Keynote Address by Mr Shane Tregillis, Assistant Managing Director (Market Conduct), Monetary Authority Of Singapore, Investment Management Association of Singapore's, 6th Annual Conference, Raffles City Convention Centre, 23rd Sept 2004
"The Investment Management Industry - Global and Local Regulatory Developments"
1 Good morning ladies and gentleman.
2 I would like to thank IMAS for inviting me to speak to you today. In the past two years, the global fund management industry has witnessed some profound changes and challenges - commercially and on the regulatory front. This annual conference of Singapore's fund management industry is a timely platform to review recent developments and reflect on what needs to be done to ensure this dynamic industry sustains its growth in the years ahead.
A Period of Boom in Asia
3 First, the good news. We are witnessing a boom in the Asian fund management industry and prospects in the region are bright. In Singapore, Hong Kong, South Korea and Taiwan, savings have grown by around 8% each year over the last two decades. Investors are entrusting more of their savings to professional managers. Assets under management in these four countries have grown by more than 12% per annum over the past decade, outstripping the 5% annual growth experienced in the US. Asia, ex Japan, is the fastest growing asset management region in the world. At the end of 2003, retail assets under management in Asia, ex Japan, are estimated to stand at over S$600 billion. Moreover, it is estimated that Asians continue to hold as much as 16% of their assets in cash . This highlights that there remains much untapped potential in Asia's fund management market.
4 On a broader front, economic growth in Asia appears healthy. The East Asian economies grew by an average 4.5% in 2003 . Going forward, while growth is likely to moderate to more sustainable levels, economic prospects appear broadly positive for the region. All this augurs well for continued high savings growth in Asia and continued investment flows to the region.
5 Singapore is uniquely positioned to be a key financial hub in a rising Asia. Today, nearly 1000 investment professionals comprising portfolio managers, analysts and economists work in Singapore. In 2003, institutional assets under management surged 35% to S$465 billion. Investments by retail investors grew 36% to S$19 billion . This sustained increase in assets under management is testament to the trust that investors have placed in our fund managers and regulatory framework. It also demonstrated Singapore's role and competitiveness as a leading asset management hub in the region.
Fundamental Tenets of the Fund Management Industry
6 Second, some important caveats. To capitalise on the opportunities for growth in Asia, the fund management industry will need to continue to focus on the two fundamental tenets on which it is built: maintaining the trust and confidence of investors; and offering real value-for-money over the longer term to retail investors.
7 From the vantage point of the year 2004, it is all too easy to forget that the mutual fund or collective investment scheme ("CIS") is one of the great innovations in finance and investment of the 20th century. It is a product that allows the mass of retail investors to access the skills of professional managers and to purchase liquid and diversified portfolios of securities at relatively low cost. What had previously been only the preserve of institutions or the very rich, is now available to retail investors.
8 At the heart of fund management is a simple contract between the individual investor and fund manager. This is - I, the investor, give to you, the fund manager, my money to pool with monies from other investors so that you can use your professional investment skills to manage my money on my behalf. As an investor, I expect this contract to meet two key tests.
9 First, you will manage my money in my interests and not use it to line your own pockets or those of other investors at my expense. This is why trust is key to fund management.
10 Second, as a professional fund manager with superior expertise and economies of scale in investing, you will generate better returns over the longer term for me than I could by investing that sum of money directly myself. This is the underlying value proposition of all fund management products.
11 The fund management contract has its basis in trust. Because I hand over my money to you to manage, I need to trust that you will look after my interests rather than your own. This is why fund managers and trustees are held to the high standards of fiduciaries.
12 But fund managers are also in business to make money for themselves. So there may be incentives for them to act contrary to the interests of their investors. While investors want to maximise their risk-adjusted returns, managers seek to maximize their own earnings. The mutual fund problems in the US suggests that some fund managers forgot the basis of their contract with investors, and paid too much attention to looking after their own interests instead of those of their investors.
