper influence on valuations; (3) the CIS depositary, as applicable, could seek to ensure that the CIS operator carries out the valuation of the CIS appropriately, therefore providing an independent check on the valuation policy and the way it is implemented; (4) the responsible entity could define and maintain a conflict of interests policy designed to manage conflicts associated with the valuation process, among other things; (5) the CIS could retain independent pricing services or other experts to assist them in obtaining independent valuations, as appropriate; (6) if the valuation is obtained from a third party that itself has a conflict of interest (i.e., the counterparty of an OTC derivative, the structurer or the originator), the verification of an appropriate degree of objectivity in the valuation could be carried out by one of the following: (i) an appropriate party which is independent from the third party, at an adequate frequency and in such a way that the responsible entity is able to check it; (ii) the depositary of the CIS; or (iii) a unit within the CIS which is independent from the department in charge of managing the assets and which is adequately equipped for such purpose.
Principle 4 states that the reasons for pricing overrides should be documented and reviewed by a party that is independent of the investment adviser or portfolio manager. Principle 5 stated that material pricing errors that cause harm to the investments should be compensated by the CIS.
Principles 6-8 proposes periodic review by the responsible entity of the pricing policies and procedures for appropriateness and effective implementation. Also, requires a third-party review of the process annually.
Principle 9 proposes that the responsible entity conducts initial and periodic due diligence on third party pricing services.
Principle 10 states that valuation procedures should be disclosed to investors about the CIS’s valuation policies and procedures could include general information about how certain assets are valued and how frequently they are valued. This information should be updated and made available to investors when these valuation policies and procedures materially change. For example, in the U.S., a CIS prospectus must disclose that the price of CIS shares is based on the CIS’s NAV and the methods used to value the CIS’s assets (e.g. market price, or amortized cost). For non-money market CIS, this disclosure must include a brief explanation of the circumstances under which it will use a price other than market price and the effects of using this price. The prospectus is updated annually or more frequently, depending on whether its information has changed materially. Other jurisdictions may require the CIS’s policy to include a specific section illustrating the criteria used to value the CIS assets. This information is then made available to investors upon request. In addition, certain valuation criteria are reported in the notes to the CIS/subCIS annual report.
Principle 11-13 adopts the U.S. forward pricing rule for CIS shares, and recommends that NAVs should be available to investors daily at no cost.