The Central Bank of Ireland (‘CBI’) issued a Consultation Paper on 19 September 2014 titled Fund Management Company Effectiveness – Delegate Oversight (‘CP86’) with a 3-month consultation period. The consultation period ended on 12 December 2014 with almost 50 consultation responses having been received by CBI. The central bank is currently studying these responses and has conducted further research with a diverse sample of fund management companies.
CBI is the competent authority for the financial services industry. It strives, amongst other goals, to ensure investor protection. Investor protection is a key driver of CP86. However CBI does not define Investor protection in CP86. I will attempt to highlight characteristics that should enhance investor protection. Investor protection is evident where the expected outcomes experienced are the result of the implementation of investment, risk management and fund operational management strategies in the manner that has been clearly outlined to that investor. In simple terms there are no nasty surprises and the management and operation of the fund has the interest of the investor at its centre. All actual or apparent conflicts of interest should be effectively managed. But to be clear investor protection does not equate to the avoidance of investment losses.
The Funds Management industry is a highly competitive marketplace. Investors increasingly are looking to the governance framework of an investment fund as a key input in their due diligence process when deciding where to allocate capital. By the governance framework, I mean the checks and balances that are in place to ensure that the fund is operated in a transparent fashion. One in which the fund is run in the interest of, and for the benefit of, the underlying investors. Thus the demand for a strong governance framework is not just a regulatory ‘push’ but also an investor ‘pull’.
Within CP86 CBI proposes four initiatives which in its view should allow fund management companies to achieve substantive control over the activities of delegates. The key drivers behind this initiative were the findings of CBI during the course of its inspection work on funds. Specifically that inspection work which focused on the oversight of the activities of delegates. A large variance was observed in how the oversight of fund delegates was performed.
CP86 propose initiatives in the following areas:
- Guidance on delegate oversight
- Streamlining designated managerial functions
- Residency of fund directors
- Board composition
Before commenting on these initiatives it is worth reviewing the process that occurs when a new fund is set up. Through its own product development function, with key inputs from existing or prospective investors, a fund management/promoter organisation looks to launch a new product. After engagement with internal and/or external legal resources an appropriate fund structure is determined. The key functions required to support that fund structure will be identified. A commercially competitive tendering process is undertaken from which key service providers are selected.
It is worth noting that CBI uses the term “delegate”. Perhaps the term that is more reflective of the commercial arrangements that generally are put in place is ‘outsource’. To delegate is defined as assigning a task/responsibility to someone less senior than oneself. In practice key functions (e.g. administration/depository/transfer agent) are outsourced under contractual arrangements to (regulated) entities that are selected based on their experience and capabilities as the result of a selection process. Often the portfolio management function is retained in-house by the fund promoter.
The fund structure normally is a corporate entity. As such it is subject to the Irish legal system that sets out the roles and responsibility of corporate directors. The board members are collectively responsible for ensuring that a corporate entity is appropriately directed and controlled. However the clear differences in commercial and investment companies should be recognised. It is through the use of these structures that fund promoter products in effect become ‘corporates’.
Thus the fund promoter has a central role in both the origination and on-going development of the fund product.
As noted above CP86 identified four key elements that it opened up for consultation. I will now briefly review each in turn.
1. Guidance on delegate oversight
As noted above, during the course of CBI inspection work a large variance in the range of practices with respect to the oversight of activities of delegates was observed. In addition CBI noted that there was uncertainty among directors as to what constituted good practice in this area. As a result the CBI is of the view that the provision of a set of good practice guidelines would promote more effective oversight of delegates. This approach, they believe, is better than devising and issuing a set of rules. Indeed the range and complexity of funds that are authorised is such that a set of rules would likely be overly cumbersome and not particularly helpful.
A number of experienced professionals were invited to work together and formed the ‘Committee on Collective Investment Governance’. This committee produced a report setting out principals to be followed in the supervision of delegates. CBI is considering the option of issuing this document by way of Central Bank Guidance.
The scope of this report covers specifically the following functions
- Investment management
- Risk management
- Operation and administration
- Support and resourcing
The detailed recommendations in each area will not be dealt with in this paper but will be addressed in the next series of articles that will explore the ‘Role of the Director and the oversight of each of these specific functions’.
