In addition to the scenario of today’s worlds market increased globalization, a specific phenomenon can be observed in Emerging Markets: the development of Collective Investment Schemes (CIS). The IOSCO Emerging Markets Committee Working Group on Investment Management (EMC WG-5) studied this specific development in a Survey on CIS Cross-Border Activities. The main conclusion of that survey was that in emerging markets CIS development is mainly domestic: cross-border being severely restricted in some countries and mainly import-oriented.

Even though, the domestic development of CIS is a reality, several emerging market countries issued new regulation or substantially changed their regulation during the past few years. A need therefore arose to look again at the CIS issue and to compare how a number of key subjects regarding CIS regulation were addressed in those markets. A subject of foremost importance is asset valuation and unit pricing, which has also been considered by the IOSCO Technical Committee Working Group on Investment Management (TC WG-5).

EMC WG-5 sought from the Emerging Markets Committee of IOSCO a mandate to consider the specific issue of CIS asset valuation and pricing in accordance with the following work schedule:

The EMC approved this mandate and work schedule during its November 1997 Taipei meeting.

The CVM circulated the questionnaire among all EMC members, in accordance with the methodology described below, compiled the responses received in a Draft Report, which was analyzed by EMC WG-5, during its Nairobi on 13 September, 1998 meeting. It was then decided to widen the database gathered by adding information obtained from some jurisdictions after the original deadline.

The original data gathered covered 53% of the EMC membership. The additional information gathered brings that percentage up to 60%.

The present Report therefore covers the following jurisdictions:  Argentina, Barbados, Bermuda, Bolivia, Brazil, Bulgaria, Chile, China, Costa Rica, Ecuador, Egypt, El Salvador, India, Indonesia, Jordan, Kazakhstan, Korea, Lithuania, Macedonia, Malaysia, Mauritius, Morocco, Nigeria, Pakistan, Panama, Paraguay, Peru, Poland, Romania, Russia, Singapore, Slovenia, South Africa, Sri Lanka, Thailand, Tunisia, Turkey, Ukraine, Venezuela and Zambia.

The questionnaire distributed among EMC members contained seven questions, some of them divided into a number of sub-questions. This report consists in the individual analysis of the answers provided to those questions by each jurisdiction.

The responses were synthesized and standardized in order to enable an easy comparison on a country by country basis. These condensed responses are presented in Appendix A.

In order to standardize the results, we had to include similar responses into a category, although there may be actually differences between the concept described and the actual methodology used by each country. For example, the term "yield curve", used in question 1.B refers to several different answers, including some jurisdictions that detailed the methodology used, which we interpreted could be gathered in that category.

Please note that in order to make this exercise, the following criteria were used:

1. countries with different regulation on different types of CIS had their responses divided in accordance with the CIS they referred to;
2. to present final results in graphic form, answers of countries provided in accordance with paragraph (1), or of countries which use more than one criteria for a single type of CIS, were considered as a relative proportion that, when added, will be equal to one for each country. E.g.:  if, in a country that has two types of funds, one of them has to disclose the price of shares daily and the other monthly, a weight of 0.5 will be assigned to each of them, in order for this particular country to have a total weight equal to one. Therefore, as 41 countries answered the questionnaire, the base weight for each table that origins each graph is 41; and
3. the term "jurisdictions" used in the tables of the next section refers basically to the number of countries that answered a determined response, but may also refer to an addition of relative proportion of each response, as described in item (2).

After calculating each weight for each country, similar responses were grouped and the result of each group was divided by 41, in order to calculate the percentage weight.

Please note that in order to minimize misleading information that could be produced as a result of this methodology, we sent to all respondents a copy of the condensed responses, so that they could confirm or not our analysis. Some countries provided us with feedback, which resulted in minor changes. Another consequence of this feedback was the replacement of the term "SEC" by "Securities Regulator" in question 2, because some members stipulated that they cannot be formally considered as securities commissions, but have broader regulatory authority, which can encompass insurance, pension funds, and bank supervision.

The next methodological step consisted in individual analysis for each question of the survey, described in the following section of this report. This consisted in:

• Copying each question;
• Presenting the data gathered (including graphs and tables);
• Analyzing this data, while referring to IOSCO principles;
• Formulating recommendations, which are summarized in the Conclusion.

This analysis does not refer to any jurisdiction and its objective is to present an overview of the data provided. Detailed responses can be found in Appendix A.

Appendix B is an extract from the 1995 IOSCO Technical Committee report entitled Principles for the Regulation of Collective Investment Schemes. It refers specifically to asset valuation and pricing and was included for comparison purposes between the results compiled in this report and the above mentioned CIS Principles.

Appendix C is also an extract from the Report on the Oversight of Collective Investment Schemes, released in 1998 by the Council of Securities Regulators of the Americas (COSRA), which also acts as IOSCO’s Interamerican Regional Committee.