13 So market timing, late trading, failure to pass on fee rebates to customers as promised, hidden payments to distributors for "shelf space", the passing on of inappropriate fund expenses to investors, and perverse reward structures linked to volume rather than performance of funds are all indicative of a failure to put investors' interests first. It seems clear that the governance, internal compliance and other mechanisms have not succeeded in fully taming these conflicts of interests.
14 The very success of mutual funds, the pressures to retain market share and the incentive structures for managers have tended to reinforce the pressures on managers to disregard the interests of investors. In a rising equity market when everybody seemed to be making money, no one seemed to pay much attention or care. But with the dramatic equity market slowdown and pressure on fund performance, these problems quickly surfaced.
15 We should expect retail investors to assess the investment risk of the products they buy. They must take responsibility for their own investment decisions. But it is not practical to expect them to be able to assess the risk of individual fund managers not living up to their fiduciary obligations, to monitor the integrity of a fund manager on an ongoing basis or to act where this trust has been breached. This is where regulation and regulators must play a role and why regulatory reform has been proposed in the US to restore the damaged confidence in a market where some 90 million Americans invest over US$7 trillion in mutual funds.
16 But the market also imposes its own sanctions, even if lagged. Although Americans have continued to invest in mutual funds, they have also voted with their dollars. They have channeled their monies to funds managed by firms untainted by the recent scandals. Fund managers implicated in the scandals have lost market share. Firms with reputations intact have benefited . As fund managers, you would know that it takes a long time to earn the trust of investors but a much shorter time to lose it.
17 The Singapore industry differs in structure and regulation from the US so we need not be driven by regulatory developments in the US. But, it is still useful to compare the issues we face with some of those being tackled in the recent US regulatory reforms.
Improved Corporate Governance
18 At the centre of the concerns in the US is the failure of fund corporate governance where the independent fund directors have not always provided the checks on the commercial interests of fund advisors in the way intended. It is for this reason the SEC has required mutual fund boards to be chaired by an independent director. Independent directors must now make up 75% of fund boards - up from the 50% previously required.
19 In Singapore, most of our collective investment schemes operate on a dual-entity structure. Funds have a trustee that is independent of the manager. The trustee is required, as matter of law, to exercise due diligence and vigilance to safeguard investors' interests. Generally, we consider this model has worked well. But we should not rest on our laurels.
20 When the SFA was introduced in 2002, MAS was given the power to inspect CIS trustees and we have conducted inspections as part of our supervision over them. We wanted to assess if CIS trustees were carrying out their fiduciary responsibilities professionally and were complying with regulatory requirements. Generally, we have found the CIS trustees diligent in carrying out their obligations in the monitoring of fund managers' compliance with the investment mandate given to them by investors. Going forward, we will continue to focus on the performance of CIS trustees. In this regard, I note that CIS trustees are working together to evolve a common standard for monitoring managers and funds so that investors can be assured of a common approach across the industry.
21 As you know, late trading is the illegal practice of accepting a purchase or redemption order at the current day's price after the cut-off time for trades that day. To deal with late trading, the SEC has proposed that managers and distributors strictly enforce the cut-off time so that such abuses do not arise.
22 For our funds, we also expect the cut-off time for sales and redemptions to be observed strictly. Managers, distributors or any intermediaries should not allow any trades after the dealing deadline. Our managers are expected to have robust internal controls and procedures to address this issue.
23 As far back as Dec 2002, we had asked all fund managers to review their fund trading, settlement and other administrative processes to ensure that the necessary control procedures are in place and that they have been complied with by their service providers and staff. We also required the external auditors of the fund managers to confirm to us that proper procedures and controls for the administration of the CIS are in place and have been complied with. The certification by the external auditors has been completed. On the evidence we have available, late trading does not appear to be of concern here in Singapore. However, in our ongoing inspections of fund managers, MAS will check that these controls are in place and complied with. We will also continue to monitor developments in other countries and ensure that our requirements remain in line with international best practices.
