Understanding investment firms and fund managers, including relevant audit considerations
Malta’s investment services sector is regulated by the Malta Financial Services Authority (MFSA) under the Investment Services Act (ISA). Companies providing Investment Services must be appropriately authorised by the MFSA and must comply with detailed MFSA Rulebooks. These Rulebooks function as operational manuals, setting out governance, conduct, reporting, risk management, and client protection requirements.
Categories of Investment Services Licences
Investment services regulation in Malta broadly applies to investment firms, fund managers, investment funds, custodians and depositaries, and recognised persons. Each category is subject to a specific licensing regime and corresponding MFSA Rulebook.
The focus of this article will centre around investment firms and fund managers.
Investment Firms
Investment firms are authorised under the MiFID framework and regulated by Part BI of the MFSA Rulebook. As per the First Schedule of the ISA, an investment firm may be authorised to provide the following services:
- Reception and transmission of orders (RTOs) in relation to one of more financial instruments
- Execution of orders on behalf of clients
- Dealing on own account
- Management of investments/portfolio management
- Investment advice
- Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis
- Placing of financial instruments without a firm commitment basis
- Trustee, custodian or nominee services
- Reception and transmission of orders (RTO)
When an investment firm is licensed to provide RTO, this allows such firm to receive an order from a client to buy, sell or subscribe to financial instruments and then pass that order on to another party to carry it out. In such a case, the investment firm does not execute the trade itself.
Such an activity would not include trading on its own account, execution of the trade, and deciding on what to buy or sell.
- Execution of orders on behalf of clients
Such a service is very similar to RTO, with one key difference. The firm would now be executing the trade itself rather than using a broker. Since the firm would be executing the trade itself, the provision of this service includes more responsibility than RTO, as the firm must ensure that it is adhering to best execution rules and is acting in their client’s best interest.
- Dealing on own account
Such service arises when an investment firm trades financial instruments against its own proprietary capital. When a firm is using its own capital to trade and invest, in addition to keeping track of its open position, it must also ensure that it has sufficient capital (own funds) to absorb any potential losses and ensure that the company can remain financially stable even if markets move against it.
- Management of investments/portfolio management
The provision of this service is when an investment firm manages assets belonging to another person. Two key points to understand here are that the firm is not using its own capital to invest but is managing its clients’ assets. Furthermore, the investment firm has discretion to invest on the clients’ behalf. What we mean by discretion is that the firm can decide on what to buy or sell without the approval of the client, as long as the trades are being made in accordance with the agreed strategy.
- Investment advice
The service being provided here is purely investment advice depending on the clients’ interests (risk appetite, investment goals, amount to invest). At no point in time will the investment firm be executing any trades.
- Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis
The underwriting or placing of instruments would mean that the Investment firm assumes the risk of bringing a new securities issue to the market by buying the issue from the issuer. The key term here is ‘on a firm commitment basis’. This means that the issuing company is guaranteed the money since the investment firm is acquiring the entire issue of financial instruments, irrespective of whether the investment firm manages to re-sell the investments to investors. In a case where investments are not all sold, any unsold financial instruments would end up as a financial asset in the accounts of the investment firm.
- Placing of financial instruments without a firm commitment basis
Such service arises when an investment firm assists a company in selling its securities, but does not commit to buy any unsold securities itself. In simple terms, the investment firm is marketing and distributing the financial instruments to investors.
As opposed to the previous service noted above, the risk of any unsold financial instruments remains with the issuing company and not with the investment firm. Thus, further explaining the term ‘without a firm commitment basis’.
- Trustee, custodian or nominee services
The main service being provided here is that the investment firm holds assets for clients or investors, even though it does not own them. The firm keeps the assets in trust or for safekeeping while still providing investment services
Classification of investment firms
When a company receives an Investment Firms license, it must be categorised into an investment firm class, made up from either of the following:
- Class 1
- Class 1 minus
- Class 2
- Class 3
The relevant classification would depend on a number of factors including the size of the company, the complexity of operations as well as the range of services being offered. Different rules would apply to the different classes, and such rules are once again stipulated within the Investment Services Rulebook.
Fund Managers
De Minimis AIFM vs. Full Scope AIFM
The determination of whether an AIFM classifies as a de minimis AIFM or a full scope AIFMD depends on the assets under management of the alternative investment funds (AIFs) being managed. The regulations classify an AIFM as de minimis if:
- The total assets under management of all the AIFs being managed is less than EUR100 million; or
- The total assets under management of all the AIFs being managed is less than EUR500 million but the portfolio of the AIFs have no redemption rights exercisable during a period of 5 years from the date of the initial investment.