The graph below shows that there are 32 jurisdictions (78.0%) in which the regulation establishes that variable-income securities that compose CIS portfolios shall be valued by their market price. Of the remaining 9 jurisdictions (22.0%), who stated that the use of market pricing is not mandatory, 5 do not have regulation on this topic, 2 explicitly stated that market pricing is not mandatory, 1 stated that market pricing is not formally required but expected, and 1 stated that pertinent regulation is being developed.

Considering that the TC WG-5 Report on Investment Management Principles reproduced in Appendix B states that:

We highly recommend that EMC countries, which are considering the development or enhancement of CIS regulation, use market price as a basic reference for asset valuation.

The issue of how to address the problem of "particular circumstances" mentioned in the IOSCO Principles, which may include lack of liquidity, derivatives, absence of standard methodology, or fixed-income securities, will now be discussed.

As shown in the table and graph hereafter presented, if market price is not available, the valuation criteria are determined by the CIS managers in 9 jurisdictions (22.0%). 22.0% of the jurisdictions which responded to the survey do not have related regulation and in their cases it is the CIS managers who determine the valuation criteria. Overall, in nearly half of the jurisdictions surveyed managers determining the valuation criteria is therefore actually the regular procedure. It is important to stress that for the majority of the countries, which stated that the managers might define criteria, they have to do so following acceptable principles.

Acquisition cost (which we obtained from book value) is used by 14% of the jurisdictions as a criterion. However, some of these do not adopt this criterion for all their funds. Therefore, the number 5.75 (please refer to the above table), expresses a relative proportion of the funds in which this criteria is used. This calculation methodology is applicable for the other criteria, as explained in the "Methodology" section of this report.

Two jurisdictions (4.9%) use average price as a valuation criterion. One refers to a 5-day average for the last trading prices and the other extends this concept to a weighted average bid price. Valuation algorithms, price in OTC market, and market price of related securities are used in only 1 jurisdiction each (2.4%).

The column "other" represents jurisdictions that use very specific valuation criteria for specific types of funds or too many different criteria when market price is not available.

The most important conclusion to this aspect is that some countries have very detailed regulation on how to value assets when market price is not available, whereas others leave the issue exclusively to the managers. It is very important that accounting principles leading to a fair value are used in order to avoid, as much as possible, prices that do not correctly reflect net worth, especially for open-ended funds (closed-ended funds are more correctly valued by the secondary market). The TC WG-5 Report on Investment Management principles states:

This is a very important point to be addressed by emerging markets, as liquidity problems are more common in such markets than in developed ones.

In addition, COSRA’s principles also state:

Therefore, we also recommend that IOSCO EMC members seeking to enhance their CIS regulation identify the potential circumstances (ex. lack of liquidity) that may lead to pricing problems, in order to offer uniform and general pricing standards. This will prevent the use of a variety of different pricing criteria among the CIS and will ensure that the used criteria reflect "fair value". This is particularly important for open-ended CIS because their units are not traded and, therefore, do not have a market value.

The graph below shows that fixed-income assets are valued by their market price in 16 jurisdictions (39.0%). Yield curve (or similar) criteria is used by 11.5 jurisdictions (30.5%), and 7 jurisdictions (17.1%) do not have regulation on the subject.

In 7.3% of jurisdictions fixed-income valuation criteria are determined by the manage (for specific types of funds or as a general criterion, depending on the country).

2.4% of jurisdictions use amortized cost as a valuation criteria, 3.7% use book value, and 2.4% use the most recent obtainable price criteria.

The valuation criteria of fixed income securities are a special case. The use of market value could be encouraged only in daily liquid markets (whose value generally converges to the yield curve, plus a positive or negative premium). If there be no liquidity, or if redemption can only be achieved when agreed directly between parties, the use of the yield curve may be more appropriate, as the value obtained may be more appropriate than the use of criteria related to past market values. Please note that the use of market price or of the yield curve is a mandatory requirement in 70% of the EMC jurisdictions who provided answers to this question.

This question seeks to determine who is responsible for setting and changing CIS valuation rules. The related graph and table indicate that, in most jurisdictions, the valuation criteria are mostly determined by securities regulators (60.6%). The CIS are directly responsible for setting or modifying valuation criteria in 16.7% of the jurisdictions. 9.8% of the jurisdictions do not have related regulation. For 6.1%, effecting modifications to the CIS valuation criteria is under the responsibility of the Minister of Finance. For 3,7%, it is the responsibility of parliamentary authorities and for the remaining jurisdictions (3.3%) the responsibility falls into the hands of Self-regulatory organizations (SROs).

The Technical Committee Report on Investment Management Principles states that:

As shown in the graph hereafter presented in 44% jurisdictions CIS unit price must be disclosed on a daily basis. In 25.6% CIS pricing disclosure periodicity is not regulated (this figure includes jurisdictions in which disclosure is determined by the CIS managers).