24 An issue sometimes confused with late trading, is market timing.
25 To combat market-timing abuses, the SEC has proposed to impose a mandatory 2% redemption fee for mutual fund shares redeemed within 5 days of their purchase. Despite this proposed rule, the SEC acknowledges that the main solution to abusive market timing transactions is the accurate determination of the fund's Net Asset Value (NAV) each day - using current and not stale prices. If market quotation for any asset is unavailable or unrepresentative, the SEC expects US managers to base their funds' NAV calculation on their fair valuation of the asset.
26 In March this year, MAS introduced guidelines in the Code on CIS ("CIS Code") to formalize the valuation practices of our funds. The Guidelines allow funds to fair value their assets when prices are unavailable or considered not representative. Even though similar rules for fair valuation have been provided in the US, the results of a SEC survey of more than 900 funds show that nearly one third of them had not performed any fair value pricing in the 20 months ending September 2003 .
27 As fair value pricing removes incentives for market timing, I urge all fund managers to use fair value when required.
Other Issues of Concern
28 Next, I would like to say a few words about several other regulatory issues and mention how they have been tackled in Singapore's context.
29 Regulators are concerned about the practice of directed brokerage because it affects how fund managers decide on where the funds' transactions are directed. It may lead to brokers recommending inappropriate funds to investors because of payments that they receive. While most of our funds are sold through banks, our managers are nonetheless expected to have a reasonable basis for the selection and use of brokers.
30 Soft dollar arrangements are also another area of concern internationally as they imply a commitment on the part of the fund manager to channel a certain level of business to the broker in order to qualify for the soft dollar package. In Singapore, fund managers are allowed to earn soft dollars only if the soft dollars assist them in the provision of investment advice to the funds and only if the broker executes transactions on the best available terms. Also, fund managers must not enter into unnecessary trades in order to achieve a sufficient volume of transactions to qualify for soft dollars. These guidelines are set out in the CIS Code.
31 The CIS Code also expressly forbids fund managers from paying any marketing, promotional or advertising expenses out of the property of funds. Such practices are of no direct benefit to the investor, and are therefore prohibited.
Adding Real Value for Investors
32 Now let me turn to the second part of the fundamental fund management contract-adding real value for investors.
33 Product innovation continues apace in the industry. Recently, the first retail fund that invests in currencies was launched. There is also an increasing number of funds using options, repurchase agreements and swaps as an integral part of their strategies. In today's increasingly competitive landscape, managers and their distributors are no longer content to roll out the plain vanilla equities, bond or balanced fund. Instead, funds with features that are designed to give a large early payout, early termination in various circumstances and other variations are all jostling for first mover advantages, distribution "shelf" space, and investors' attention so as to attract new fund flows.
34 Innovation is the lifeblood of the financial services sector. As I have already noted, the fund structure itself was a key innovation in financial and investment markets. So it is important that we continue to encourage this innovation. But at the same time, fund managers should not lose sight of the fundamental goal of providing retail investors with value-for-money products to serve as long-term savings vehicles. This goal must not be forgotten in the rush from both fund managers and investors alike to follow the latest investment fads and fancies.
Sales Practices of Financial Advisors
35 There have been some concerns expressed about "product pushing" by some distributors. While MAS will continue to keep regulatory pressure on these practices with our supervision under the FAA, this tends to deal only with the end symptoms rather than the underlying causes. In my view, a key contributing factor is that remuneration structures of distribution agents are still largely structured to meeting quantitative sales targets. As a result, sales representatives have strong incentives to focus on product sales rather than on whether the particular product really suits the needs of the individual investor. The challenge is for the industry and individual firms to develop remuneration structures that provide clear incentives for good quality, professional advice and promote the sales of products appropriate to the specific circumstances of individual investors.
36 Financial advisers should also not recommend switching from one investment product to another in a manner that would be detrimental to the interests of their clients. Recently, MAS has issued a consultation paper on guidelines on switching of investment products. The guidelines give direction to the industry on the controls and procedures that financial advisers should have in place to monitor and deter undesirable switching. These guidelines are in the process of being finalized and will be released shortly.
