Asset management company: professional management in the field of collective investment

What you need to know about asset management companies and the specifics of their work

The National Securities and Stock Market Commission (NSSMC), together with LIGA.net, has prepared a series of publications to explain the essence and specifics of financial instruments and mechanisms for their use in a simple and accessible manner.

In the previous publication, we considered the peculiarities of using the Islamic finance instrument – sukuk. In this and the next publication, we will talk about an investment mechanism that is quite well-known all over the world, as well as in our country – investment funds. In Ukraine, this industry is called «UCITS» and consists of such main entities as funds (which can be different) and asset management companies (AMC). Today, we will start with AMCs as the main actor in this market.

What is an asset management company?

Let’s start with the main thing: an asset management company (AMC) is a financial institution whose task is to manage the assets of funds (UCITS) and non-state pension funds (we will talk about them separately in the next publication).

To do this, the AMC must find attractive projects (assets) in the interests of fund participants, invest investors’ funds in them, and make a profit.

The main functions that AMC should perform are: assessment of the profitability and riskiness of investments, analysis and constant monitoring of the value of assets that it already owns and plans to invest in, and all this within the framework of the investment declaration (strategy) that all funds have.

In order for such a company to become a professional participant in the capital markets and start operating, it must obtain a license from the National Securities and Stock Market Commission (the NSSMC), which is the regulator of this market.

Before granting a license, the NSSMC usually checks such a company for compliance with certain criteria: the amount of capital, the availability of a minimum number of certified specialists, material and technical support, the level of corporate governance, and an impeccable business reputation.

All of this is checked by the NSSMC with one goal in mind – to make sure that a new participant appears on the market that has the minimum necessary capabilities to manage the funds of fund investors.

In the future, when AMC operates, it also needs to constantly comply with the license conditions and other requirements established by law.

Legal basis for AMC activity

The activity of AMC in Ukraine is regulated by a number of special laws and decisions of the NSSMC, the main ones are:

• The Law of Ukraine on Capital Markets and Organized Commodity Markets;
• The Law of Ukraine on UCITS;
• The Law of Ukraine on Private Pension Provision;
• Law of Ukraine on Financial Services and Financial Companies;
• NSSMC`s Resolution No. 92 dated 03.02.2022 on Approval of the Licensing Conditions for Professional Activity in the Capital Markets – Asset Management of Institutional Investors;
• NSSMC`s Resolution No. 1414 dated 06.08.2013 on Approval of the Regulation on Peculiarities of Conducting Asset Management Activities of Institutional Investors (Asset Management Activities).

What is the place of AMC in the capital markets and what is the main problem?

In Ukraine, unfortunately, there are very few AMCs that really perform a real asset (fund) management function – when AMCs find projects for investment and/or investors themselves, that is, capital for these projects. There are a few more AMCs that find business groups on market conditions and structure these businesses and capital flows internally, using UCITS as a tool for business structuring, redistribution and capital flows with legal tax optimization.

Today, there are 283 AMCs and 1661 active funds on the market. The funds’ assets exceed UAH 616 billion. As for non-state pension funds, their number is 57, and the volume of assets is almost UAH 4.9 billion. Such popularity of the funds is explained by the tax benefits granted to UCITS. Thus, in accordance with the provisions of the Tax Code of Ukraine, collective investment funds (including income from transactions with UCITS assets and income accrued on UCITS assets) are exempt from income tax.

This reason for the attractiveness of the use of funds led to the creation of such a large number of AMCs – quite often AMCs were created to service a small number of funds owned (directly or indirectly) by the owners of AMCs. That is, such AMCs were created as captive companies and actually provided nominal services to fund owners. Sometimes such AMCs are generally considered as internal divisions of corporations, and the management of operations on bank accounts of funds is transferred to the accounting department of such corporations, which is a gross violation of the current legislation.

The consequence of such structuring is a distortion of the essence of AMC as a professional manager for funds and, as a result, laying the foundation for future problems for the funds themselves.

