Act CXX of 2001 on capital markets (the "2001 Capital Markets Act"), came into force on 1st January 2002, and generally redefined the regulations applicable to the activities of almost all those participants in capital markets engaged in investments. The 2001 Capital Markets Act superseded the Act LXIII of 1991 on investment funds (the "1991 Investment Funds Act") and replaced the provisions concerning investment funds regarded as rather out-of-date with new and more detailed rules.
The fund manager
Under the 1991 Investment Funds Act, in addition to their own fund managing activity, investment fund managers were only allowed to provide asset management services to voluntary mutual insurance funds and to private pension funds. Under the 2001 Capital Markets Act, the scope of these activities was extended with portfolio management and securities lending (such activities being now regarded as independent services), investment advising and the sale and redemption of investment units of funds managed by the fund manager as an agent. In relation to this latter activity, it should be noted that under the 2001 Capital Markets Act, the sale and redemption of investment units is the duty of the distributor instructed by the fund manager. But, as the distributor can engage an agent to perform the sales activity, in theory it is possible that the instruction given to the distributor concerning the sale of investment units is returned to the fund manager as agent from the distributor. Under the 2001 Capital Markets Act, fund managers may also operate branches, allowing Hungarian branches of foreign fund managers to start their own fund management activity in Hungary. The minimum registered capital requirement applicable to fund managers was increased to HUF 100,000,000 (five times the previous minimum requirement). At the same time, a further condition is that if the value of private pension fund assets managed by the fund manager reaches HUF 2,000,000,000, the fund manager's equity capital must be at least HUF 250,000,000 plus 1% of the private pension fund assets in excess of HUF 2,000,000,000. However, if as a result of the foregoing the fund manager's equity capital reaches HUF 1,000,000,000, it is not necessary to increase the equity capital upon increase of the private pension fund's assets. As far as the fund manager's actions in the course of managing the fund are concerned, under the 2001 Capital Markets Acts the fund manager must comply with the rules of operation (which are not specified more closely) as well as to the rules of law and the management rules in force from time to time. Furthermore, the fund manager must act in accordance with the principal of equal treatment in relation to investors. The exact meaning and the reason for inclusion of these provisions in the 2001 Capital Markets Act are not clear.
Investment units and their distribution
The name of the custodian was deleted from the list of the mandatory elements of the content of investment units, obviously in order to make it easier for funds to select a new custodian. As investment units are also securities, they cannot be issued as bearer securities in accordance with the new regulation. Regarding the calculation of the returns due to the investor, the 2001 Capital Markets Act broke with the former fiction that one investor can have one investment unit only. Therefore, under the 2001 Capital Markets Act, the investor is entitled to distributed returns on the amount of investment units owned by him/her in proportion to the ratio of the total face value of his/her investment units to the total face value of investment units in trade upon distribution of profits. In relation to public offerings of investment units, the 2001 Capital Markets Act makes the former practice the rule. According to this rule, the fund manager must publish the appropriate management rules and a shorter prospectus in addition to the public prospectus with the required contents. Under the 1991 Investment Funds Act, the sale and redemption of investment units and the payment of returns thereon were the duties of the custodian or the securities trader instructed to do so. The modification of the custodian's duties is also contained in the new rule that the fund manager must organise the redemption of investment units (at least in the case of public, open-end funds) through the distributor instead of the custodian. The 2001 Capital Markets Act also makes it clear that in relation to securities funds, the net asset value taken into consideration upon redemption cannot be more than the net asset value valid on the third day of trading following the announcement of the redemption claim. In the event of the suspension of trade in investment units issued concerning open-end funds the reason for suspension is not that the value of the investment units cannot be determined but that the net asset value of the fund cannot be determined. The 2001 Capital Markets Act emphasises this more precisely by stating that the net asset value of the fund cannot be determined if trading in the relevant securities is suspended where it concerns more than 10% of the equity capital of the fund. As the 2001 Capital Markets Act mentions securities, it may be assumed that this rule does not apply to other investment instruments also traded (e.g. money market instruments, forward and derivative transactions). In addition to the above, an important new element is that while under the former regulation, a reason for suspension of trade was the suspension of the trade at the stock exchange, now (in compliance with market trends) the 2001 Capital Markets Act provides that a reason for suspension can be the event when the technical conditions of trade are not met at least half of the places of trade. It is not clear whether places of trade means each distributor as a whole or their organisational units (branches). In relation to the supervisory powers, owing to aspects of the protection of investors it was necessary to specify the reason for termination when the fund manager fails to meet its obligation to provide information. The 2001 Capital Markets Act provides separately for the trade of foreign collective investment securities (which are not necessarily identical to the investment units defined by the 2001 Capital Markets Act) in Hungary. The most important aspects are that the securities must be distributed in accordance with the general rules of the 2001 Capital Markets Act (through a Hungarian distributor) and foreign funds must comply with its obligations to provide information regulated by the 2001 Capital Markets Act. Foreign fund managers no longer have to take into consideration the investment rules which made the appearance of foreign funds in Hungary practically impossible before.