9.8% of jurisdictions require disclosure on a weekly basis, 6.1% require fortnightly pricing disclosure and 7.3% state that price must be disclosed on a monthly basis. For 2.4% of jurisdictions price disclosure periodicity is on quarterly basis. This is also the case (2.4% of jurisdictions) for semi-annual periodicity. The remaining 2.4% of jurisdictions indicated that price disclosure is provided only when investors specifically require it.

It is also interesting to note that in some jurisdictions disclosure periodicity may differ from the calculation period (for detailed information, please refer to Appendix A). In addition, requirements for open-ended CIS may be different from requirement for closed-ended CIS, which is can be justified by the fact that the unit price for close-ended funds is better determined by secondary market pricing, rather than book value.

Concerning disclosure, the Technical Committee Report on Investment Management Principles states that:

With respect to net worth, disclosure periodicity is often established to be less than that for net of unit price.

The graph and table shown below demonstrate that, although 26.8% of jurisdictions require net worth disclosure on a daily basis, this is a small number compared to the 43.9% that require daily disclosure for unit price. 30.5% of jurisdictions do not have regulations on CIS net worth disclosure.

Of the rest, 13.4% of jurisdictions required weekly disclosure, 2.4% of jurisdiction state that this must be performed every fortnight, 11% indicate that it must be monthly, 6.1% quarterly, 4.9% on a semi-annual basis, and 2.4% annually. Finally, 2.4% of jurisdictions state that disclosure is to be provided only when investors request it.

The discrepancy found between the periodicity of the disclosure of price and net worth may be the result of a greater interest of investors for unit price. In addition, disclosing both figures may cost more than the disclosure of only one of them. However, it can be argued that calculating the net worth is necessary for the calculation of the unit price, which is also called "net asset value per unit".

The Technical Committee Report on Investment Management Principles states that:

This shows that, as a general rule, unit price calculation should be performed taking as a base the net worth (total assets minus liabilities), which is then divided by the number of existing shares.

Given that the net worth has to be calculated before the share value can be established, the periodicity of calculation requirements for both figures could be the same if the cost of disclosing additional information is not relevant (e.g. disclosure through the Internet).

COSRA Principles also state that:

Especially for open-ended CIS, daily calculation of unit price and net worth ensures that the mispricing risk is minimized. Mispricing may lead to problems, notably when someone has material information. For example, an open-ended CIS invested in local stocks has its price calculated weekly and the last calculation took place on a Monday. If someone wants to invest in the fund on Thursday, and by then the market has risen by 10%, he will have an advantage over the other shareholders (this is called backward pricing, and it will be further discussed in relation to the next Survey question). On the other hand, if he has to wait until the next calculation to invest into the fund, he will lose investment opportunity.

Another key factor for encouraging daily calculation: if a market opens daily, nothing is fairer for CIS investors. The only exception is if markets are illiquid.

As shown in the following tableau, 9.5% of jurisdictions reported that the unit price used at purchase is established at P-1, i.e., the day before the purchase.

The most widely used unit price (40%) is that established at P+0 (day of purchase). Price at P+1 (day after the purchase) is used in 9.8% of jurisdictions. There are a significant number of jurisdictions (36.6%) that do not have regulation concerning the unit price used for the purchase of CIS units.

3.7% of jurisdictions report that a valuation date not exceeding one week must be used by each CIS to calculate the price of purchase. For example, if the normal valuation date is on a Monday and an investment is made on Tuesday, the unit price used for the purchase will be determined only on the following Monday.

Forward and Backward pricing are defined as follows in COSRA’s Report:

Backward pricing (i.e. pricing at P-1) is not recommended. An investor purchasing CIS shares using backward pricing knows the price of those shares before purchasing them. This enables a speculator to take advantage of fluctuations in the price of the securities of the CIS portfolio, which took place after the CIS unit net asset value has been calculated.

Some jurisdictions using backward pricing minimize this problem by using regulation prescribing that when a significant market movement (e.g.:  3% or 5%) occurs, a new calculation must be done. The following example is mentioned in the COSRA Report:

A more complex situation results when a CIS may invest in securities traded in markets trading at different hours. The COSRA Report in that regard states that:

If the regulation prescribes the use of P+0 to determine the purchase price of CIS units and the main asset of a particular CIS is a stock traded in a market that closed hours ago, an investor knowing how this particular security has behaved would introduce a similar backward pricing problem into the buying equation. This is particularly true for equity funds.

Please note that the G-30 recommendation of accomplishing the settlement in T+3 could not be lower exactly due to the time frame between markets.

Redemption price dating data shows that the timeframe used is generally longer than for determining purchase price. 34.6% of jurisdictions require redemption calculation at R+0 (compared to 40.4% for investment calculation at R+0).

