Establishing Index Funds and mutual funds

Index funds and mutual funds are two important financial instruments.

Index funds provide market exposure by tracking the returns and characteristics of an index as closely as possible.

Mutual funds are investment strategies that allow investor to pool his/her money together with other investors to purchase a collection of stocks, bonds, or other securities that might be difficult to recreate on his/her own.

If you want to invest in Iran stock exchange funds, we can help and advise you to do your best.

There are some kinds of funds that each of them has its own benefits,constraints and regulations.

To make the best decision based on your criterion and preferences it’s highly recommended to use our consultation services. In these services we show you the investment perspective and the risks might affect that.

Mutual Funds

۱- Introduction

Mutual funds are modern financial institutions which are designed with aim of collecting

funds from armature investors and devoting them to variety of securities to create a

reasonable return. These funds are kinds of intermediary financial institutions which help

reintroducing and reconciling amateur investors to professional capital markets. The

purpose of forming the Fund is to pool money from investors. Then the money would be

invested in different subjects such as particular securities or building projects which are

specified in the fund prospectus. Securities can include stocks, different types of sukuk,

future contracts and banking deposits for which the issuance license has been granted by

the Central Bank of Iran (CBI) or Securities and Exchange Organization (SEO) and their

specifications have been described in the Funds’ prospectus. Funds can also use the

collected money to carry out a building project. Obviously most investors intend to gain a

profit but there are some investors who would like to help specific groups or activities.

There are charity funds in which these investors can reach their goal through capital

market. Collecting small amount of money from investors, mutual funds mitigate the

investment risks, exploit the economies of scale and protect the interests of investors.

۲- Definition

According to paragraph 20 of article 1 of Securities Market Act (2005), a mutual fund is

defined as a financial institution whose main area of activities are investing in securities

and their holders shall share in the fund’s profit and loss in proportion to their

investments. Later in 2008, expanding the definition of mutual funds, the Law for

Development of New Financial Instruments and Institutions amended the definition as ‘a

financial institution which invests in the financial resources derived from issuance of

investment units in its designated area of activity’.

۳- Rules and regulations

Mutual Funds operate under a lot of rules so they are considered financial institutions

with the most concise, organized and comprehensive supervision by SEO. The rules

include acts, laws, bylaws, regulations and circulars. Mutual funds have their origin in

Securities Market Act of the Islamic Republic of Iran and as mentioned above, the Law

for Development of New Financial Instruments and Institutions made some amendments

and facilitations to the mutual funds. The rest of rules governing on mutual funds are as

follows:

- Anti-Money Laundering Act;

- Executive By-Law of the Anti-Money Laundering Act;

- The Regulations on the Record-Keeping and Reporting Requirements of

Information and Documents by the Regulated Persons/Entities;

- Disciplinary Regulations Governing Non-Brokerage Financial Institutions;

- The Regulations on the Prevention of the Mutual Funds’ Abnormal

Transactions;

- The Regulations Governing the Proceedings for Violations Committed by

Persons Mentioned in the Article 35 of the Iran Securities Market Act;

- The Executive Regulations on Record-Keeping and Reporting Mutual Funds’

Financial Events;

- The Procedure of Subscription, Issuance and Redemption of Funds Units;

- The Regulations Governing the Requirements for the Capital Adequacy of

Financial Institutions;

- The Regulations Governing the Valuation Method of Securities Purchase and

Sale in the Mutual Funds;

- The Standards Governing the Establishment of Construction Funds;

- The Regulations Governing the Establishment of Construction Funds;

- Regulations Governing the Issuance of the Construction Funds Units;

- Regulations on the Method of Calculating the Net Asset Value (NAV) of the

Construction Fund Units;

- The Regulations Governing the Market-Making Activities of the Units of the

Construction Funds;

- The Regulations on the Procedures of Tender Documentation in the

Construction Funds;

- The guidelines on preparing the feasibility report of construction projects;

- Article of Association of the Mutual Funds;

- Prospectus of the Mutual Funds;

- The Procedure for forming and revising portfolio in Index Funds;

- Furthermore, Mutual Funds shall comply with circulars. SEO has issued 26

circulars for Mutual Funds since the beginning of 2012 and there has been

issued 6 circulars for all the financial institutions including Mutual Funds.

۴- Types of Mutual Funds

Although not a long history in Iranian capital market but surprisingly Mutual Funds were

very warm welcomed by Iranian investors society and it didn’t take a long time to get

acquainted with them. To categorize kinds of Mutual Funds, one classification could be

securities Mutual Funds (including; Stock Mutual Funds, Fixed Income Mutual Funds,

Mixed (Motley) Mutual Funds & Index Funds), Charity Funds, ETF, Construction Funds,

Currency Funds and Gold Funds (Regulations of the last two, will be prepared in near

future).