Establishment, termination and transformation of funds
Investment funds are established upon registration by the Supervisor. As far as this is concerned, it is a new provision of the 2001 Capital Markets Act that following the successful payment of the equity capital, the fund manager must take measures forthwith to have the fund registered. As the equity capital of property funds may include properties as well, then if the fund is a property fund, it may be necessary to attach a certificate confirming that in the event of the contribution of property, the property was handed over to the fund. If the fund failed to collect the equity capital, it is not the custodian but the distributor who must repay the total amount paid by investors within 5 days (instead of 15 days). It is no longer a condition that the amount to be repaid should be determined according to the face value; consequently, the investors may claim interest. The minimum initial equity capital of public investment funds was doubled for both securities and property funds, while for private funds, it remained unchanged: HUF 100,000,000 and HUF 500,000,000 (respectively). In the event of the termination of investment funds, only securities traders being exchange members could perform the sale of securities under the former regulation. The 2001 Capital Markets Act includes a substantial relief if the equity capital of the fund involved is positive. In this case, the fund manager itself can perform the sale of investment instruments. If the above condition is not met, in relation to a securities fund, an investment service provider must be instructed, whilst for a property fund, a real estate agency must be instructed. The 2001 Capital Markets Act provides details for the transformation and merger of investment funds, which were not regulated in the 1991 Investment Funds Act. Any change in the class, type or term of an investment fund is deemed to be a transformation. Among restrictions, the following must be highlighted: a public open-end fund cannot be transformed into a public closed-end fund and a closed-end fund of a definite term cannot be transformed into a closed-end fund of an indefinite term. It would have been useful if the 2001 Capital Markets Act had also provided for transformation limitations concerning special funds. In relation to the merger of investment funds, it must be pointed out that only funds having similar investment policies and of the same class and type may merge. In order to decide the question of "similarity" three issues are important: the type of the securities of the portfolio (e.g. government bonds, shares), the place of issuance (e.g. Hungary, European Union, USA) are the industrial sector (e.g. pharmaceutical industry, telecommunication).
