In September 2003 the government presented a bill proposing a new legislation (the "Investment Funds Act") regarding mutual funds and other undertakings for collective investments. The new legislation cover both mutual funds that fulfil the UCITS directive requirements, and special funds that in one way or another fail to comply with these requirements and therefore may not be marketed or freely traded outside Sweden. Special funds were previously referred to as national funds. Mutual funds and special funds are now collectively named investment funds.
The new Investment Funds Act is based on the following premises:
- Consumer/Investor protection.
- Awareness of different risks (financial, administrative and conflicts).
- New provisions in the UCITS directive.
The following is a brief summary of some of the main features of the new legislation affecting both Swedish and foreign mutual funds (UCITS and non-UCITS). The summary is merely a general description of certain major aspects and consequently it does not deal with all aspects that will need to be taken into account when considering fund activities in Sweden. Professional advice should be obtained on a case-by-case basis, and the contents of this article should not be relied on alone.
The new Investment Funds Act is expected to come into force on April 1 2004. However, the UCITS directives allow management companies and UCITS (Swedish and foreign), authorised in accordance with the previous provisions of the UCITS directive, to continue their activities until February 13 2007. Thus Swedish management companies, UCITS and non-UCITS that want to continue their activities shall obtain authorisation in accordance with the provisions in the new law of investment funds no later than February 13 2007.
Swedish UCITS established after February 13 2002 (when the new provisions in the UCITS directive came into force) and in accordance with current mutual Fund Act, may not by invoking the UCITS directive promote or sell shares in other countries within the EU after 13 Februaury 2004 without prior adjustment to the new provisions in the Investment Funds Act. These UCITS may be stopped by foreign authorities. According to the government, Swedish authorities shall not stop activities in Sweden conducted by foreign UCITS after February 13 2004 up to February 13 2007, irrespective of these UCITS have been adjusted to the new provisions in the UCUTS directive.
Establishment of a Swedish Management Company
Fund management companies must be authorised by the Financial Supervisory Authority to manage investment funds. They will be allowed to accept mandates from other Swedish or foreign fund management companies to manage funds, help sell units or otherwise perform such tasks as fund management involves.
A management company may also provide what is termed individual portfolio management (mandates to manage portfolios under a separate agreement). In this area, the government has chosen to introduce the right to purvey such a service as provided for by the UCITS Directive.
In accordance with the new provisions of the UCITS Directive, fund management companies must fulfil certain capital requirements. These requirements go further than the present ones. A management company must have a initial capital of 125,000 EURO. Further the company must have additional capital sufficient to the assets managed and fixed operating expenses.
The executive board, the managing director, others in top executive positions in the company and the owners must meet certain requirements. The proposed new law prescribes further rules regarding close links between a fund management company and other natural or legal persons. In line with other types of financial legislation, prudential rules and rules of conduct are also introduced specifying how the management companies should conduct their activities in order to retain the confidence of the general public.
Branch Office and Cross Border Provision of Services
According to the present Mutual Fund Act, UCITS may carry on activities in Sweden without prior Swedish authorization, subject, however, to certain notification procedures. This could be done with or without establishing a branch office. Third country funds are subject to more restrictive regulations. Such funds may carry on activities in Sweden if they have obtained a licence. The business may also be conducted with or without a branch office.
According to the Investment Funds Act, even management companies will be allowed to conduct business in Sweden. A management company domiciled within the EU may establish a branch in Sweden without prior Swedish authorization, subject, however, to certain notification procedures involving the home state authorities. Further such a company may by invoking their home state authorisation and subject to notification to the home state authority, engage in activities in Sweden without any establishment (cross border services).
Management companies domiciled outside the EU, and companies domiciled within EU that do not fall under the UCITS Directive) are subject to more restrictive regulations. Such companies may only carry on business in Sweden if they have obtained a licence.
According to the new provisions of the UCITS directive, UCITS may invest in a wider range of assets than before. Further, the directive contains new provisions regarding risk-spreading. These new provisions will make it possible for several index-funds and funds in funds to act as UCITS in the future. As UCITS these funds will be allowed to market and sell its shares in other countries within the EU.
Under the new provisions of the UCITS directive and of the Investment Funds Act, mutual funds may invest in a wider range of assets than before. They may invest in transferable securities, money market instruments, deposits with credit institutions, fund units and financial derivative instruments (e.g. options, futures contracts, etc, the value of which depend on an underlying financial asset such as shares, bonds, etc.). Previously, fund management companies were allowed to use various kinds of derivatives, but only in order to make their management undertakings more efficient. Under the new provisions, money may be invested in derivatives in the same way as for investments in shares, bonds and the like.
The new provisions also allow for the operation of ‘funds of funds’, i.e. funds that invest in other funds.
Assets such as securities, money market instruments or derivative instruments must be quoted or traded in an exchange market or in some other regulated market. The motive is that the assets are thereby easily assigned a value so that a rate may be determined for the fund units. Also, the assets can more easily be sold should unit holders wish to redeem their fund units. To some extent, however, the fund will be allowed to invest in unquoted securities and money market instruments. In addition, a fund will be able to invest in OTC derivatives, i.e. derivative instruments traded not via a regulated market but directly between the parties concerned. In such cases, special demands are placed on the other party.