Although, major Mutual Funds are in the form of Stock and Fixed Income Mutual Funds

but there are two licensed construction funds now.

Construction Funds in Iran were approved as a Financial Institution, by the Securities &

Exchange High Council in Aug 2008. Having Young population, general attitude toward

investing in housing sector as a way to protect the purchasing power of money, growing

liquidity rate in recent years and good situation for speculators’ activities, have been

among the key factors to stimulate the demand curve in housing sector. On the other hand

the lack of proper capacity has prevented the supply side of this equation to grow

proportionately to the demand side and this has caused a price boom in real estate sector

especially in megacities. Construction Funds are newly founded funds which help

constructing the mass production of domiciles and afterward quenching the increasing

growth of demands engendered in the domicile sector. The philosophy behind that was to

diminish the dependence of housing industry on banking system and to facilitate

financing through capital market. Construction Fund is a financial institution, which is

authorized by SEO as an independent legal entity. Objective of a Construction Fund is to

collect macro and micro savings, devote them to build specified constructing project, sell

the construction and eventually distribute obtained benefits among investors. The rules

and the framework of activity of these Funds have been set up upon the results of the

SEO experts’ studies with cooperation of the construction sector experts. One of the most

important characteristics of these Funds is the possibility of trading their units in the

secondary market (including Exchanges or OTC markets). The pooled funds are intended

for certain construction project and then the returns coming from selling completed

apartments, will be divided among the investors. The executive and supervisory bodies

are designed to have the project completed in time with certain expenses prescribed in the

feasibility document. Construction funds have provided several privileges for the

investors, including: a) By investing in a construction fund, investors enjoy the profit of

constructing and selling of the buildings and also they highly protect their purchasing

power against the rising prices of real estate, especially in the area which the fund’s

project is located. B) Investors may sell their units to the market maker or others

whenever they wish. This would not be possible in direct investment in construction

projects, because selling a building (especially a part of building) would be much more

difficult than selling the Fund’s units. Market maker will announce daily quotes for

buying and selling of units, according to the rules and the fund articles of association.

However, listing units in an Exchange or an OTC market provides a strong market for

that kind of investment. C) Investors may access the information about the fund and

underlying construction project through the website of the fund. Information concerning

the progress of the project will be displayed monthly and financial statements and

performance report of the fund will be displayed every three months. D) Although

investment in these funds is not free of fraudulent risk, the mechanism for administration

is so designed to let the supervisory bodies (including supervisor, trustee and auditor)

have a great role in monitoring Fund operations, and this causes the fraudulent risk to

decrease. E) Qualifications of the Fund’s bodies would be examined by the SEO. The

project control and accounts maintaining software’s are also approved by the SEO.

Generally, there are different methods of profit allocation in mutual funds as follows:

۱- In most Funds, if an investor redeems the fund units, the redemption would

be on the basis of redemption NAV.

۲- Some mutual funds, majorly fixed income funds, distribute dividends on a

regular basis namely monthly and quarterly to their investors.

۳- In charity funds, investors can allocate all or a portion of profits to charitable

activities in the manner described in the fund prospectus.

۵- Purpose of Mutual Funds

The purpose of forming securities mutual funds is to pool resources or capital from

investors and invest such funds in the purchase of securities of all kinds mentioned in the

fund’s prospectus, or in the construction project outlined in the fund prospectus, so as to

mitigate the investment risks, exploit the economies of scale and protect the interests of

investors.

۶- Mutual Funds Bodies

According to the Law for Development of New Financial Instruments and Institutions,

Funds, by virtue of the arrangements provided in the articles of association, have at least

one governing body and one supervisory body acting in the capacity of the inspector or

auditor. Subsequently, their detailed functions and responsibilities of these bodies and

also required qualifications for granting Funds’ licenses were defined in related

regulations. Generally, there are three separate kinds of bodies including decision making

body (General Meeting), governing body (fund manager, liquidity guarantor, and

registrar) and supervising body (trusty and auditor) in Iranian Mutual Funds. In this part,

different bodies of mutual funds are described. The first step to implement supervision is

fulfilled by Mutual Funds qualified Bodies. It will significantly enhance the corporate

governance elements and framework in Mutual Funds.