Investment rules applicable to funds
Regarding investment rules, one of the most important changes is that the former obligation of the fund manager to keep at least 15% of the net asset value in cash and/or sight deposits and/or deposits blocked for not more than 3 months and/or bills and securities negotiable by the national bank in order to ensure the fund's immediate liquidity was terminated. Compliance with such a rule seemed to be unreasonable for Hungarian investment funds as well. At the same time, the 2001 Capital Markets Act still includes a provision referring to the obligation that the fund must continuously have (not specified) liquid assets securing the redemption of the investment units. Under the 1991 Investment Funds Act, funds could purchase securities that had prices suitable to determine the net asset value. The logic of regulation under the 2001 Capital Markets Act is reversed: it determines the assets in which public securities funds can keep their equity capital and thereafter, also provides for the method of calculation of the net asset value of such assets. Similarly, there was a change in the principle that the fund's portfolio mainly comprised securities listed on the stock exchange and government bonds and it was only secondarily possible to purchase securities for which a distributor published prices for 7 business days before such purchase. Now, the 2001 Capital Markets Act allows the purchase of securities listed on, or to be listed on the stock exchange as well as securities traded over the counter for which at least two investment service providers continuously publish prices deemed to be irrevocable purchase obligations for 30 days before the purchase. In addition to the foregoing, the equity capital of public securities funds can be kept in securities representing credit relationships having outstanding terms of not more than two years, investment units, bank deposits, foreign exchange as well as derivative instruments. Accordingly, the limitation that the value of securities not listed or traded on the stock exchange cannot exceed 10% was removed. The 2001 Capital Markets Act sets less strict rules for the amount of ownership shares that can be obtained by one issuer. According to these provisions, upon purchase, the fund can acquire securities representing votes reaching 10% (instead of 5%) in one issuer. The maximum proportion of securities purchased from the same issuer was doubled as well (from 10% to 20%). Furthermore, there are additional detailed rules applicable to the securities issued by OECD member states and securities representing credit relationship. The 1991 Investment Funds Act had a "gap" in the sense that investment restrictions were only applied to the date of the acquisition of securities. The 2001 Capital Markets Act now provides that, if as a result of a change in the valuation prices or redemption, the ratio of any component of the portfolio is materially (i.e. by more than 25%) over the statutory requirement in an investment fund, the fund manager is to reduce the ratio of the relevant component of the portfolio down to the limit permitted by the 2001 Capital Markets Act within 30 days or, in the case of property funds, within 180 days. It is not yet known what should be done with a portfolio element continuously fluctuating at the 25% limit. The rules on derivatives were likewise missing from the 1991 Investment Funds Act. The 2001 Capital Markets Act now regulates that fund managers may only enter into derivatives, which are for hedging, for the efficient formulation of the portfolio, which make a safe income (arbitrage) or result in closing an open derivative. The 2001 Capital Markets Act also regulates the rules on the netting of short and long positions of investment instruments. How much the new rules are consistent with business practice cannot yet be judged. Pursuant to the 2001 Capital Markets Act it is possible for fund managers to draw down a credit facility up to 10% of the equity of their fund for a term of not more than 30 days for the redemption of investment units of open-end funds. Further, the 2001 Capital Markets Act permits fund managers to lend the securities of a securities fund up to 30% of the equity. It remains forbidden to sell securities, which are not owned by the fund. The 2001 Capital Markets Act expressly forbids that the equity of funds shall be invested into investment units issued by the same fund. With regard to the quarterly statement to be submitted to the Supervision and to be made available to investors, please note that the deadline for submission is reduced from 60 days to 45 days. The 2001 Capital Markets Act has detailed rules on the announcement of the completion of the statement and the deadline for this announcement. It is a new rule that each month fund managers are to make a report on the portfolio on the basis of the net asset value calculated as of the last day of trading of the month and are to make this report available to the distributor from the tenth day of trading. The report has to contain the description of the types of investment instruments of the portfolio, the list of accounted/booked costs, the amount withdrawn by the fund as a loan, assets blocked or pledged, equity and net asset value per unit. However, the provision that yields of each investment fund managed by the fund manager may only be compared with clearly published methods of calculation has been repealed. The 2001 Capital Markets Act regulates, in greater detail than previously, what mandatory elements the management rules of investment funds must have.
Special funds
The 2001 Capital Markets Act deals with each special type of investment fund. In the portfolio of a fund investing into funds, there may be only liquid assets (not specified in the 2001 Capital Markets Act) ensuring the performance of the continuous redemption of collective investment securities and investment units. Fund managers may not enter into derivatives on behalf of investment funds investing into investment funds. If a fund investing into investment funds wishes to invest into an investment fund or a collective investment form to an extent over at least 25% of its equity, then the investment policy of the investment fund and the costs incurred by this fund are to be stated in the management rules of the fund. The name of an investment fund investing into derivatives must contain the designation "derivative fund". Investment funds investing into derivatives may take a net short position through derivatives or the sale of securities borrowed. The aggregate value of short positions with respect to an instrument may exceed the aggregate value of the amount of the same in the instrument portfolio and long positions under the relevant derivatives by not more than 30%. Investment funds investing into derivatives must continuously maintain liquid assets equivalent to 50% of the aggregate rates of exercise of the long positions of derivatives in addition to liquid assets ensuring the redemption of investment units. The 2001 Capital Markets Act, however, does not restrict the gross notional value of the derivatives. The designation "index-linked" must be contained in the name of index-linked funds. Save for government securities, index-linked investment funds may only contain securities listed in the index. The weight of securities in the portfolio of index-linked investment funds may only vary by not more than 5 basis points from the weight of each of the securities in the index. The simplified prospectus and the management rules of the fund are to contain the maximum difference between each of the securities and the weight of each of the securities in the index. A fund manager is to act while managing an index-linked investment fund so that the performance of the index defined in the management rules shall be appropriately adjusted to the performance of the portfolio. An index-linked fund may only be founded in the respect of an index whose value is continuously published for at least a year. This provision allows the use of existing indices; however, the 2001 Capital Markets Act provides that indices must be "previously announced" to investors, which means that funds may be established for new indices as well. If the index ceases to be published continuously, the index-linked fund is to be wound up or transformed within 90 days.
