New Regulation of Mutual Investment Funds: Much ado about Nothing, or a Real Step Forward?

Artem V. Shyrkozhukhov, Yuriy P. Zaremba

On 15 August 2012 the President of Ukraine signed the new On Mutual Investment Funds Act of Ukraine (the New Investment Funds Act). The New Investment Funds Act will come into force on 1 January 2014. Within a year after it comes into effect, Ukrainian mutual investment vehicles (Investment Funds) will have to bring their operations into compliance with the New Investment Funds Act.

The New Investment Funds Act has been widely welcomed by professionals working in the field as a right step towards development of investment funds in Ukraine. In this article, we will analyse whether this is really the case, compare some provisions of the New Investment Funds Act with approaches taken in the United States and the European Union and look at what else needs to be done to make Ukrainian regulation of Investment Funds closer to that in developed economies.

What’s new in the New Investment Funds Act?

The New Investment Funds Act has introduced several changes that improve regulation of Investment Funds in Ukraine. The most important of these changes is the long-awaited separation of regulations of the operations of Investment Funds from the general corporate legislation applicable to all joint stock companies. As a result, Investment Funds will be exempt from some cumbersome procedures, most notably those aimed at protecting minority shareholders in joint stock companies.

The New Investment Funds Act has also introduced more detailed regulation of the structure of Investment Fund’s assets. Depending on a particular investment rating of securities and bank institutions, Investment Fund’s assets will be subject to several additional restrictions, namely:

Investment Fund assets may not include corporate bonds, mortgage bonds or municipal bonds rated lower than at investment level (as determined by a reputable international rating agency) in the amount of more than 20% of all of an Investment Fund’s assets;

Investment Fund’s assets may not include monies and bank metals on current or deposit accounts in banks rated lower than at investment level (as determined by a reputable international rating agency) in the amount of more than 20% of all of an Investment Fund’s assets.

On the other hand, derivatives were allowed to be part of the structure of assets of Investment Funds, subject to compliance with requirements to be established by the National Commission for Securities and Stock Exchange of Ukraine.

The New Investment Funds Act introduced several restrictions as to who can be a member of the corporate Investment Fund’s governing body, the supervisory board. Specifically, individuals who were convicted of economic crimes or committed more than three administrative violations on the stock market may not be members of the supervisory board of a corporate Investment Fund or an asset management company.

The New Investment Funds Act distinguishes the following new types of Investment Funds: “specialised Investment Funds”, “qualified Investment Funds” and “stock Investment Funds”. The New Investment Funds Act provides detailed qualification requirements for each of these types of Investment Funds. It is expected that these qualification requirements will ensure higher quality of asset management by Investment Funds.

Furthermore, the New Investment Funds Act sets out additional limitations with respect to participants of Investment Funds. Custodians, depositories, auditors, appraisers and their affiliates, which provide services to Investment Funds, may not be participants of Investment Funds.

Are we moving forward?

One of the recurring themes of many Ukrainian regulatory reforms is bringing Ukrainian law closer to laws and regulations of more developed economies. In general terms, the New Investment Funds Act is a step forward in the right direction.

All major jurisdictions have separate legislative and regulatory acts dealing with investment funds. In the United States and the European Union, investment funds are regulated separately from other corporate entities (i.e., corporations, limited liability companies, etc.) from the very moment of their establishment. The principal reason for such separate regulation is recognition that investment funds hold a special status and bring forward regulatory issues which are distinct from those that exist in a general corporate entity. Moreover, depending on the jurisdiction, investment funds may be established in forms other than corporate, e.g. a trust (in common law jurisdictions). Regulating investment funds separately also allows regulators to react more quickly to specific market conditions that investment funds may face.

A few restrictions for members of the supervisory board of an Investment Fund can also be viewed as positive developments. However, they are quite far away from the standards for managers of investment funds which are imposed by laws and regulations of major Western economies. In particular, these countries aim, through their laws, to protect investors by ensuring that investment funds are operated by managers who work in the interests of participants as well as preventing managers from abusing insider information and using a fund’s assets in any way other than in the interests of participants.

In the European Union, investment funds and management companies are subject to authorisation requirements and certain conduct of business and financial resources rules. In the United States, directors of investment funds are subject to fiduciary duties with a minimum number of directors who have to be independent.

New limitations that were introduced by the New Investment Funds Act with respect to assets structure, which aim to stimulate more sophisticated and less risky investment strategies of Investment Funds, are also progressive improvements. However, these improvements can be viewed as minor if we compare them with more robust financial regulation of American and European investment funds. For example, if an American investment fund intends to invest in certain types of securities, it is obliged to obtain specific advice on securities law in this area. Furthermore, US investments funds are generally subject to regular diversification tests. European investment funds have to comply with several restrictions on assets that they can invest in (e.g., they cannot invest in real estate) as well as detailed spread and concentration rules.

Future trends

Summing up, the New Investment Funds Act is not a revolutionary law, but it will introduce some progressive ideas for the regulation of investment funds in Ukraine which should be further developed. The United States and Europe have long recognised the importance of investment funds both as an effective tool for corporate and individual investments which is reflected in the focus of their regulatory regime on protecting investors. Ukrainian law still has a lot of catching up to do, but we already see some movement in the right direction, which has to be welcomed.