۶-۱- BODIES COMMON IN ALL KINDS OF MUTUAL FUNDS

۶-۱-۱- General Meeting

The fund’s general meeting shall formally convene with the presence of the holders of the

half plus one of the fund’s top investment units with the rights to vote and has powers; to

appoint the fund manager, registrar, trustee and guarantor with SEO’s approval; to change

the fund’s manager, registrar, trustee and guarantor on the condition of selecting

substitutes for them with the SEO’s approval; upon the trustee’s recommendation, to

appoint and remove the fund’s auditor and specify his office term, fees and the manner of

its payment; to adopt the modifications made in the fund’s articles of association and in

the prospectus after the SEO’s approval; to take decisions on the fund dissolution; to

approve the fund’s annual financial statements; to hear the manager’s report on the fund’s

statement and performance during every fiscal year; to hear the auditor’s report and

opinion on the financial statements as well as his report on the fund’s statement and

performance; to select a mass-circulated newspaper for the fund; and finally to approve

the expenses required for establishing the fund and the costs for holding the fund’s

general meeting.

۶-۱-۲- Fund Manager

The fund manager shall be elected by the fund’s general meeting upon the SEO’s approval

and pursuant to the rules and provisions of the articles of association and is referred to as

“manager” in the present document.

The manager shall introduce at least three natural persons who are experts in the area of

investment in securities as the “group of investment managers” of the fund so as to

discharge the following duties on behalf of the manager and upon his own liability:

  1. Policy-making and formulation of the fund’s investment policy and decisionmaking

on the buy sell or hold the fund’s assets ownership within the framework

of the rules, articles of association and prospectus of the fund;

  1. fixing the purchase and sale price of the fund’s securities in compliance with

the procedures for establishing the securities purchase and sale price in the

investment funds approved by the SEO so as to calculate the price for issuance,

redemption and net assets value of each of the fund’s investment units as per the

articles of association;

  1. Other functions and powers delegated by the fund manager.

In addition, other functions and responsibilities of the manager are set out as

follows:

  1. To allocate at least 40 square meters of proper space for administration with

the required facilities and equipment to discharge the fund’s current affairs;

  1. To participate in the fund implemental stages such as subscription, issuance

and redemption of the investment units pursuant to the provisions of articles of

association;

  1. To record and keep track of each investor’s account including the amounts

paid and received, the number of investment units issued and redeemed and the

number of investment units owned by him;

  1. To designate the holders of authorized signature for the fund and the scope of

functions and responsibilities of each of them and inform the matter to the trustee,

registrar, guarantor and auditor;

  1. To appoint the fund’s broker or brokers and supervise the optimum execution

of the fund’s securities purchase and sale orders by them;

  1. To notify the trustee of the fund’s securities transfer among its brokers within

two business days at the latest after performance;

  1. To inform the registrar concerning the monies paid to each one of the

investors within one business day at the latest after each payment;

  1. To collect and retain all positive documents relating to the fund’s financial

events, record the fund’s financial events in accordance with the accounting

principles and procedures and prepare the required reports as per the rules in the

articles of association;

  1. To introduce the group of investment managers and specify the procedure of

their service compensation which should be commensurate with the management

fee or the fund’s performance;

  1. To handle the common questions raised by investors;
  2. To procure the required software and hardware and apply them towards

achievement of the fund’s objectives;

  1. To initiate a publicity campaign to introduce the fund to the public this is, if

necessary, exercised at his own discretion;

  1. To act as the fund’s representative with the investors, all governmental and

non-governmental departments, judicial authorities and other individuals and

entities;

  1. To institute any type of legal proceedings and criminal cases on behalf of the

fund and defend the pending cases versus the fund at any law-courts, public and

special tribunals and Administrative Justice Tribunal, being vested with all powers

prescribed in the Civil Code Procedures, Criminal Code Procedures, the law and

regulations of Administrative Justice Tribunal.

۶-۱-۳- Registrar

The person charged with the registration affairs of the fund’s investment units shall be

appointed by the fund’s general meeting in accordance with the rules and provisions of

the articles of association and is referred to as the “registrar” in this instrument.

Main functions and responsibilities of the registrar are; to designate at least 5 branches so

as to deal with the issuance and redemption of investment units; to designate and

introduce one of his trusted staff as the fully-authorized representative and holder of the

authorized signature on behalf of the registrar to act for the fund’s affairs; to receive and

enter the identification data of each investor or his agent and particulars of each investor’s

bank account and transmit such information to the manager and the trustee; to participate

in subscription, issuance and redemption of investment units pursuant to the articles of

association and appendices; and finally to enter and keep records of each investor’s

account containing the amounts paid and received, the number of investment units issued

in his name, the number of investment units redeemed at his request and the number of

investment units owned by him in accordance with the accounting principles as well as

preparing the required reports as per the provisions of the articles of association.

