Investment Industry Documentation
Investment Industry Documentation
Investment Industry Documentation
INVESTMENT INDUSTRY
DOCUMENTATION
by Ravi Nevile, CFA, and Robin Solomon
LEARNING OUTCOMES
a Define a document;
INTRODUCTION 1
Documentation touches every aspect of investing, from internal documents to con-
tracts with external parties. Every time an investment manager places an order and
purchases a security, for instance, a large number of documents are developed to
record the trade.
Policies, procedures, and processes are the fabric of companies. They are essential in
the investment industry to ensure successful outcomes for clients. Recall from the
Regulation chapter that policies are principles of action adopted by a company. They
are typically driven from the top down, with rules cascading down through the vari-
ous business units and functional areas of the company. Procedures identify what the
company must do to achieve a desired outcome. Processes are the individual steps
that the company must take, from start to finish, to achieve that desired outcome.
Documentation of policies, procedures, and processes helps to communicate them
and to ensure compliance with rules, laws, and regulations.
Protects Educates
Records Communicates
Objectives
of
Documentation
Measures Authorises
Organises Formalises
From a legal perspective, documents also establish proof: proof of existence, authority,
activity, and obligation.
Origin relates to the source of the document. Documents can be classified by their
source as
■■ original documents,
■■ derived documents, or
■■ associated documents.
An employee travels for work and incurs expenses while doing so.
■■ The expense claim form the employee has to fill out when she returns to
the office is a derived document; this document exists because of other
documents—in this case, the taxi or train ticket receipt.
■■ Ad hoc documents, such as letters, memos, and e-mails, are typically informal.
The free-form nature of ad hoc documents means that they carry additional risk
for the company, particularly if the records are subpoenaed in a legal dispute.
Consequently, companies may implement policies and procedures to impose a
process of peer review for ad hoc communication. Peer review should be docu-
mented and auditable.
3 INTERNAL DOCUMENTATION
A standardised template helps maintain version control. Given the level of legislative
and regulatory activity affecting most companies, it is rare for policy and procedure
documents to remain static. Any changes reflected in a policy document need to be
similarly reflected in all associated procedure and process documents. Simply stating
the document title, the version number, and the date on which the version came into
effect helps ensure that, in case of a review, a company can show it has made efforts
to meet the required standards imposed by the relevant laws and regulations.
Internal Documentation 213
Policies, procedures, and processes are living documents and should be subject to
a regular review and confirmation process as a function of good governance. This
review and confirmation process should not be merely event driven. Even without a
notable event, attitudes and practices change over time. So, if policies, procedures,
and processes are not regularly reviewed, they can become outdated or even obsolete.
A regular review process is often managed with the use of registers, which are doc-
uments containing obligations, past actions, and future or outstanding requirements.
Registers of the previous and next review dates should be maintained by a control
function (generally, the compliance or internal audit function) and scheduled for dis-
cussion. A sign-off process is generally also incorporated into the document template.
A travel policy that simply states that employees must provide both receipts and
boarding cards for air travel is not as effective as one that provides additional
context of the reasons for the policy. The company’s travel policy not only should
clearly state that employees are prohibited from downgrading their class of
seat or ticket, but also should mention that the rule prevents employees from
booking a higher class of seat, downgrading, and then benefiting from either a
cash credit or free flights. The consequences of violating the travel policy should
also be explained.
A policy statement that merely states that a company’s employees will not engage
in insider trading is not as effective as one with additional context to make the
statement “real” for the employees. It should be explained that the policy has
its origin in law and that violation carries penalties for the company and the
individual. It should also be explained that the policy applies to everyone who
has access to sensitive information that could be considered “inside information”,
which includes not only decision makers but also anyone with access to sensi-
tive information. For example, the boardroom attendant serving refreshments
during board meetings may have access to sensitive information and, therefore,
would require training.
The importance of understanding the origins of, reasons for, and implications of doc-
umentation, for both the company and the individual, should not be underestimated.
People create and implement policies, procedures, and processes, and they need
214 Chapter 20 ■ Investment Industry Documentation
context in which to learn them, understand them, and attribute the proper degree
of importance to them. Failure to do so increases operational risk, which can have
severe consequences, as noted in the Risk Management chapter.
One role of the board of directors is to ensure that the company works within the law
and, in doing so, protects and represents the interests of all stakeholders. This over-
sight usually results in policy documents that help a company develop and implement
procedures and processes.
