On December 19th 2016, the Central Bank of Ireland (“CBI”) published final guidance on consultation paper 86 (“CP86”). CP86 introduces initiatives “designed to underpin the achievement of substantive control by Fund Management Companies (“FMCs”), acting on behalf of funds, over the activities of their delegates.” The guidance applies to UCITS management companies (“ManCos”), authorised Alternative Investment Fund Managers (“AIFMs”), self-managed UCITS and internally managed Alternative Investment Funds (“AIFs”) that are authorised as AIFMs.
Historically, self-managed fund structures have been most common with directors (both independent directors and directors from asset managers) performing the UCITS/AIFMD managerial functions. CP86 introduced three key changes which make this model no longer practical in most instances:
- CP86 introduced a requirement for an organisational effectiveness role which must be performed by an independent director. This person may not perform any of the managerial functions
- CP86 highlighted a clear distinction between the role of a director and that of a designated person. A director is responsible for oversight while a designated person exercises control over delegates on a day-to-day basis, i.e. performance of managerial functions
- CP86 requires a time commitment from each designated person. If a single individual acts as both a director and designated person, two separate time commitments are required. Historically, no additional time commitment was required where a director performed managerial functions.
In developing a response to CP86 asset managers with existing fund structures place particular emphasis on:
- Mitigating the risk of inadvertently failing to comply with the detailed requirements of CP86
- Minimising the time burden placed on internal resources.
KB Associates (“KBA”) has advised a diverse range of fund boards/asset managers on the implementation of CP86. Many have early adopted the requirements of CP86. KBA has seen three principal models:
- Appointment of KBA’s ManCo to perform the managerial functions
- A “split model” where certain managerial functions are performed by staff of the asset manager and certain functions are performed by designated persons from KBA
- Appointment of KBA staff to perform all six managerial functions.
In this note, we discuss KBA’s experiences with each model.
Model 1: Appointment of an External ManCo
Asset managers are not establishing proprietary ManCos to address the requirements of CP86. The cost of establishing, capitalising and operating a proprietary ManCo (which would likely require the support of a consulting firm to address the managerial functions) mitigates against the use of this model.
The appointment of an external ManCo by an existing fund to meet the requirements of CP86 is extremely rare. Various factors mitigate against this model:
- The prospectus needs to be updated to reflect the ManCo structure
- The fund needs to enter a new contract, i.e. with the ManCo
- The administration, depositary, investment management and distribution agreements all require updates
- The appointment of an external ManCo (and any future replacement of such ManCo) is visible to investors. Investor notification of a ManCo is required
- There is, ostensibly, a loss of control by the fund board as the external ManCo is legally responsible for the appointment/removal of the investment manager/administrator/distributor. It should be noted that for a UCITS fund arrangements can be put in place such that the removal of the investment manager requires a joint decision by the ManCo and the fund board
- The external ManCo is required to post capital and assumes significant risk given its appointment of the investment manager, distributor and administrator. Thus this structure is less cost efficient than other models as set out below.
Model 2: The “Split Model”
Utilisation of a “split model” or a fully outsourced model using designated persons (see below) both benefit from the following advantages:
- There is no re-drafting of legal documents with the exception of the UCITS Business Plan or AIFMD Programme of Activity (“PoA”). These must be updated to reflect the new designated persons
- It is easy at a future point to alter the designated persons allocated to the managerial functions
- No additional capital is required.
Many fund boards/asset managers have considered the split model initially but few have decided to proceed with this model. Factors driving this include:
- Many tasks that are completed by designated persons are relevant for multiple managerial functions. Where managerial functions are split between asset management staff and a local consulting firm, duplication often occurs. Examples of duplication of tasks within the six managerial functions include :
- NAV production issues may be relevant to both regulatory compliance and operational risk
- Financial statement production issues are relevant to operational risk as well as capital and financial management
- Portfolio management issues may be relevant to fund risk management, monitoring investment performance and compliance
- In instances where only three functions are assigned to staff from a consulting firm, there is still a requirement for the firm to provide two designated persons (this is in addition to the designated persons provided by the investment manager)
- Given the above, the cost of appointing a consulting firm to support three functions in a “split model” is not materially different to the cost of appointing a consulting firm to address all functions.
Model 3: Fully Outsourced Model
Most fund boards/asset managers have opted for the fully outsourced model. Entities recognise the risk mitigation and cost efficiency benefits of appointing consultants with extensive knowledge of the regulatory environment in Ireland. Key benefits of this model include:
- Absence of any additional time commitment to the CBI by existing fund directors
- Availing of designated persons for whom this is their primary focus and who have in depth knowledge of the regulations. This reduces the risk of accidental breach of the regulations
- Reduction of time required from asset managers’ internal resources in operating the structure
- Efficient as it avoids the duplication of tasks which occurs in the “split model”
- Efficient as it avoids the need for any re-drafting of documents with the exception of the UCITS Business Plan or AIFMD Programme of Activity (“PoA”)
- Flexible in that future changes to the designated persons are not visible to investors
- Cost efficient as no additional capital is required. Furthermore, the consulting firm assumes less risk than an external ManCo as it is not contracting with the investment manager, administrator and distributor.
For self-managed fund structures and ManCo’s established before November 1st 2015, the deadline for the full implementation of CP86 is July 1st 2018. KBA’s experience has been that fund boards/asset managers have set a deadline of year end 2017 to determine which model they will employ with a view to implementing the new model in quarter one 2018. However, in a small number of instances we have noted UK managers defer the decision as to the model to be utilised while awaiting clarification as to whether or not the CBI will deem the UK to be EEA equivalent post Brexit.
To date the fully outsourced model, with the appointment of expert designated persons to perform all six managerial functions, has been identified as that which best mitigates regulatory risk in a cost efficient manner.
Download your copy of CP86 – Lessons from Early Adopters here
How can KB Associates Assist?
KB Associates provides a range of services to investment funds including:
- The provision of UCITS ManCo/AIFM services
- The provision of designated persons to perform UCITS business plan/AIFMD PoA functions
- The provision of operational and compliance services to both UCITS and AIFMD compliant structures.
If you would like to discuss any issues raised in this paper, please feel free to contact any of the contacts below:
- Mike Kirby (firstname.lastname@example.org, +353 1 667 1980).
- Cormac Byrne (email@example.com, +353 1 667 1981).
- Paul Carrigg (firstname.lastname@example.org, +353 1 667 1982).