۶-۱-۴- Liquidity Guarantor

The liquidity guarantor mainly plays its roles in circumstances that the Fund does not

have sufficient cash to make any payment out of its liquidity to investors. At this moment

the manager shall have to convert the fund’s assets into cash in a timely manner so as to

provide sufficient cash in the fund banking accounts for such payments. If, during the two

business days before the due date for payment, the manager predicts that sufficient cash

shall not be provided in the fund banking accounts on the due date for such payments, he

shall, by the end of the same day, has to inform the liquidity guarantor of the cash

shortage. In such case, the liquidity guarantor shall, by the end of the following day at the

latest, have to credit the shortage of the given cash to the fund account and submit the

application for issuance of investment units out of such cash to the manager so that the

investment units in a number proportionate to the paid cash will be issued in the

guarantor’s name.

۶-۱-۵- Profitability Guarantor

The fund profitability guarantor shall be elected by the fund’s general meeting in

accordance with regulations and as per the rules in the articles of association. The

guarantor shall have to accept his position in writing and assume his responsibilities and

functions pursuant to the articles of association and send a copy of his acceptance to the

SEO, manager, trustee and auditor each. The profitability guarantor has the

responsibilities for cash payment to investors under particular circumstances to

compensate for their return up to the amount fixed in the fund prospectus.

۶-۱-۶- Fund Trustee

To enhance internal controls procedures in operational affairs to be performed

conveniently, this pillar was designed in Funds’ structure. The fund trustee shall be

elected by the fund’s general meeting as per the regulations and pursuant to the provisions

of articles of association. Some of the more important functions and responsibilities

would be illustrated as; designating and introducing one of his trusted staff as the fullyauthorized

representative and holder of the authorized signature on behalf of the trustee

to act for the fund’s affairs; examining and confirming the amounts receivable and

payable; receiving and keeping the identification data and bank account information of

each investor so as to carry out all operations of receipts and payments between the

investor and the fund; keeping records of each investor’s account containing the amounts

paid and received, the number of investment units issued in his name, the number of

investment units redeemed at his request and the number of investment units owned by

him; receiving information on the fund’s daily transactions at the end of each business

day and monitoring the fund’s balance of accounts with the fund brokers; and finally the

last and most important one examining and approving the manager’s application to open

bank accounts in the name of the fund. All payments by the fund from the fund’s banking

accounts shall be made upon the order given by the manager and the trustee’s approval.

The trustee shall endorse the payment order before payment and after obtaining assurance

about the conformity of the payment order with the related provisions. This last

mentioned function can tremendously mitigate the risk of misusing Mutual Funds’

accessible funds.

۶-۱-۷- Auditor

The second designated supervisory body of a Fund is the auditor that some of its most

important functions and responsibilities are; to examine the principles and procedures of

internal control exercised by the manager or the trustee in the discharge of the duties

prescribed in regulations; to conduct an investigation to ensure that the principles and

procedures of internal control designed for the discharge of manager’s and trustee’s

duties are applied in practice; to examine and express his opinion on the Fund’s

semiannual and annual financial statements in accordance with auditing standards and

national accounting standards and also the accuracy of the performance reports; to

examine and express the accuracy of calculating the market net asset value, statistical

value, the issuance and redemption price of investment units through a sample survey in

accordance with auditing standards.

The fund auditor shall be recommended by the trustee from among the auditing firms

trusted by the SEO to be approved by the fund’s general meeting. The auditor’s fee shall

be proposed by the trustee and approved by the fund’s general meeting. The term of the

auditor’s office shall be appointed by the fund’s general meeting.

۶-۲- BODIES JUST IN CONSTRUCTION FUNDS

Construction funds’ operations are different from securities mutual funds. The person

who is in charge of carrying out the construction project as well as the person in charge

of supervising the construction procedure should be well aware of and specialist in

construction. So Constructor and Supervisor are two bodies of just construction funds.

Similarly, due to the different operations of construction funds, you can find three other

new bodies in their structure namely Board of Directors, Underwriter and Market maker.

These specific bodies of construction funds are described in this part.

۶-۲-۱- Constructor

Constructor is a legal entity with at least 5 years of effective experience in management

of large construction projects that can be changed after the approval of SEO. Constructor

has the responsibility of performing the project. He can do it independently or delegate

implementing the project to other qualified contractors. At each step, he presents physical

and financial progress reports of the project to supervisor and fund manager accordingly.