2. Streamlining designated managerial functions
CBI is proposing that nine UCITS and fifteen AIFM managerial functions be consolidated into six managerial functions. The other managerial function, Decision Making, remains the responsibility of the whole board as a collective and cannot be delegated. The goal is to clarify accountability as doubt may have existed as to where this lay due to the possible overlap of existing tasks. The consolidated managerial functions identified are as follows:
- Investment Management
- Risk management
- Regulatory Compliance
- Capital and Financial Management
- Organisational Effectiveness
The document provides a (non-exhaustive) description of the role of the designated person with respect to each of the management functions. These descriptions would appear to suggest that director roles performing these management functions are de-facto executive positions. Such persons in addition to having potential day to day responsibilities would also require the requisite authority over the daily functional operation of these tasks in order to be effective.
The chair of the board is considered the most appropriate for having responsibility for Organisational Effectiveness. Again this is a role viewed as having on-going responsibility not just at but also between board meetings. The paper notes the potential of day to day engagement for this role.
This may suggest that designated management functions should not be performed by the independent non-executive directors (‘INED’) on the board. It can be argued that the role of the INED is one of oversight rather than one of management and control over day to day functional activities. Indeed whilst some directors may have executive roles (perhaps at the fund promoter) it does not also follow that they have the requisite authority over a functional area and there may be a conflict between where they sit in the organisational structure at the service provider and their role as director within the fund structure.
3. Residency of fund directors
Currently there is a requirement on fund management companies to have two Irish resident directors. However CBI is concerned that this is resulting in two specific problems. They have a concern that this rule is limiting the skills and expertise available in the boardroom. This is specifically the case with respect to portfolio management and risk management expertise. The second issue surrounds the lack of a definition as to what exactly constitutes residency.
At the outset it should be acknowledged that Ireland has had a long history of fund management through which skills and experience in investment portfolio management and investment risk management have been developed. However perhaps there has been little overlap to date between the funds and the investment management sub-sectors of the Irish financial services industry to bring this expertise together.
Expertise in portfolio management and risk management are required in a fund’s boardroom. This expertise normally can be found in the fund promoter organisation. Where an employee of the fund promoter brings this expertise into the board room, it is important that there is clarity between their roles and responsibilities as a director of a fund and that as an employee of the fund promoter.
A key issue for consideration by CBI is to ensure that the board or individual directors acting on behalf of the board are available to engage with it in a relatively short period if required on any substantive issue that may arise.
In CP86 CBI is proposing that one out of the two required Irish resident directors could be substituted by a director that fulfils the following requirements:
- Affirms that they are available to engage with CBI supervisors within any 24 hour period at reasonable notice
- Is unconnected to the depository or a service provider
- Is competent in one of six designated tasks.
For definition of residency CBI is proposing that this would be a person who is present in Ireland for 110 working days per year.
4. Board composition
To ensure good corporate governance the board should comprise of a broad range and depth of skills and competencies. CBI is proposing the introduction of a rule for new authorisations. This would require new funds to document how the board composition provides it with ‘sufficient expertise to conduct the tasks expected of directors, whether acting as members of the board or, where relevant, as designated person for a managerial function’. For existing funds CBI believes a transitional period may be required. During this time a fund would review, and if deemed necessary alter, the range of expertise available to it on its board.
In cases where the fund has a contract in place for the provision of expert services, CBI does not expect that expertise be necessarily replicated on the board of directors. CBI does note the development of executive education in the area of Investment Fund Directors and the existence of experienced professionals from a range of relevant fields making themselves available as directors. These are viewed as positive developments as they broaden and deepen the expertise available to serve on fund boards.
As part of the ‘Organisational Effectiveness’ function, detailed above, an on-going review of the effectiveness of the board in total and the contribution of individual directors is anticipated.
We look forward to the CBI publishing the detailed paper, which can be expected over the coming months. This will aid in the debate and also help to understand more clearly the expectations of CBI with respect to the operation of fund management companies and specifically this area of delegate oversight.