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Structuring Options to Address the New CP86 Substance Requirements

The Central Bank of Ireland (“CBI”) guidance on Fund Management Company Effectiveness (CP86) by fund management companies (‘ManCos’), self-managed UCITS and internally managed AIFs (together ‘SMICs’) provides guidance on seven key areas:

  • The rationale for board composition
  • Directors’ time commitments
  • Organisational effectiveness
  • Managerial functions
  • Delegate oversight
  • Operational issues
  • Procedural matters

In mid-2019, the CBI commenced a thematic review of compliance with CP86. Questionnaires were submitted to over three hundred ManCos and SMICs. KB Associates (“KBA”) previously circulated a summary of the thematic review process, which can be found here.

Following this thematic review, it is anticipated that many existing SMICs and ManCos will be subject to increased substance requirements. Substance requirements are communicated by the CBI in the form of day counts per annum required for the six UCITS/AIFMD managerial functions set out in CP86. The CBI has provided an indicative timeline of Q3/Q4 2020 for when it will communicate with ManCos/SMICs in relation to changes required to existing substance requirements.

KBA has recently assisted a number of firms address the CBI’s new time commitments. A summary of new CBI substance requirements witnessed by KBA are outlined here.

In this note, we are pleased to provide a summary of the primary structuring options available to an existing SMIC to address the new CBI substance requirements.

Structuring Options

For simplicity, this note relates to a SMIC established as an Irish Collective Asset-management Vehicle (“ICAV”). A PLC may also operate as a SMIC. Other fund legal structures such as Unit Trusts and CCFs cannot operate as SMICs. All fund structures such as a CCF/ICAV/PLC/Unit Trust, may be supported by an external ManCo or a proprietary ManCo.

Option 1: ICAV SMIC

The SMIC has traditionally been the most common structure in Ireland. However, the CBI has significantly increased the local substance, which it requires from new SMICs. This calls into question the future viability of the model. In 2019, we have seen day count requirements of up to 286 days from the CBI.

The SMIC is responsible for, and performs, the UCITS/AIFMD managerial functions. Historically, SMICs have relied on designated persons seconded from consulting firms to address the six managerial functions. As mentioned above, there is currently a lack of clarity as to the CBI’s time commitment requirements from such designated persons. No explicit guidance has been issued.

The SMIC is a corporate entity with its own board of directors, which is responsible for all functions, though in practice all functions (administration, distribution and investment management) are outsourced. The UCITS/AIFMD compliant fund contracts directly with each of the investment manager, the depositary and the fund administrator. A diagram of this structure is attached as Appendix I.

Advantages

  • No external control issues beyond fund board composition, which the investment manager/promoter may defacto control.
  • Ability to retain the existing SMIC UCITS Business Plan/AIFMD Programme of Activity (“POA”).
  • No transition/conversion process or contract updates required.
  • Ease of removal of designated persons in the future. It is invisible to investors as no prospectus updates are required.
  • No non-investment manager/promoter involved which could require explanation to investors.

Disadvantages

  • Provides the least robust demonstration of substance in Ireland and is subject to uncertainty regarding its future viability.
  • The fund itself is directly responsible for governance/compliance and must maintain a UCITS Business Plan/AIFMD POA.
  • This was traditionally the most cost-effective model. However, it is likely to become more expensive than utilising an external ManCo due to the new substance/day count requirements for SMICs.

Option 2: ICAV managed by a Proprietary ManCo

This requires the establishment of a proprietary ManCo. An ICAV supported by a proprietary ManCo is generally utilised where an asset manager wishes to retain maximum control over a fund structure, while also ensuring there is significant demonstrable substance.

A proprietary ManCo is responsible for maintaining its own UCITS Business Plan/AIFMD POA. It is responsible for performing the UCITS/AIFMD managerial functions. It may rely on seconded consultants from a consulting firm to address these functions. There is no longer a UCITS Business Plan/AIFMD POA at fund level.

The proprietary ManCo (a wholly owned subsidiary of the investment manager, established in Ireland) is appointed by the fund. It contracts with the fund administrator and the investment manager. The fund may also be party to these contracts, which are often tri-partite. The fund itself appoints the depositary. The proprietary ManCo may also be party to this contract. A diagram of this structure is attached as Appendix II.

Advantages

  • Clear retention of control by the investment manager.
  • Clear demonstration of substance in Ireland.
  • Potential to utilise the proprietary ManCo to manage the allocation of revenues.
  • No non-investment manager/promoter involved which could require explanation to investors.

Disadvantages

  • Establishment timeframe of up to nine months for the proprietary ManCo.
  • Requires investment manager proprietary capital.
  • Governance risk retained within an investment manager entity.
  • Most expensive option due to the operation of two entities i.e. the proprietary ManCo and the fund. The ManCo may require three full-time senior staff in Ireland. Estimated minimum operating costs of €600,000 p.a.

Option 3: ICAV managed by an External ManCo

An ICAV supported by an external ManCo is generally utilised where an asset manager wishes to place reliance on an existing infrastructure in respect of the operation of a fund. The asset manager can rely on the external ManCo’s operational infrastructure and the ManCo’s UCITS Business Plan/AIFMD POA.

All CP86 obligations reside at the external ManCo. There is no UCITS Business Plan/AIFMD POA at the fund. The UCITS Business Plan/AIFMD POA of the external ManCo is the relevant governance document.

The ManCo is appointed by the fund. It contracts with the fund administrator and the investment manager. The fund may also be party to these contracts, which are often tri-partite. The fund itself appoints the depositary. The external ManCo may also be party to this contract. A diagram of this structure is attached as Appendix III.

Advantages

  • Turnkey solution as the external ManCo assumes responsibility for the operation of the fund (including the relationship with the CBI).
  • No capital is required from the investment manager.
  • Governance risk is transferred to an external entity, i.e. the external ManCo.
  • Clear demonstration of substance in Ireland (external ManCo office and staff). It future proofs the fund against increasing substance requirements.
  • The use of an external ManCo provides assurance to sophisticated investors, as it undertakes independent oversight.
  • Speed of transition (ten to twelve weeks).
  • Traditionally more expensive than the SMIC/designated person model. Increased costs of the SMIC/designated person model makes the external ManCo cost efficient.

Disadvantages

  • The external ManCo is identified in the fund prospectus and this may need to be explained to some investors.
  • Some degree of control, ostensibly, is lost to the external ManCo, however ultimate control resides with the fund board, which the investment manager may defacto control.
  • Replacement of the external ManCo in the future would require prospectus and contract revisions.

You can download your copy of Structuring Options to Address the New CP86 Substance Requirements here

KB Associates Services

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 the contents of this note further, please contact:

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