Through the project, bodies such as supervisor, trustee and judicial experts will need

some information on the project. So constructor cooperates with them to visit the project

and access any necessary information.

۶-۲-۲- Supervisor

Supervisor is a legal entity (usually consultant engineering institutions) that according to

construction law and related regulations has the first class operation permission. It can be

changed after the approval of SEO. He performs the tasks mentioned in the national

construction standards and regulations.

According to the article of association of the fund, supervisor should approve the

business plan of project including maps and steps of construction. He also supervises the

implementing the project to assure that it complies with business plan and national

construction standards and regulations. Besides, the physical progress reports prepared by

the constructor need the approval of supervisor who prepares periodic progress reports of

project accordingly.

۶-۲-۳- Board of Directors

Board of directors consists of five namely fund manager, trustee and three people

appointed by the General Meeting. The members’ qualification must be approved by

SEO. The amount of capital raising, qualification of constructor and its nominated

contractors should be approved by board of directors. Board of directors also determines

selling approach and confirms the procedure of selling and up front selling of

construction. If there is any delay in project implement, board of directors has the

authority to make decision whether the fund would take the responsibility for or not.

Furthermore, in exceptional conditions, board of directors can change costs or time

schedule of project implement.

۶-۲-۴- Underwriter

Underwriter is a legal entity that can be changed after the approval of SEO. Underwriter

is obliged to buy the unsold units of fund in any IPOs (either when establishing the fund

or raising capital) and provide the deficit in liquidation procedure.

۶-۲-۵- Market Maker

Market maker is a legal entity that can be changed after the approval of SEO. He is

obliged to make market of fund units (except those of the fund bodies) until the end of

fund’s operation period. He will do it with a limitation on quote range that falls between a

price limit.

۶-۳- BODIES JUST IN CHARITY FUNDS

As the name conveys, some part of assets in a charity funds are supposed to be allocated

to some specific area. Obviously, one cannot control and manage the expenses unless he

knows about the specific area outlined in the prospectus of the charity fund. That’s why

there is a different body in charity funds’ structure called Executive Manager. It’s

described in more details in the following part.

۶-۳-۱- Executive Manager

Executive manager is a legal entity (usually charity and welfare agencies) whose

professional competency and qualification shall be approved by SEO and it shall be

selected by the fund’s General Meeting in compliance with regulations and the fund’s

article of association. The manager shall have record on the charitable affairs mentioned

in the fund’s prospectus or shall have the ability to carry out that affairs.

۷- Supervision on Mutual Funds

Enacting the Securities Market Act of the Islamic Republic of Iran (2005) was a turning

point that caused considerable transformations in Iran’s capital market. According to the

article 7 of the mentioned act, SEO shall adopt the necessary measures to prevent the

occurrence of violations in the securities market. In order to get such a target, SEO owns

different tools and one of the important ones is the power to grant business and activity

licenses. So it can assess qualifications of applicants for establishing financial institutions

and their plans. Also, according to the same article, SEO has the duty to report such types

of violations in the securities market whereby the reporting task has been entrusted to

SEO to the appropriate authorities. This duty has had SEO to conduct a consistent

supervision on capital market participants. Due to the importance of financial institutions

among other capital market participants, there is a separate deputy in SEO called ‘Deputy

of Supervision on Financial Institutions’ which is responsible for granting

establishment/activity licenses and continuous supervising activities of financial

institutions. This part describes how financial institutions are supervised.

۷-۱- SUPERVISION BEFORE ISSUING BUSINESS/ACTIVITY

LICENSES

As mentioned above, SEO has the authority to grant establishment/activity licenses. This

is a very preventive tool because many important items are examined and assessed

through the establishment process. Since the financial institutions have different

structures, different requirements are considered for business/activity licenses that are

described in this part by the kind of financial institutions.

In order to establish a mutual fund, generally there are two groups of items considered by

SEO. First of all, the fund structure should be determined by the applicants. The kind of

fund, its size, including the minimum and maximum number of fund units, their base

value and restrictions/requirements for owning them should be determined. Besides, it

should be specified what portion of expenses is supposed to be paid by the fund and what

portion by investors. When it comes to the construction funds, the applicants should

introduce the characteristics of land such as its address and dimensions, the

characteristics of its owner and the records of changing in the ownership. Furthermore,

estimations about construction plan and the costs of the project and estimated cash-flow

should be presented.

