Chapter 9: Applications of legislative and regulatory frameworks (1)

Question 1

Trust

Answer 1

A trust is an agreement under which one party (the trustee) has legal ownership of certain property that they must manage for the benefit of another party (the beneficiary).

Terms of the agreement are set out in the trust deed or will. Specifies purpose of fund and how it’s to administered.

Question 2

Trustees may have the following resposibilities

Answer 2

• Exercising control over the investment and management of assets
• Payment of benefits to beneficiaries
• Ensuring compliance with the trust deed and rules and legislation
• Exercising discretionary powers in the interest of the members
• Ensuring the smooth running and admin of the trust

Note: standard of care required is that of the ordinary prudent person of business acting in the management of their own affairs

Question 3

Main concerns of the trustee in carrying out their duties

Answer 3

• act prudently
• act in the beneficiaries’ interests
• demonstrate fairness and equity between beneficiaries of the trust
• not to profit directly from action taken
• act in line with the constraints of the trust deed and rules and any overriding legislation.

Question 4

Function of a trust

Answer 4

1. Assets placed in a trust are kept separate from the settlor’s personal affairs to protect the beneficiaries. The assets are shielded from potential risks or liabilities that might arise from the settlor’s actions after the trust is established.
2. Provide mechanism for the collective representation and protection of members of a group of people linked by common interest.

Question 5

Corporate governance

Answer 5

Refers to the high level framework within which managerial decisions are made in a company.

Question 6

Main aim of corporate governance

Answer 6

• Managing the company in a way that reflects the interests and needs of the various stakeholders including those who are affected by company’s operations but don’t have a contractual relationship with them.
• Tackles agency problems and costs, and other potential conflicts of interest.

Question 7

How is good corporate governance achieved?

Answer 7

Achieved through:

• remunerating management in such a way as to align their interests with stakeholders’ interests.
• a requirement to have non-executive directors, who provide an independent voice on behalf of shareholders.

Question 8

Role of non-executive directors

Answer 8

• challenging and contributing to the development of strategy
• monitoring the performance of management
• role in setting remuneration for executive directors’ pay
• role in nomination and appointment of new board members
• role in audit committee

Question 9

Listings authority

Answer 9

Responsible for ensuring any new issue of shares is conducted in orderly and fair way and that the conduct of the company remains consistent with the listing of the shares after the issue.

Question 10

Role of listing authorities

Answer 10

Regulates:

• production of relevant business and financial informationon the issue of shares.
• process by which the shares are offered to potential shareholders and price is set for the issue of shares.
• production and distributing of business and financial information on timely basis on companies with listed secuities
• conduct of the market in listed securities - ensuring market is fair to all participants, pricing process is fair and reasonable.
• conduct of listed companies - don’t behave in manner that conflicts with the objectives of the listing authority.

Shorter list
Regulates the:

• financial and business information made available to the public at issue
• issue process
• financial and business information made available post issue
• conduct of the listed security market (to ensure fair to all participants)
• conduct of the listed companies

Question 11

What does the share prospectus include?

Answer 11

• number of shares on offer and offer price
• number of shares currently in circulation
• underwriters of the issue
• details on how shares will be allocated if offer is over-subscribed
• how money raised will be used
• company’s intended dividend policy
• audited financial statements
• aims and objectives of the company and any special factors
• senior management details and board of directors and their salaries.

Question 12

Investment approaches that incorporate both financial and non-financial objectives

Answer 12

• Sustainable investing
• Impact investing
• Socially responsible investment
• Ethical investment

Question 13

Responsible investment

Answer 13

The UNs Principles for Responsible Investment (PRI) defined it as ‘ a strategy and practice to incorporate environmental, social and governance factors in investment decisions and active ownership’.

Question 14

Examples of ESG factors

Answer 14

Environmental:

• climate change
• resource depletion
• pollution
• deforestation

Social:

• human rights
• modern slavery
• child labour
• working conditions

Governance:

• bribery and corrption
• executive pay
• board diversity and structure
• tax strategy

Question 15

Impact investing

Answer 15

Seeks to generate positive social and/or environmental impacts as well as a financial return

Question 16

Sustainable investing

Answer 16

Takes account of ESG issues in way that’s consistent with long-term sustainability of society and the natural environment

Question 17

Principles for Responsible Investment

Answer 17

We will:
1. incorporate ESG issues into investment analysis and decision making processes
2. be active owners and incorporate ESG issues into our ownership policies and practices
3. seek appropriate disclosure on ESG issues by the entities in which we invest
4. promote acceptance and implementation of the Principles within the investment industry
5. work together to enhance our effectiveness in implementing the Principles
6. each report on our activities and progress towards implementing the Principles.

Question 18

Socially reponsible investments

Answer 18

Incorporates social, environmental and/or ethical objectives as well as financial ones

Question 19

Ethical investment

Answer 19

Incorporates one or more ethically or morally motivated constraints

Question 20

Risks arising from climate change

Answer 20

• Physical risks - effects of the changing climate itself
• Transition risks - arise from shift away from lower fossil fuel use. Sources include policy measures, technological change and changing customer preference.
• Liability risk - potential costs from 3rd parties seeking compensation because they’ve suffered loss/ damage from the effects of climate change.

Question 21

How can ESG factors affect the financial performance of investments?

Answer 21

• reduce costs - more efficient use of energy and resources
• face higher costs if government introduce pollution taxes/minimum wages.
• attract new customers or charge a premiums if strong ESG practices enhance their brand.
• suffer reputational damage
• perform better if staff enjoy better working conditions
• underperform if pay structures don’t align executive incentives with shareholders’ interests.

Question 22

Social impact investing

Answer 22

Investment in companies and projects that consider ESG factors as part of their strategy and hold themselves accountable for delivering an explicit positive impact on society.

Question 23

Objectives of the action plan adopted by the European Commission on sustainable finance

Answer 23

1. Reorientate capital flows towards sustainable investment to achieve sustainable and inclusive growth
2. Manage financial risks stemming from climate change, resource depletion, environmental degradation and social issues
3. Foster transparency and long-termism in financial and economic activity.

Question 24

Mandate

Answer 24

Term used to refer to the authority given by the owner of investments to the investment manager whom they employ to manage their investments.

Question 25

Specialist mandate basis

Answer 25

Invest in a single asset class

Question 26

Balanced or multi-asset mandate

Answer 26

Invest in a range of asset classes with certain restrictions

Question 27

Restrictions applying to all mandates

Answer 27

• asset classes that are entirely prohibited
• limitations on the use of assets and asset classes
• maximum permissable holdings in individual assets or asset classes
• counterparty exposure limits for derivative instruments
• prohibition on ‘self-investment’ in sponsor’s own securities
• ethical, social or governance limitations

Question 28

Regulation may impose investment restictions such as

Answer 28

• Requirement to hold government bonds and bills
• Requirement to match assets and liabilities by currency
• Restriction on choice of assets or asset classes
• Specification of admissable assets used to demonstrate statutory solvency

Question 29

Statement of Investment Principles

Answer 29

• Less prescriptive approach than admissibility regulations
• Requirement that any restrictions in the mandate are set out in this statement for the information of beneficiaries
• May include statements to highlight any departure from accepted ‘best practice’ and justification for such departures
• This increased disclosure will enable the beneficiary will perform the regulatory function
• Sanctions for failure to meet standards

Question 30

Purpose of restrictions on investment agreements

Answer 30

1. Protect beneficiary from gross incompetence or mismanagement by fund managers
2. Encourage confidence in investment schemes and benefits they secure
3. Promote the accumulation of investible funds