Many companies look externally to identify standards that should be followed. There
are numerous standards that can be readily adopted and applied, including those
issued by professional groups. For example, CFA Institute has established the Global
Investment Performance Standards (GIPS) for the presentation of investment perfor-
mance information. In some instances, professional standards are considered “best
practices”.
It may not be economically feasible, however, for smaller companies to adhere to best
practices. An alternative approach for such companies is to apply standards that suit
their own specific circumstances. These standards are known as “fit for purpose”, and
a company using this approach has to critically assess and document its own needs
and requirements. The result should strike a balance between practicality and cost on
the one hand, and between control and assurance on the other hand.
The keys to good policy documentation are simplicity and transparency. Policy state-
ments do not need to be overly detailed, but they should include a statement of intent
that explains the purpose and goals of the policy. The statement of intent should cover
the circumstances under which the policy is invoked and establish any parameters for
its use. The policy document should also clearly designate who needs to comply with
the policy and who is responsible for controlling and monitoring activities.
To ensure stakeholder confidence, and hence support, the firm must demonstrate the
Statement
... ...
Starting from a simple and concise policy statement about adhering to the highest
standards, the firm implements four procedures and processes related to each
procedure. For example, the fourth procedure relates to training employees
to mitigate breaches and lists a couple of possible processes. The first process
listed to train each employee is to ensure that each new employee undergoes
compliance training when hired. The second process listed is to ensure that all
employees go through compliance training every year.
or process and the limitations in place at the time of its creation. Companies must also
make sure that all employees receive adequate training regarding existing procedures
and processes, and that they are kept informed when changes are made.
Assume that an asset management firm has a gift policy stipulating that gifts
worth more than $100 require compliance approval. The policy is intended to
prevent conflicts of interest that might arise if receiving gifts influences employ-
ees’ behaviours. So, the asset management firm has established procedures and
processes that employees must follow when offered gifts.
Statement
to determine potential conflicts of interest.
Policy
receipt in is notified to
receives
automated determine gift No
a gift. Employee
system. eligibility. Compliance
Employee s keeps gift.
determines Ye
potential is notified
INPUT ACTIVITY OUTPUT conflicts about gift No
of interest. eligibility. Employee
returns gift,
or gift
becomes
INPUT ACTIVITY OUTPUT property of
company.
The first procedure refers to gift management. The first process in that pro-
cedure starts when the employee receives the case of wine—that is, the input.
Her first activity is to record this gift in the automated system, which triggers
a notification to the compliance department—that is, the output. If the gift is
eligible, the employee receives an automatic notification that she can accept the
gift and no further action is required. Alternatively, the compliance department
may need to determine whether there is a potential conflict of interest, which
would trigger a second process. If the compliance department concludes that
the gift is eligible, the employee can keep the case of wine. But if the compliance
department decides that the gift is not eligible, the employee must either return
the case of wine to the brokerage firm or give the gift to the company.
EXTERNAL DOCUMENTATION 4
External documentation exists between a company and external parties, including
clients, market participants, and service providers. External documents aim to artic-
ulate business relationships and obligations undertaken by the parties involved and
are often legally binding. Examples of external documents in the investment industry
are a contract between a buyer and a seller of an asset, an investment management
agreement between a firm and a client, and a “know-your-client” (some people call
it KYC) document for a new client. Because contracts and other legally binding
documents are governed by law and are enforceable, parties are usually motivated to
218 Chapter 20 ■ Investment Industry Documentation
comply with them. If any of the parties fail to fulfil their obligations, the law offers the
other party or parties protection or help. The level of protection or help often varies
depending on the jurisdiction that applies to the contract.
External documents may also be used to inform the public or other external parties
about a company’s activities or changes in its business—for example, a press release
announcing the appointment of a new chief executive officer, a marketing presenta-
tion for a new investment product, or a statement about the launch of a new website.
■■ Groups that help organise the market, such as stock exchanges, clearing houses,
and depositories
■■ Professional firms and individuals serving the needs of the industry, including
credit rating agencies, auditors, lawyers, consultants, and trustees
The relationships between parties dictate how they use documentation to formalise
their relationships.
The rest of this chapter focuses on a typical client interaction and the different types
of external documents that exist at different stages of the client’s investment cycle.
Differences among products, laws, and regulations in different jurisdictions, as well
as the client’s objectives and constraints, affect the nature of the client interaction
and hence the documentation involved.
Marketing
on
i
pt
On
em
Cliearding
-Bo
Red
nt
Client
Investment
Cycle
I n v e s t nts
Ev e
in g
me
nd
nt
Fu
Re p o
rtin g
4.1 Marketing
Most companies in the investment industry share the same basic objective of winning
clients. So, most companies’ documentation at the marketing stage of the cycle shares
the same purpose: to promote and position the company’s products and services to
persuade the client to invest.