In another step, the mutual fund’s bodies are assessed by SEO. Several bodies in a

securities fund includes: fund manager, investment managers, registrar, fund trustee and

auditor. In some of mutual funds there are also bodies as liquidity and/or profitability

guarantor. In construction funds, there are other bodies namely constructor, supervisor,

underwriter and market maker while executive manager is a body that is laid just in

charity funds’ structure. Since all these bodies are legal persons, the applicant should

present SEO some specific information about them through an application form. In the

form, they present each body’s paid capital level and the identity of board members and

major shareholders, as well as human resources. They have to present their last audited

financial statements as well. Besides, a group of investment managers for large mutual

funds or an investment manager should be introduced by the fund manager. So their

educations, certificates and professional records can be assessed by SEO. When the

structure of the fund and the professional competency of executive and supervisory

bodies are approved by SEO, the applicants would be informed about SEO’s initial

approval for the fund establishment through a letter. If there need any other documents to

grant subscription permission, they are announced through the same letter.

To receive subscription permission, applicant has to present SEO the several documents,

some of which are as follows:

- The fund’s article of association and its prospectus consistent with the sample

one of SEO. They should be signed and sealed by all the fund bodies;

- The acceptance of positions by the fund bodies;

- a copy of the last gazette announcements of each bodies and the founders

about the condition of signing binding documents;

- Fund’s bank accounts number;

- The bank’s certification as regards the payment of the base value of the

preferred investment units (at least 20% of the minimum capital of fund);

- A copy of contract for subscribing and accessing a fund software along with a

letter of commitment of the fund manager to fulfill the requirements of the

fund’s article of association and prospectus and other regulations of SEO

through that software;

- A certificate that shows passing at least 15 hours of a training course on the

fund software;

- Announcement about the launching the fund’s website;

- introducing the delegate of the fund trustee for the fund affairs;

- Letters approving that the founders are not governmental;

If all the documents are provided the fund would be registered with SEO and in order to

collect the mandatory minimum capital, the permission for initial underwriting and public

offer of investment units at the base price would be issued for a specified period. The

applicant has to disseminate the initial subscription date through the fund’s website and

newspaper.

After a successful underwriting and receiving a confirmation from the bank, a registry

permission letter is given to the founder or his legal representative along with other

documents.

When the mutual fund is registered with the Company Registry General Office and the

fund’s article of association is sealed by the Office, the applicant present the supporting

documents along with an application for mutual fund activity license. Then the activity

license would be issued by SEO and if the fund can receive a Trading Code from Central

Securities Depository of Iran can trade share for the fund.

Renewing an activity license needs SEO’s agreement and the retention of all the

requirements that have been considered at time of activity license issuance.

۷-۲- SUPERVISION AFTER ISSUING BUSINESS/ACTIVITY LICENSES

Subject to article 2 of Securities Market Act of the Islamic Republic of Iran, SEO along

with Securities High Council are formed in order to protect the investors’ rights, maintain

and develop a transparent, fair and efficient market of securities and supervise the proper

enforcement of this law. In order to have a transparent, fair and efficient market of

securities, SEO launched an online database called ‘Comprehensive Database of All

Listed Companies (CODAL) late in 2006. At the beginning, different information which

could affect investors and other participants of capital market such as annual and

quarterly financial statements of just listed companies were published through CODAL.

But later, SEO issued a circular whereby mutual funds, as new financial institutions, have

to publish some financial information through CODAL. It would be described in more

detail later in this part.

In regard to financial institutions, it’s Deputy for Supervision on Financial Institutions

that is in charge of mentioned objectives. So, specific plans are scheduled on an annual

basis and of course, achieving those objectives needs tools that vary from a kind of

financial institution to another. In this part, we describe what the plans are and how the

mentioned objectives are achieved for each kind of financial institutions.

۷-۲-۱- Transparency, fairness and efficiency

The first step toward having a transparent, fair and efficient market of securities in regard

to mutual funds is timely publishing of financial information about funds. Since 2013,

mutual funds have to publish some financial information through CODAL. The most

important financial information of a mutual fund includes the fund’s financial statements,

its performance report and auditor report on them. According to one of SEO circulars, a

fund manager should publish the fund’s annual and quarterly financial statements and

performance report through CODAL within 20 days from the end of reports’ date.

Besides, the mutual fund’s auditor should publish his opinion about the fund’s annual and

semi-annual financial statements and performance report directly through CODAL within

۲۰ days from receiving the reports. All the mentioned reports have to be published

through mutual fund’s website too by fund managers. Timely publishing by fund

managers are examined regularly in SEO.