37 While aggressive sales tactics and switching practices may increase sales and commissions in the short term, I believe they will be detrimental to the fund management industry in the longer term. By failing to meet the specific needs of or add real value for investors, these practices risk undermining investors' confidence in the industry as a whole.
Comprehensible, Complete and Clear Disclosure
38 In line with our disclosure-based regime, it is important that investors are given comprehensible, complete and clear disclosure for each investment. It is the reality that most fund management products are sold on the basis of the brochures and marketing materials rather than the more detailed prospectus. I therefore welcome IMAS' initiative in taking the lead to develop a code to set out best practices on fund advertising ("Advertising Code"). It is important that all marketing materials present a balanced picture of the investment and not merely highlight a large headline return.
39 The aim of disclosure is to enable an investor to judge the value of the product on offer compared with the alternative uses of the money he or she has to invest. Most investors do not carry around option pricing models in their heads. Thus, they will find it difficult to assess complex trade-offs between highly contingent events and are not able to judge easily outcomes over multiple time horizons. In fact, most investors tend to place a higher value on closer events, even when this may not be justified. But it is this type of complex mental juggling that confronts many investors when making investment choices based on the available offer documents and brochures. That is provided the investor even gets to assessing the fund's intricacies and is not distracted by the chance of winning some expensive give-away!
40 Going forward, a key challenge for the industry and regulators is how best to deliver to investors, in a form they can easily digest, information that helps them make comparative product assessments. I do not consider this requires ever more detailed "prospectus style" information. Unfortunately, I doubt few investors even read what is currently available in the prospectus. Rather, it requires a focus on innovative methods of delivering and presenting information to investors in ways that help them make meaningful decisions in a real world context.
41 In addition to the work on its Advertising Code, IMAS might like to consider taking up the challenge of developing innovative point of sale information formats that will help investors make meaningful comparisons of funds. I think an essential part of this process would be user testing of both content and format of any such documents.
A Sustained Commitment from All Stakeholders
42 To further grow our retail financial market, sustained commitment from the industry is vital. Bodies, such as IMAS, play a very important role as they can promote the collective responsibility amongst its members. MAS recognises that legislation is not a complete solution since equally important is each firm's commitment to ethical practice as part and parcel of its organizational culture. I am therefore pleased to note that IMAS has initiated a review of its Code of Ethics and Standards of Professional Conduct to ensure that it stays current and relevant in light of domestic, regional and international developments.
43 During the year, IMAS was involved in many other initiatives including the proposed integrated dispute resolution scheme. This will benefit consumers by providing them with the convenience of a one-stop shop and ensure that consistent processes and procedures are applied to customer disputes across the banking, insurance and capital markets sectors.
44 IMAS is also involved in the national financial education programme - MoneySENSE. It has published a handbook on personal investing for retail investors and sponsored an 8-part series on investments in both the English and Chinese television channels. It is especially encouraging to see such keen involvement from IMAS in financial education projects. This is because the success of the national financial education programme requires the concerted efforts of the investing public, the financial industry and the public sector.
45 Going forward, we intend to issue consumer guides on product classes to help investors better understand their characteristics and investment risks. For example, MAS will soon be issuing a guide on structured deposits. We also consider outreach to the community a key to raising financial literary levels in Singapore. In this respect, IMAS would be an ideal candidate to partner organizations such as the various Community Development Councils to bring investment talks to the heartlands.
46 Let me close by saying that we can be upbeat about the long-term potential of the fund management industry in Singapore. The prospects are very good indeed and Singapore fund managers are ideally positioned to take advantage of the potential industry growth in the region. But sustained long term industry growth requires that industry players continue to focus on getting the two fund management fundamentals right: maintaining public trust in this industry; and delivering products that add real long-term value for investors.
47 While maintaining high standards of regulation here in Singapore, MAS is committed to fostering a close working relationship with the industry. We share the common objective of maintaining public confidence and trust in our fund management industry to underpin its sustained growth in the coming years.
48 Thank you.