Custodians
Only credit institutions may be custodians. Although custodians must obtain the Supervisory authoristation, the 2001 Capital Markets Act introduces the requirement that Supervisory authorisation is required before the custody agreement may come into force. Consequently, the licence of the Supervision is not necessary for the amendment of the custody agreement. One of the most important duties of custodians is to calculate the net asset value both of the fund in aggregate and for each unit under the 2001 Capital Markets Act. In this respect, another new regulation that the net asset value must be calculated on the basis of the (somewhat subjective) "latest" rates of the market with respect to the instruments of the fund. Open-end funds calculate the net asset value on each day of trading and make the same available to investors at the places of trading. Previously, the fund manager had to ensure publication, now the 2001 Capital Markets Act transfers this duty to the custodian. The deadline for publication is two business days following the calculation of the asset value. The 2001 Capital Markets Act has made the established practice of the co-operation of fund managers and custodians an obligation, by requiring fund managers to provide custodians daily with the documents required for the calculation of the net asset value of the fund. The technical arrangements in relation to the performance of instructions for sale and purchase are missing from the list of custodians' duties. However, the definition of this activity in the 2001 Capital Markets Act continues to list technical tasks related to the sale and redemption of investment units and the payment of the yield of funds. Moreover, the 2001 Capital Markets Act gives a new duty to custodians, namely that the custodian is to ensure that the fund will receive all payments for transactions affecting the instruments of the fund and from the trade of investment units within the customary deadline. Presumably, this duty tries to define the technical tasks mentioned above. The duty of keeping securities accounts and current accounts related to investments also relates to this. Pursuant to the 1991 Investment Funds Act in relation to the legal supervision, custodians were to facilitate fund managers in acting in accordance with the laws, the license of Supervision and investment rules. The 2001 Capital Markets Act is stricter, as custodians are to check whether fund managers are in compliance with the laws and the investment regulations of rules on the management of the fund. Custodians are to report in writing to fund managers and the Supervisory body any deviation in this respect or the equity of the fund becoming negative. Custodians are not only obliged to refuse unlawful instructions or instructions against the management rules but have to require fund managers to reinstate the lawful situation. If fund managers fail to comply with this requirement, custodians shall immediately notify the Supervisory body. In addition to the custodians' customary duties, the 2001 Capital Markets Act imposes other obligations on custodians. One such obligation is that custodians are to certify that the equity has fully been paid up upon the foundation of funds. Upon the termination of funds custodians are obliged to perform the duties arising if fund managers cannot perform their own duties or are under liquidation. The 2001 Capital Markets Act has a noteworthy provision in relation to property funds under which custodians are to countersign sale and purchase agreements for properties so that they shall come into force. In this case, custodians may only assess transactions in the aspect of lawfulness, so they are not entitled to evaluate fund manager's decisions with respect to business considerations. This means that aspects of the legal review by custodians differ from those of lawyers involved in the conclusion of a transaction. This specific custodial review extends to the professional checking of the investment and other limits set out in the 2001 Capital Markets Act. For further information please contact Dr. Arpad Lantos at mailto:arpad.lantos@cms-cmck.com or Dr. Erika Papp at erika.papp@cms-cmck.com or on 00 36 1 4834800.