Understanding whether a fund manager classifies as de minimis AIFM or a full scope AIFM is key as de minimis AIFMs are subject to lighter EU and MFSA regulation.
Activities
The activities of a de minimis AIFM are limited to the management of collective investment schemes that are licenced as professional investor funds. On the other hand, the core activities of a full scope AIFM are portfolio and risk management services to AIFs. Full scope AIFMs may also provide administration and marketing as ancillary services to the collective management of the AIFs.
A fund manager could also be licenced as a UCITS management company. The core activity here is the portfolio management of a UCITS fund.
Why is it key for auditors to understand the services being provided?
In accordance with ISA 315 (Revised), it is necessary to develop an understanding of the type of license held by the Investment firm or fund manager, including the key business processes (KBPs) associated with any financial statement line item where a relevant assertion has been identified. Specifically, regarding revenue, the risk of material misstatement is always treated as a significant risk due to the potential for fraud.
A thorough understanding of licensable activities is essential in the audit process, as this helps us identify the services provided and the company’s various revenue streams. It is also important to note that investment firms may conduct multiple licensable activities, resulting in several distinct sources of revenue. As can be seen below, the revenue generated can be either transaction-based or based on the assets-under-management. Given these differences, there may also be some variations in the KBPs. Furthermore, the company may implement different internal controls for the different revenue streams, and the understanding of such controls is also key.
Audit procedures will then be designed on our understanding of such KBPs, including the internal controls in place, as well as any possible ‘what could go wrongs’ within the process.
The revenue streams generated by investment firms and fund managers are summarised below:
The above mentioned revenue streams can be further divided into two categories:
- Transaction based; and
- Assets under management based
Audit considerations
Revenue – management fee and performance fees
Given that such revenue is dependent on the net asset value of the SICAV being managed, it is important to understand the type of the underlying investments. Moreover, understanding whether the underlying investments are listed or private is critical.
Should the investments be listed, this means that the investments are being traded in an active market and hence less judgment is required to value the investments. In this case, the auditor would request the audited financial statements of the SICAV. Should audited financial statements not be available at the time of audit, the NAV pack can be obtained. When using the NAV pack, which is being prepared by the fund administrator, the auditor must also ensure that the internal controls are operating effectively to rely on such a document.
On the contrary, if the underlying investments consist of private investments, this means that there is no observable data hence significant management judgement and estimation is needed to value such investments. Our audit procedures would therefore depend on the complexity of the calculation.
Direct costs – sub-investment management fees
There may be instances whereby a fund manager appoints a sub-investment manager to assist with the investment management. Should this be the case, there are two scenarios of how the sub-investment manager fee can be accounted for, and this depends on who bears the economic burden.
VAT
Typically, the management of special investment funds and collective investment schemes is an exempt without credit supply in terms of Item 3(6) Part Two of the Fifth Schedule to the Value Added Tax Act. For this exemption, “management” includes the following services where they are specific and essential to the management of the fund:
- Portfolio management (buying and selling)
- Risk management (identifying, measuring, and monitoring markets, credit, and liquidity)
- Investment guideline compliance specific to the fund (pre/post-trade compliance checks)
- Derivatives and collateral management
- Liquidity management
However, where a fund manager makes both taxable and exempt without credit supplies, input VAT recovery must be carefully assessed through the partial attribution ratio. The partial attribution ratio would therefore need to be calculated on an annual basis to assess the percentage of VAT which may be claimed back.
Concluding remarks
In summary, a clear understanding of the licensable activities carried out by investment firms and fund managers is essential for accurately identifying revenue streams and tailoring audit procedures accordingly. The diversity of services, ranging from transaction‑based activities to AUM‑based transactions, demands a thorough grasp of the relevant services that may be offered, internal controls, and underlying investment structures. By grounding the audit approach in this knowledge, auditors can better assess risks, design effective procedures, and ultimately deliver a more robust and reliable audit outcome.
At Zampa Partners, we support investment firms and fund managers from multiple angles, offering a fully integrated service across audit, tax, and VAT and ensuring that clients receive comprehensive guidance throughout all relevant obligations.
Should you wish to reach out and discuss further, please contact us.