۷-۲-۲- Supervising the proper enforcement of rules and regulations

۷-۲-۲-۱ Book-keeping

In order to have consistency of record-keeping in mutual funds, SEO has issued ‘The

Executive Regulations on the Record-Keeping and Reporting Mutual Funds’ Financial

Events’. One the powerful tools that SEO use to ensure that the regulations are complied

with mutual funds are the fund’s software. SEO has a full access to the same software in

which financial events of funds are recorded. So, SEO can examine online the accuracy

of fund’s records. But there are lots of things to check too often. To solve such a problem,

companies which provide mutual funds with software services are coordinated with SEO.

So, a considerable part of accounting records in software is made automatically. In this

way, the risk of manipulation in accounting records by funds’ software operators is

۱۸ constrained in a great deal. For instance, when some shares are sold or bought by the

fund, there is a predetermined accounting article with specific accounts that gets

complete with the number and sell/buy price of shares and forms an accounting article. In

the article, items such as transaction fees and sale tax are calculated automatically. As far

as the accounting articles in mutual funds can be predetermined and a sample article

makes sense, they are programmed in funds software and any further extension,

improvement or even tiny changes in the software will occur with SEO permission.

۷-۲-۲-۲ Fund’s reporting

Funds reports include: financial statements, performance report and auditory report.

Financial statements and performance report are quarterly, for instance they are prepared

for 3, 6 and 9-month and annual periods. Fund’s auditor should examine the biannual

financial statements and performance report and express his opinion of them. This is the

first supervision tool that ensures the regulations and standards compliance. On the other

hand, the first page of financial statements should be signed by the fund manager and the

fund trustee. Although the fund trustee supervises the fund activities on a consistent basis

but approving the fund’s financial statements by signing it imposes him more

responsibility to ensure the accuracy of the statements. This is not the end and fund’s

financial statements, performance report and auditory report on them are examined

through specific checklists in SEO. This way there will be enough confidence in accuracy

of the funds’ reports.

۷-۲-۲-۳ Investment restrictions

There are three different kinds of securities funds by their investment restrictions, namely

stock funds, fixed-income funds and mixed funds. Each kind of funds has specific

restrictions on their investment that are outlined in the fund prospectus. For example, a

stock fund has to invest at least 70% of its assets in stocks and is not permitted to invest

more than 30% of its assets in one industry. The restrictions on investment vary from a

kind of mutual fund to another. On the other hand, pursuant to a SEO circular, investment

managers in mutual funds have to prepare an Investment Policy Statement (IPS) and

publish it through the fund’s website. In the IPS, they determine what the investment

objectives, policies and strategies are in the mutual fund for short, medium and long term

among other items. Compliance with investment restrictions outlined in the prospectus

and applying IPS by the investment managers are examined regularly through funds

software. Some special reports in the funds software shows the investments levels for

each item mentioned in prospectus, so it can be checked easily.

۱۹

۷-۲-۲-۴ Market Maker of ETFs

One of the important bodies in an Exchange-traded Fund (ETF) is the market maker. The

fund’s market-maker will help facilitate the trading of the investment units and will

additionally provide an opportunity for the investors to sell their investment units against

cash at a fair price any time they wish to do so. The market-maker has to carry out the

market-making activities for ordinary investment units under the provisions of the article

of association and the prospectus and subject to the regulations on the market-making

operations. For this purpose, the market-maker will, during the course of all trading days,

be engaged in buying and selling the ordinary investment units. The quotation range of

the broker’s sales and purchase (spread between the buying price in the purchase order

and the selling price) are determined in the articles of association. This spread can be

examined partially through a public website of securities transactions (www.

tsetmc.com). Also, there is a minimum for accumulated order and daily transactions

made by the market-maker. These items are examined through the fund software in which

there are special reports on the orders and transactions of fund units.

۷-۲-۲-۵  On-site inspection

According to funds article of association, SEO is the authority charged with investigating

all violations of regulations, fund’s articles of association and prospectus by the manager,

registrar, guarantor, trustee, auditor and brokers. The supervising mutual funds are not

restricted to online inspection or examining funds software and their report but in some

cases, on-site inspections are carried out. For example, when a probable violation of rules

and regulations are partially discovered anyway and needs more information on the event

to get clear, a delegate or a group of delegates go to carry out an on-site inspection. So,

SEO can inspect items that normally cannot be examined online. Filing documents,

procedures to trade securities, completely filling out different forms and efficiency of

equipment and human recourse of a fund are inspected on-site. This kind of inspection is

more effective for a construction fund where physical progress of construction project is

of a great importance.