■■ Fact sheets about the company’s products that provide short summaries of the
investments and typically detail historical performance
For asset management firms, the marketing documentation also contains information
about the managers, including their investment strategy and competitive advantages.
Other features include past performance, risk analytics, and characteristics of the
product, such as liquidity, distributed income, and fees that will be borne by the client.
220 Chapter 20 ■ Investment Industry Documentation
Marketing materials are typically regulated to ensure that companies in the investment
industry provide fair representations of their products, as discussed in the Regulation
chapter. The regulation is usually more onerous as the client’s level of investment
sophistication decreases. Most developed markets tightly regulate the sale of financial
products to retail investors, who are considered the least sophisticated investor type.
■■ provide proof of the source of funds to verify that the money does not originate
from an illegal or criminal source.
Companies must constantly monitor activities and transactions to ensure that they
are not suspicious. If something suspicious does arise, companies must report that
activity or transaction to the authorities. The heavy penalties imposed by most regula-
tors globally help combat identity theft, criminal activity, and the flow of money from
illegal sources into the financial services industry, including the investment industry.
The KYC process also serves to define the client’s level of knowledge and sophistica-
tion, assign associated and specific risk profiles, and assess any possible restrictions.
Depending on the type of client and the purpose of the relationship, different types
of information might be required to ensure that the company provides appropriate
products and services for the client’s needs.
Moreover, the KYC process is important in setting the basis for the relationship, in
particular to differentiate between discretionary and non-discretionary relationships.
Discretionary relationships permit the service provider to act on behalf of the client—
for example, as an investment manager with a specific mandate or as a trustee of a
trust. In such cases, the service provider must act in the best interest of its clients. In
contrast, a non-discretionary relationship permits the service provider to undertake
only specific tasks that are authorised by the client on a per task basis.
External Documentation 221
4.3 Funding
Once the client on-boarding process is complete and the relationship has been initi-
ated and approved by the compliance department, the next stage is the cash transfer
and the investment of the money. The client authorises his or her bank to make a
payment to the company’s client account, and the bank acts on this instruction and
provides a confirmation of the cash transfer. After receiving the money, the company
initiates the investment transaction and sends a formal confirmation to the client. For
example, the documentation associated with the investment transaction could be a
share certificate or confirmation of an investment in a mutual fund.
4.4 Trading
Documentation is important in trading—to provide a record of which assets were
ordered and traded, in what quantity and at what price. You may be surprised just
how much documentation must be produced for a single order and trade.
The diagram below shows a simplified version of the trading process, as presented in
The Functioning of Financial Markets chapter. It illustrates some of the documents
that may be produced during a trade. Depending on the asset, where it is traded, and
between which counterparties, the documentation required can vary widely.
Documents
Order Placed
Order Document
No Yes Execution
Market
Order? Instructions
Notification to
No Issuer’s Transfer
Order Closed Order Settled
Agent
When an order is placed, a document is sent to the chosen trading venue, specify-
ing what security to trade, whether to buy or sell, and how much should be bought
or sold. Another document is often attached, as discussed in The Functioning of
Financial Markets Chapter, giving instructions about order execution, exposure, and
time-in-force.
222 Chapter 20 ■ Investment Industry Documentation
Once the order has been received, a number of documents record the progress of the
trade until execution. These include:
■■ A submitted-for-dealing note
■■ Confirmation of dealing
Once the trade has been settled, the settlement agent reports the trade to the issuing
company’s transfer agent. This generates yet another document. Documents will also
be produced by accounting and other departments.
4.5 Reporting
After funding, regular communication will occur between the company and its client.
A valuation (if a market price is available) or an appraisal (that is, an estimation if no
market price is available) of each asset held is sent to the client on a regular basis.
For example, a mutual fund may report the fund’s daily net asset value per unit in a
national newspaper.
Some events are expected, such as regular income in the form of interest from a bond
investment, dividends from an equity investment, or rental income from a commercial
real estate investment. Typically, income is accompanied by a written confirmation
of payment to the client or of re-investment. Income must be accounted for in future
performance reporting as well as for income tax purposes.
■■ Merger and acquisition activity. If a company merges with, spins off from, or
acquires another company, its business and operations may change, affecting
the client’s investment.
Document Management 223
■■ Natural disaster. This type of event may affect a real asset or even a financial
asset.