R+1 is used in 13.2% of jurisdictions (compared to 9.8% for purchase pricing), while 8.3% use R-1 (compared to 9.5% for purchase pricing). The one-week maximum timeframe is used in 8.5% of jurisdictions. A one-month maximum timeframe is used in 3.7% of jurisdictions.

Regulators are generally flexible on this point, some of them even permitting that the CIS managers use a redemption dating period between R-1 and R+1. One regulator specifically reported taking into consideration backward pricing problems in imposing that the redemption price should not be calculated before R+1. A longer timeframe for redemption pricing may however generate liquidity problems for investors because redemption can only effected after the redemption price has been calculated.

Redemption price dating was reported not regulated in 29.3 % of jurisdictions (slightly lower that the 36.6% reported for purchase price dating).

The payment date issue brought surprising results as most jurisdictions reported not have any related regulation (31.7%).

Among the jurisdictions where payment date is regulated, R+0 is used by 14.7%, R+10 and R+4 by 9.8% each and, R+5 and R+6 / R+7 by 8.5% each. R+15 and R+3 is respectively used in 4.9% of jurisdictions.

2.4% of jurisdictions respectively set the payment date at R+30, R+1, and R+2. Please note that R+8 or R+9 is not used in any jurisdiction, but is shown in the following graph for reference purpose only.

It is important to emphasize that the diversity of responses gathered on this issue is far higher that those compiled for purchase or redemption dating because, in many cases, the clearing and settlement cycles have to be taken into consideration. It is interesting to note that the R+5 and R+10 jurisdictions (36.8%) are four times more numerous than those using R+1 and R+3 (9.7%).

Some jurisdictions allow the settlement period to be different in case of liquidity problems, which is acceptable according to the Technical Committee Report on Investment Management Principles:

Regulators should generally keep in mind the following Technical Committee investment management principle, especially applicable for open-ended CIS.

"A CIS must redeem its units at the request of any investor, in a manner and frequency laid down in the law or the CIS rules."

"Purchase and redemption orders are to be settled as soon as possible, in accordance with the law, the CIS rules and the prospectus."

 

 

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6. Are the asset / unit pricing criteria regularly audited by independent auditors? Must the auditors be registered with the securities regulator?

As reported in the table and graph hereafter presented, in most of the jurisdictions (almost 80%) the regulation requires CIS auditing. However most jurisdictions (45.2%) having auditing requirements do not have specific pricing provisions. The regulation requires auditing of the unit pricing criteria in only 34.1% of jurisdictions. A significant number of jurisdictions (20.7%) do not require auditing or have a regulation on the subject.

Considering that only 34.1% of the jurisdictions reported having pricing regulation, this is a relevant issue to be addressed by EMC regulators.

In general, two auditing provisions should be introduced in the regulation:

1. Asset valuation and pricing criteria are the legal or fair ones.

2. CIS use of these legal and fair criteria in all cases.

Please note that the COSRA’s Report states that:

As shown in the following graph, 61% of EMC jurisdictions reported that valuation criteria must be disclosed. 39.0% reported that this was not the case.

The Technical Committee Report on Investment Management states that:

This problem must be addressed by EMC regulators, which should ensure that all investors have the right to access this important information, either through public disclosure documents or upon investor request.

The EMC thanks all the members, which have participated in the CIS unit pricing survey.

This Report is not intended to evaluate in any way the regulatory approach of individual jurisdictions. It objective is only to provide a general assessment of the regulatory framework in place in a number of EMC jurisdictions and to formulate corresponding recommendations, which should individually be considered by EMC members in the context of the specific characteristics of their respective markets.

The main conclusion reached in this Report is that, in EMC jurisdictions, there are presently a wide variety of criteria used for CIS asset valuation and pricing. Some jurisdictions use very complex regulatory approaches, whereas others have only very general rules, leaving several issues to be determined by individual CIS. Some jurisdictions are still in the process of preparing related regulation, or have in place very limited regulation.

Based on the data gathered in this Report, it is therefore recommended that EMC members implement in their respective jurisdictions the following set of key regulatory principles for CIS unit pricing. These principles complement the ones already adopted by the IOSCO Technical Committee. The principles recommended by the EMC are:

1. Market price should be used as a basic reference;
2. Define and address specific cases where market price cannot be used;
3. Specify who may change CIS accounting criteria and under which specific circumstances;
4. Encourage daily pricing calculation and disclosure for open-ended CIS and full disclosure for closed-ended CIS transactions;
5. Avoid the use of backward pricing for the purchase or redemption of equity funds units, or create mechanisms intended to minimize its effects;
6. Encourage the use of independent auditors for reviewing CIS financial statements, including for the correct use of pricing principles.
7. Encourage the disclosure of pricing principles, at least on demand.