It has been over a year since the amendment of the Law on Investment Funds, which required investment funds operating in Moldova to reorganise or liquidate. It is early to discuss the effects of the Law; certain preliminary conclusions yet can and need to be made.
The Concept for Mending the Stock Market, adopted by the Government at the end of 2003, initiated the actions towards the amendment of the Law on Investment Funds and some experts were taken by surprise by that Concept.
First of all, they argued the subject of the document was more related to the competence of another public authority – the National Securities Commission. Second of all, the document’s format was unusual: a concept on recuperating the securities market laid in only one page! Also, despite a comprehensive title, the content of the document was limited to provisions regarding investment funds only. Several sentences in the introduction set out the overall picture of the investment funds’ activity – the findings were lamentable. Also in several sentences, the Concept’s concluding part presented the methods for the securities market’s recovery; the methods were solely regarding investment funds as well. An almost utopian vision: “let’s adopt some provision only relating to the existing investment funds and expect the entire market to improve.”
The proposed measures were also rather vague. For example, one recommended the funds to make a decision about “reorganisation by exchanging its own shares for shares of companies in the portfolio.” What that denoted was not clear, neither from a purely theoretical nor from a practical point of view. Fortunately, the Concept was advisory in nature and its provisions were not fully implemented. Thus the Concept remained only a part of the history of the Moldovan investment funds.
The amendments to the Law on Investment Funds came to eliminate the Concept’s flaws overall and centre on two fundamental measures to be implemented by funds. First, it was the obligation of the fund to reorganise or liquidate the fund itself; the second – the obligation to carry out its own share repurchases in the event of reorganisation.
The “Classic Fund” Myth
While the amendments to the law were being designed, some funds stated, at least in informal discussions, that they were seriously considering converting into mutual (specifically open-end) funds. These statements served as a pretext to announce that, with the entry into force of the amendments, the existing closed-end investment funds would be able to reorganise themselves into the so-called “classic funds.”
This expression is familiar to those knowledgeable with the history of Moldovan funds: the reorganisation of the ’96-98s of (all the same) investment funds took place under the motto “providing classic funds.” Under the “classic fund” concept, there were (and often still are) open-ended funds and interval funds referred to. However, neither after the previous reorganisation, nor the current one, none of the investment funds came forward to become an open-ended or interval fund.
It should be pointed out that the definition of a “classic fund” is far from being synonymous to the one of a “mutual fund.” To be classic, a fund must carry out a specialised function – to gather funds from small investors, to group these funds into somewhat sizeable investment amounts and to invest these into profitable assets. In other words, “classic” should not be a term to classify investment funds, their characteristics and their qualitative results. A closed-end fund can also be classic without the need to reorganise into in any other form – the only requirement to be a classic fund is to be a professional.
Thus, investment funds can (be forced to) reorganise countless times, but this cannot make them any more or any less classic.
Preliminary Results of the Law
A main achievement of the amended Law was that it gave the opportunity to “blow off steam.” The shareholders, dissatisfied with the outcomes from the investment funds, gained the right to demand that the funds redeem their shares within a set time interval. The drawback was that only 10% of the total of shareholders utilised this right. The naive and optimistic would be quick to point out that that should mean that only 10% of the shareholders were unsatisfied. However, most likely, the poor “participation” rate of the shareholders was due to the redemption price of only half of the face value (with the exception of the fund “Daac – Hermes” redeeming its shares at par value). In addition, the redemption terms of receiving the money in six months after applying for the shares’ sale were not rather appealing as it might have been expected. Many simply assumed that was another scam. It is not to be excluded that those assumptions led to increased dissatisfaction of the remaining shareholders (the 90%). Thus, the problem of the majority of the shareholders was not resolved but rather deferred for an amount of time.
Another achievement was two available options for liquidation and what those entailed. The fund could either “voluntarily liquidate” or liquidate its activities of a professional market participant and become a regular corporation or holding company. That was the defining point of the Law. The transformation into joint stock companies or holding companies meant that any investment-related requirements as to diversification, restriction in portfolio sizes, admissible types of transactions, loan attraction, etc. would cease to apply and most importantly the supervision and monitoring of fund investment activities by government agencies would disappear. The investment funds would become “free.” That is, it was assumed that the investment funds obtained what they wanted. What the funds had sought for years became possible due to the provisions in question.
Provided the usual thrill and nervousness specific to how investment funds were treated in Moldova, the amendments for reorganising the funds had to be an uncommon event. It was suggested it was almost a form of amnesty: not only a thorough and detailed evaluation of the funds since their origins was initiated (to clearly understand how and to what point Moldovan investment funds had evolved), but also the specific amendments to the Law were set forth!
The funds must have started celebrating too early though. In various contexts, there were discussions but only at the level of general discussions to establish investment-related requirements when the reorganisation of all investment funds was complete. Those requirements should have, to a greater or lesser extent, replicated the existing rules of investment for investment funds: diversification, restrictions on portfolio sizes and admissible types of transactions, etc.
Isn’t this an odd, not to say an absurd judgment: developing laws and regulations for reorganisations, conducting expensive and complicated procedures of reorganisations, tormenting the investment funds, obliging them to take actions to become compliant with various requirements, assuaging the shareholders with promises, just so to return to the original state in the end!? Following these transformations, the funds would evolve into an incomprehensible form. After the reorganisation and application of the new requirements, an investment funds could be referred to as a “mutant fund”: half investment fund that would not be able to factually attract financial resources and invest and half holding company, that would not be able to manage the assets in their own portfolio, as it did not hold a majority necessary to make decision, and that was unmanageable due to the large number of shareholders.
There is no use in evaluating the provisions in question anymore (the author of this article opposed at the time the provisions’ ratification in their proposed form). At this stage, as the provisions have been already ratified, it is important that they are not modified till a logical conclusion is reached. And a logical conclusion is simple: if it was planned from start that the reorganisation process would be followed by the establishment of investment restrictions for funds, this is what should be carried out.
It is unnecessary to invent investment restrictions for the reorganised structures, since the supervision of corporate relations, management activities, relations with shareholders – this form of control – was not annulled by the Law on Investment Funds since the reorganised funds remained under the direct authority of the Law on Corporations. However, unwarranted changing of the rules of the game is a process that has already commenced
Where to next?
The critical state of the investment funds is not only, or may be not as much, due to the low quality of the management as it is due to the poor supervision/regulation of their activity. If, at the beginning, at least a few of the misbehaving managers would have been held accountable, may be the story of privatisation of the funds would have not been so tragic. Neither investment restrictions, nor diversification requirements, the restrictions for conducting certain types of transactions would have prevented that provided: the lack of valid, focused and smooth actions among the regulatory, legal and judicial authorities is what allowed the managers to think outside the interests of the shareholders.
If we were to analyse the entire period of existence of the investment funds in Moldova, we would be able to assert that they had been constantly “policed”. Yet on one hand, the funds were constantly accused of unknown sins, yet on the other – none of the fund managers was seriously punished for an offence proven in court. Moreover, on one hand, it was considered creating favourable conditions for the activity of the funds; on the other – the legislation was supplemented with new restrictions. All these dynamics just created tension, stalling the investment funds and the market in general
Besides, all this fuss with the existing funds simply prevented new funds from appearing on the market. Rather than develop a new, high-quality law on collective investments, everyone was forced to tiptoe around the old law, which was completely exhausted and played with changes that do not change anything.
Hence it is necessary to stop experimenting with existing/former funds and think ahead: a brand new law on collective investments, to restore a good name for the investment funds and convince investors to put money into new collective investment schemes.