4.7 Redemption
At some stage, a client may want to redeem or sell an investment. Depending on the
type of investment, a written request may be required. After verifying the authenticity
of the client’s instruction, the company arranges for the investment to be sold. The
timing of redemption depends on the type of investment and its liquidity. When the
investment is sold, the company’s authorised signatories allow the bank to release
the cash proceeds. A final written confirmation statement is then sent to the client.
Although redemption is the end of a transaction, it does not necessarily mean the end
of the client relationship. The client may want to invest or conduct other transactions
with the company in the future. The documentation relating to the final transaction
will be retained, as discussed in Section 5, should there be any future dispute or dis-
agreement between the parties.
DOCUMENT MANAGEMENT 5
It should by now be clear that documents serve an important role in establishing the
rules by which a product or service is supplied, in formalising the rights and entitle-
ments of ownership, and in recording events that take place after the purchase of an
asset. Given that millions of typical client interactions occur each day and given the
complexity of all the different parties involved in the investment industry, the amount
of existing external documentation is enormous and constantly growing. This final
section describes some of the aspects of managing documentation, including the role
of information technology and how companies access, secure, retain, and dispose of
documents.
IT has also affected the way external documentation is handled. Thanks to the advent
of straight-through processing (STP), also referred to as straight-through exception
processing (STeP), the need for manual intervention has been removed. It is often
224 Chapter 20 ■ Investment Industry Documentation
The use of IT can also reduce risk. For example, payments from an investment account
may be subject to fraud. To limit the risk of fraud, payments typically require a dual
sign-off process. If implemented correctly, a dual sign-off process makes collusion
between two parties easier to identify. Automated processes also help reduce errors.
For instance, the manual dual sign-off process involves a physical cheque and two
signatories, which is time consuming and prone to errors. A fully automated process
that relies on dual independent (blind) input with automated reconciliation and release
reduces the risk of errors and time for review.
Access. Documents that staff need to access should be easily retrievable. Companies
usually have a centralised repository that is often electronic: a read-only drive, docu-
ment database, or documentation management system capable of storing internal and
external documents relevant to the company’s business activities.
Retention. Documents are official records that offer proof and protection. So, it is
important, not only for business reasons but also often for legal or regulatory reasons,
that all documents are retained until the risk associated with the action described in
the document no longer exists. There are generally laws or policies in place to prescribe
document retention. Each legal jurisdiction has its own time frames for retention, and
some types of documents may have more specific time frames than others. Although
most documents today are held electronically, there are still requirements to hold
physical, original documents. These documents include certificates of title, contracts,
and trust deeds. Companies typically store historic information, backups, and physical
documents at an off-site location, which is often managed by a third party.
SUMMARY
Whatever your role in the investment industry, you will have to deal with documenta-
tion. Properly prepared documentation can save you and others time, assist everybody
to perform their role better, and help protect you and your company against unethical
behaviour. Key points in this chapter include the following:
■■ Policy broadly sets the rules, procedures help apply policies, and processes
divide procedures into manageable actions.
2 A broker receives a purchase order by e-mail from a client and a printed mem-
orandum with some policy updates from the human resources department.
Which of the following statements is most likely correct?
C Both the client e-mail and the memorandum are considered documents.
A an official record.
C not an official record because it conveys only information and not evidence.
A Educating
B Organising
C Formalising
A origin.
B direction.
C level of standardisation.
A ad hoc document.
B derived document.
C associated document.
A policy document.
B process document.
C procedure document.
B Process flow diagram that guides employees when they receive gifts from
clients
C Policy document that states the organisation will not engage in insider
trading
A legally bind.
12 When a client wants to sell an investment, the documentation needed from the
client relates to:
A funding.
B reporting.
C redemption.
13 The external document that is most likely used during the reporting stage of the
client investment cycle is a:
A prospectus.
B share certificate.
C monthly statement.
ANSWERS
3 A is correct. Fact sheets are documents that provide short summaries of invest-
ments and typically detail historical performance—in this case, the monthly
performance of the mutual fund. Fact sheets represent an official record. B and
C are incorrect because official records can be in electronic or printed format
and can provide information or evidence.
13 C is correct. In the reporting stage of the client investment cycle, the external
document usually takes the form of a statement, often provided by a third-party
custodian or administrator. A is incorrect because an external document, such
as a prospectus or a term sheet, is usually provided during the marketing stage
of the client investment cycle. B is incorrect because a share certificate is an
external document associated with an investment transaction, which occurs
during the funding stage of the client investment cycle.