Fund Custody and Administration

David Loader

• Publisher: Academic Press
• Year: 2016
• Print ISBN: 9780128044001
• eBook ISBN: 9780128499016
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Fund Custody and Administration provides an overall perspective of investment funds without limiting its analysis to specific fund structures, as other books do. Since governance and oversight of investment funds are now major regulatory requirements, administrators and custodians must place greater emphasis on the custody and safekeeping of fund assets, on the independent and robust valuation of the assets, and on collateral management. By focusing on both the asset transactions made by the investment manager for the portfolio and on the transactions in the shares or units of the fund itself, it gives readers insights about the essential elements of investment fund management and administration, regardless of their geographical backgrounds. - Explores the key stages in the investment process, from setting up a fund through its launch and operation - Explains the roles of participants as well as the ways regulation affects the fund and its operation - Describes the work flow associated with custody and administration procedures and processes - Defines the role of compliance and risk management in the context of the fund and also how compliance requirements apply to custodians and administrators

Part 1

Introduction to Investment

Abstract

This part focuses on the investment environment by looking at the objectives of investment and then moving on to the basis for collective investment schemes. The investment management process is then explained covering portfolio management, assets classes, some example strategies, and finally discusses investment performance.

Keywords

investment

portfolio management

fund management

assets classes

unregulated funds

Investment environment

The process of investment is a concept that has been around for a long, long time. For the purposes of this book we will be considering the investment industry from the 1900s onward.

It is always interesting to ponder the question of what is gambling and what is investment?

Is the pursuit of profit greed or a structured contingency against future requirements, for example, a pension?

In the 1800s canal and railway mania in the UK created and lost fortunes so was this gambling, speculation, or structured investment?

Certainly for the lucky ones it was a foundation for enormous wealth that has sustained the family through generations. Others lost all their money and often ended in debtors jails with families broken and living in terrible deprivation. This was not a UK phenomenon but spread across the globe as the industrialization and growth of economies, often on the back of colonization and empires captured the imagination of entrepreneurs, businessmen, and of course speculators.

In the United States, which originally was what we would call today an emerging market, an example would be the gold rush and this was also in evidence in Australia and New Zealand, Africa, and other countries. In Asia and the Caribbean, the spice trade was heavily “invested in” and of course at the other end of the spectrum slavery was another “investment” that generated huge fortunes for individuals and families.

Today we can look back at this “market” and recognize that most fortunes were built on exploitation, often brutal and uncaring, of people, often children like in mining and industry, and the natural resources of other countries with little or no benefit to the people of that country.

Traders, merchants, and speculators were totally dominant and profit and returns came before all.

Ironically, today we have some disturbingly similar parallels with investment (or some will say exploitation) in “emerging markets” where the wages, working and living condition of workers is appalling, particularly compared to the standards found in the mature markets of the United States and Western Europe.

The kind of highly speculative investment found in the 1800s underwent an evolution and to all intent a purpose became the forerunner of the investment industry we are familiar with today, as those with insufficient capital to take a reasonable stake in an enterprise joined together to create “collective investment” often in the form of syndicates and partnerships.

Earlier “investors” were exposed to some extraordinary risks, often without being aware of such risks, and their general naivety left them vulnerable to scams and frauds.

Today investment is a structured process with collective investment schemes (CIS) created in the form of investment funds, many of which are regulated. In many jurisdictions around the world investors, especially those with limited knowledge of finance and awareness of risk are offered high levels of protection.

Those investors with greater knowledge and awareness can opt to invest their capital in more lightly regulated products and even products that are unregulated.

The need for the regulation of investment and the adoption of change can be found in numerous case studies, some a long time ago but also some more recent.

Case Study 1—Bearer Securities

The main form of asset that investors typically have exposure to are equities and debt instruments or generically known as securities.

For many years a significant number of these securities were in bearer format meaning that they were physical or paper securities that did not carry the name of the owner of the securities (hence the term bearer—whoever had possession of the instrument was the owner).

This created problems and risks, not least loss through theft or destruction.

It became clear that these types of securities needed safekeeping and so the concept of the “custody and safekeeping” was born to reduce the risk of loss of assets.