What is meant by this? If an AMC does not make independent decisions on the search, selection, purchase and sale of assets, but only executes instructions from fund owners who do not understand the special legislation and taxation of such funds, this will inevitably lead to problems related to violation of the law, including tax law.

When AMC management works simply as an executor, it does not create additional value (value) even for the very idea (essence) of «asset management», not to mention the development, competition, reputation and profit of AMC. Not working in the classical investment market (where there is constant competition for investor capital and high-quality investment projects), they do not study the industry, create analytics, build risk management, or fight for clients by creating various products and projects. They simply fulfill the tasks of fund owners by serving business structures. All of this leads to a decline in professionalism and qualifications, and most importantly, the very essence (nature) of qualified asset management is in decline.

Given that the beneficiaries of captive companies usually consider them as «expendable», no one cares about improving the skills and preserving the business reputation of the management of such AMCs.

As for the potentially troubled funds, quite often fund owners rely on the principle of «too big to fail», which is unacceptable in a competitive environment.

Such contradictions create a risk of destabilization of the system and a conflict between the regulator and market participants, which leads to a new round of regulation to protect the interests of investors.

What an AMC should be like

The main philosophy of AMCs is to sell their asset management services, i.e. the ability to effectively invest investors’ funds, find projects, assets, and maybe even portfolios for these investments, create funds to attract investors’ funds, and earn money for management.

The main criteria include the following:

First, AMC’s management should independently make Resolutions regarding management of UCITS assets. Thus, the UCITS documents may provide for the need to coordinate certain actions with the supervisory board and/or shareholders of the corporate fund, but in any case, the decision to conduct operations should be initiated by the AMC.

Secondly, the AMC should act in the interests of the institutional investor (form an investment portfolio in accordance with the investment declaration in order to obtain the maximum income at the lowest possible risks, taking into account the conditions specified in the asset management agreement, securities market conditions, risk of counterparty selection and other risk factors).

It should be emphasized here that an AMC acts in the interests of funds (fund investors), not their counterparties. Unfortunately, there is often a misconception that fund investors are counterparties that purchase assets from funds. This is not the case – the investors of funds are the holders of securities of such funds.

Thirdly, an AMC should analyze assets owned and managed by an institutional investor (and assets to be invested in), monitor the value of such assets and calculate the risks associated with holding or selling assets.

Fourthly, AMC should develop proposals for the investment policy of collective investment institutions, and in the case of the creation of funds, formulate it.

Of course, the question arises: «How to achieve this?»”

When establishing a fund, it is necessary to clearly and consciously indicate the main investment areas in the investment declaration. The idea that the same investors are going to invest in all sectors of the economy in the interests of the same investors is rather dubious. In other words, the investment declaration of the fund should not be a formal document, but a real and well-developed document, since it is this document that should be used by the AMC in managing the fund’s assets.

At the same time, AMC specialists should have an understanding (have the necessary competencies) in the industries in which the funds are planned to invest. It should be remembered that the Commission sets only minimum requirements for AMCs, including the number of specialists. And if an AMC manages the assets of 10 funds that have «broad» or quite different investment declarations, and at the same time, such AMC has only a minimum number of specialists, it is highly doubtful that such a company can effectively manage the assets of all these funds.

In other words, the material and technical support, complexity and level of corporate governance and risk management systems, organizational structure and number of employees should be commensurate with the volume and complexity of the operations conducted in the interests of the funds.

Conclusions and prospects

AMC is a financial institution with professional management, which should ensure efficient management of institutional investors’ funds, and the available tax benefits make UCITS an attractive mechanism for continuous reinvestment of investors’ funds in the Ukrainian economy.

This mechanism has a great potential both for the formation of investment culture within Ukraine and for use as a financial infrastructure in the process of attracting funds from foreign investors.

Recently, funds with truly unique investment declarations have already begun to be created in order to attract a large number of investors.

It should also be noted that the NSSMC is constantly cooperating with other state authorities to improve the quality and transparency of capital markets.

These trends indicate a gradual reboot of the market, which should lead to its qualitative growth.

The text was prepared by the NSSMC specially for LIGA.net.