A fund must spread its risks. To this end, a number of provisions are included to prevent excessive investment in individual assets. The rules on risk spreading are largely unchanged in the case of shares and bonds. Generally speaking, a fund may not invest more than 5 per cent of its capital in one and the same share or bond. As before, however, there are a number of exceptions to this rule. A new feature, however, is that index funds will now be allowed to invest up to 20 per cent of their capital in one and the same security if the purpose is to replicate the composition of a certain stock or dept securities index. In some exceptional cases, this limit may be increased to 35 per cent of the fund’s capital, but then only for a single share or bond. Risk spreading rules are also included for other types of assets that a fund invests in.
Besides the requirements governing assets and the provisions on risk spreading, there are a number of further rules aimed at enhancing consumer protection. As before, a fund management company is required to inform unit holders about its investment strategy, but a new condition requires it to specify whether the fund can be expected to vary significantly in value as a result of the way the capital is invested. The Investment Funds Act also includes a number of constraints on management companies, such as one that prevents them from exacting certain kinds of charges in funds of funds that invest in other funds managed by the same company.
A fund management company may not acquire, on behalf of a mutual fund, a sufficiently large holding to enable it to exercise a significant influence over the management of an issuing body. This rule harmonises with the UCITS directive but is a new feature in the Swedish regulatory framework. Under the present rules, a fund may only hold shares corresponding to a maximum of 5 per cent of a company’s voting power. Under the new proposals, this percentage limit is replaced by a more descriptive rule. Corresponding rules – expressed, however, in percentage rates – exist for dept securities, fund units and other types of assets.
These rules are intended to limit the amount of influence that funds can exercise in a given company and to prevent a fund from acquiring an excessively large share of the dept securities distributed by an issuer. These rules supplement the general risk spreading rules, which focus exclusively on investment in relation to a fund’s capital. A new condition is that under the fund provisions, management companies must specify how they intend to proceed with respect to ownership issues arising out of a fund’s holdings. This rule supplements the industry’s own self-regulating practices.
The basic principle is that a mutual fund may not incur obligations. At the same time, however, there are a number of rules in Swedish fund legislation that allow management companies to incur obligations on behalf of a fund. For example, a management company may, on behalf of a mutual fund, raise small, short-term loans. Another example is that surety is often required for investments in derivative instruments. According to earlier preparatory statements, fund management companies should also be given the opportunity to use fund property as security.
Now, the Investment Funds Act includes an explicit rule to the effect that funds may not incur obligations of a greater magnitude than specified by the law. In such cases, the management company may also put up fund property as security for obligations entered into on the fund’s behalf.
The rules concerning special funds are made clearer in relation to the current rules for what are named national funds. The law on investment funds specifies what rules apply in the case of mutual funds and which rules special funds can be exempted from. Mutual funds and special funds, however, are subject to the same regulations in such areas as the depositing of fund assets and supervision.
Special funds must invest their money in accordance with the principle of risk spreading. In contrast to the provisions for mutual funds, no percentage limits are specified for individual holdings. Instead, special funds are required to specify in their fund provisions the investment strategy they intend to adopt and describe this in a relevant manner. The fund provisions must also show how the risk-spreading requirement is to be met.
Special funds may also be given greater powers to invest in different kinds of assets, for instance to invest in unquoted companies to a greater extent than is permitted in the case of mutual funds. Similarly, special funds may seek exemption from other rules such as the ones on borrowing and short selling, etc.
All special funds must specify in their provisions the level of risk they are seeking to maintain in their fund management. In addition, unit holders in the fund are to be informed of the actual level of risk (realised volatility) attained so that they can compare risk levels between different funds.
Ordinarily, a traditional investment fund is dependent on rising market prices in order to achieve favourable returns. Hedge funds are the generic term for funds that are managed more freely and where the aim is normally to achieve favourable returns irrespective of market trends. The manager can use a wide range of methods and strategies, and as a rule takes advantage of the managing organisation’s specific competence in a given field. Accordingly, hedge funds are a particularly heterogeneous fund category, and are much more dependent on managerial skills in their search for favourable returns than traditional funds tend to be. Today, hedge funds can be established under the rules governing national funds. The governmental committee wanted to introduce additional provisions for hedge funds with a view to protecting consumers in an adequate manner. However the government did not find it necessary to regulate headge fund in a different manner than other special funds.
Fund management companies must prepare and distribute information to unit holders. As before, prospectuses are required and semi-annual and annual reports are to be drawn up. A new requirement is that the fund management companies must also prepare simplified prospectus presenting important data about the company and the fund in a clearer, more straightforward manner. These simplified prospectuses must be similar in content throughout Europe and are designed to make it easier for unit holders to compare funds from different companies and member states.
This simplified prospectus must be offered to all persons wishing to buy fund units. Other information is to be sent free of charge to any unit holder requesting it.
Fund Entry and Withdrawal
Investment funds are reserved for collective investment and must therefore be spread to a wide circle of subscribers. However, the government proposes that special funds shall be allowed to limit their range of subscribers on condition that the target group is not too narrow and that the group can easily be defined. This would allow special funds to focus exclusively on the employees of a given company, for instance, or on the members of an employee organisation.
The basic principle is that investment funds are open-ended, which means unit holders are entitled to have their holdings redeemed whenever they wish. There may be reason, however, to curtail this right under certain conditions. Restrictions may be approved, therefore, if fund subscribers have been advised beforehand as to when the managing company redeems units. A special fund must, however, be open for the redemption of units at least once a year.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.