The first custodian banks surfaced in the United States in the 1930s as simple safekeepers of paper assets holding them in a vault on behalf of the owner. Today the role of the custodian is far more diverse and has undergone huge changes as we will see later in the book.

Case Study 2—Bernie Madoff

The market crash of 2008 and the subsequent recession and economic problems of the United States and Europe created cash flow issues for almost everybody from government, through corporate companies to individuals and not surprisingly many investors looked to exit investment funds to raise much needed capital. The market crash of 2008 preceded by the demise of Bear Stearns and precipitated by the collapse of the sub-prime mortgage market and Lehman Brothers bank in the United States led to a global credit crisis, the collapse of banks and massive government bailouts followed by severe austerity measures in many countries. From an investment point of view, this was the worst possible time to exit funds as many assets were at all-time lows, but needs must as they say.

Bernie Madoff was a highly respected and influential individual in the US capital markets. He had held high positions of responsibility, was hugely experienced and had set up an investment fund, which naturally attracted many investors around the world who implicitly trusted him and believed in his skills and talents. As a well-respected financier, Madoff convinced thousands of investors to hand over their savings, falsely promising consistent profits in return. He was caught in Dec. 2008 and charged with 11 counts of fraud, money laundering, perjury, and theft.

Sadly for those investors Mr Madoff was not operating an investment fund. Instead he was operating a Ponzi scheme.

Definition—A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns for older investors by acquiring new investors. This scam actually yields the promised returns to earlier investors, as long as there are more new investors.

So what purported to be and was assumed by investors to be an investment fund that had assets and was performing extremely well had actually defrauded investors and left most with a complete loss of capital.

Just over six years ago Bernie Madoff was sentenced to 150 years in prison for running the biggest fraudulent scheme in United States history. Even now, only a few of his victims have since regained all of their losses.

Had the market crash not put pressure on investor’s finances and thus led to redemption requests that could not be met, his scam could still be working today with no one any the wiser.

Readers can find further details of how a Ponzi scheme operates and Madoff’s downfall at http://www.businessinsider.com/how-bernie-madoffs-ponzi-scheme-worked-2014-7.

Fund management became an enormously important component of what was rapidly becoming a key part of the capital markets as the increasing wealth of individuals sought returns and the capital needs of growing companies and indeed economies had to be financed.

Diagram 1.1 shows the general structure of the capital markets broken into sectors. Purists may consider commodities and other assets as being outside the scope of capital markets.

Diagram 1.1 The markets. (Source: The DSC Portfolio Ltd.)

Investor’s pooled capital in a CIS became a prime source of the capital flow. Their capital was either passively managed, which meant it was placed in a fixed, unchanging portfolio of assets or one that tracks a benchmark like an equity index, or is actively managed, which means that an investment manager creates and manages the portfolio seeking to generate a return higher than a benchmark. We will consider this again shortly.

In the capital markets, financia...

Table of contents

• Cover
• Title page
• Table of Contents
• Copyright
• About the Author
• Preface
• Introduction—What Is Fund Administration and Custody
• Part 1: Introduction to Investment
• Part 2: Regulation and Fund Structures
• Part 3: The Day-to-Day Operation of a Fund
• Part 4: Risk
• Part 5: Introduction to derivatives
• Part 6: Summary—Fund Administration Notes
• Part 7: The Future of Fund Custody and Administration
• Appendix 1: The Investment Association Categorization of Funds
• Appendix 2: Source-Investment Association
• Appendix 3: Glossary of Risk Terminology
• Appendix 4: Organization of the SESC
• Appendix 5: Reporting Annex IV Transparency Information Under the Alternative Investment Fund Managers Directive
• Appendix 6: Questions and Answers: Application of the AIFMD
• Appendix 7: China Securities Regulatory Commission (CSRC)
• Appendix 8: October 2015—Top 10 Performing Funds
• Appendix 9: Global OTC Derivatives Market-Source BIS
• Appendix 10: Global OTC Derivatives Market-Source BIS
• Appendix 11
• Glossary of Terms
• Useful Websites and Links
• Index