Also, SEO delegates participate in the annual general meeting of almost all the mutual

funds. In a general meeting, SEO delegate can discuss different issues with preferred

fund unit holders, auditor and fund trustee. The SEO’s delegate is a supervisor in

governing body combination and helps making decisions within the framework of

regulations and if needed usually warns them about the subsequent if probable violations.

In case of lack of inviting the said delegates, the general meeting is deemed void.

۷-۲-۲-۶ On-Line inspection

There are different sophisticated software that help SEO make sure all the processes are

being performed in comply with codified rules and regulations. Major functions including

calculating NAV (Net Asset Value) process, issuing and redeeming investment unites and

inflow and out flow of Funds are all fulfilled by intelligent and approved software

automatically and subsequently reflected in Funds general ledgers simultaneously. The

manual vouchers are reduced to least possible amount and all the mentioned functions are

spied by regulator during the day.

۷-۲-۲-۷ Self-control mechanism

According to the funds article of association, if any of the fund bodies is informed of the

negligence in the discharge of duties or violation of the rules and articles of association

by other bodies, it (they) have to report the matter to the trustee or the SEO as practically

as possible. This commitment of bodies helps ensure the accuracy of each fund bodies’

activities.

۷-۲-۲-۸ Pursuing violations

As discussed earlier in this part, there are several supervising methods some of which are

carried out by SEO and some by the fund bodies. The fund auditor might send a especial

report on the mutual fund, proposing the risks, probable violations, professional

misconduct etc. Similarly and more often, the fund trustee due to his duties outlined in

regulations, reports different actual or possible problems of a fund to SEO. If a probable

violation of rules and regulations is suspected in a mutual fund, regardless of how it is

discovered, through the fund trustee or its auditor, the Deputy for Supervision on

Financial Institutions is in charge to follow it up. The first step in following up is to ask

the fund manager or other responsible bodies about the possible violation and request

their response. Since the fund trustee has the responsibility to carry out a consistent

supervising for rules compliance by the fund, he’s usually asked for his response. The

responses received by the Deputy for Supervision on Financial Institutions get examined

and scrutinized and if they are not acceptable and reasonable, the violation is reported to

Deputy for Offence Prosecution which is in charge of prosecuting any violations of rules

committed by financial institutions. Usually the defendants are invited to SEO to present

their responses and defenses verbally and then the related committee in Deputy for

Offence Prosecution judges the defendant. If the violation is proved, there will be

different orders. For example, sometimes a warning notice would be sent to the defendant

and it would be filed in his history.

From April 2014 to April 2015, the Deputy for Supervision on Financial Institutions has

reported 15 violation cases to the Deputy for Offence Prosecution and there has been

issued the same number of written cautions for financial entities.

۷-۲-۲-۹ Liquidation and Settlement

Since the liquidation of a mutual fund is a crucial point in fund business cycle, all the

settlement process of a mutual fund is set out in the fund’s article of association. Due its

importance, especially for investors, the settlement steps are monitored by SEO through

specific checklists whenever a fund liquidates.

According to the funds article of association, during the fund’s primary liquidation

period, receipt of the application for issuance of investment units by the registrar should

be stopped and at the end of the liquidation period, purchase of assets in the name of the

fund and sale of the fund’s assets shall be stopped. Also, the day after the end of the

primary liquidation period, the manager should, upon the trustee’s confirmation, pay all

the fund’s matured debts out of the fund’s cash apart from the fees claimed by the

manager, registrar, trustee and guarantor. All these activities are monitored through the

fund’s software and website.

Afterward, the manager has to prepare the fund’s financial statements, performance report

as well as a report on fund’s unsold assets. Then the auditor has to present his opinion on

them to SEO and some of fund bodies. SEO examines the reports through a checklist to

make sure the regulations are complied.

Then if the auditor expresses a clean opinion as to the fund’s financial statements and

unsold-assets report and where the fund’s general meeting approves the financial

statements, thereafter the manager have to settle with investors on the basis of redemption

price of investment units at the end of the fund’s primary liquidation period. This step is

monitored through the fund’s software where the financial transactions are recorded.

Then all of the fund’s investment certificates should become invalidated. The manager

immediately has to publish a notice on the fund website for the information of investors

in this respect which is monitored by SEO.

Except for the fund’s debts to the guarantor, the fund’s remaining debts should be paid out

of the fund’s cash. Finally, the minutes for the fund’s liquidation should be drawn up

bearing the signatures of the manager and the trustee whereby a copy of it, should be kept

in records by the manager and a copy of it, should be transmitted to the SEO. The receipt

of the minutes by SEO shows the end of the fund’s liquidation procedure.