consultation on fund management company effectiveness – delegate … · delegate oversight the...
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Leading business advisers
Consultation on fund management company effectiveness – delegate oversight (CP86)The Central Bank of Ireland (CBI) has recently issued a ‘Consultation on Fund Management Company Effectiveness – Delegate Oversight’ (CP86) (the Consultation). Its aim is to enhance the effectiveness of fund managers, their boards, and the boards of investment funds. It also aims to improve investor protection, particularly given the abolition of Ireland’s previous promoter regime. CP86 is focused on two areas: firstly, the authorisation process where the quality of the boards and internal arrangements of fund management companies are scrutinised and secondly the day-to-day process of guiding and overseeing the administration and investment of the monies invested with investment funds.
Boards of directors have always been tasked with overseeing the operation and soundness of the companies whose boards they served on, including protecting the interests of the investors in those companies. This has included the boards of fund companies and fund management companies. These responsibilities stemmed from common law, fiduciary duties, and statutory obligations under the Companies Acts.
In recent years, the funds industry has been subjected to a wave of new regulation aimed at reducing the risk in the industry. Some of this new regulation has compounded the historic responsibilities of boards both at fund and fund manager level. This new regulation includes the ‘Alternative Investment Fund Managers Directive’ (AIFMD) on an EU-wide basis, the ‘AIF Rulebook’ introduced by the CBI, the ‘Corporate Governance Code for Collective Investment Schemes and Management Companies’, and the ‘Corporate Governance Code for Fund Service Providers’ produced by the Irish Fund Industry Association (IFIA).
The framework proposed by CP86 would apply to authorised alternative investment fund managers (AIFMs), internally managed AIF which are authorised AIFMs, UCITS management companies and self-managed UCITS investment companies.
The CBI is separately reviewing the impact of the IFIA’s Corporate Governance Code on the standards applicable to the allocation of responsibilities within fund boards and fund managers’ boards.
Fund management company effectiveness – delegate oversight
The CBI is seeking views on four areas.
i. Central Bank Fund Management Company Delegate Oversight Guidance
The CBI wishes to encourage oversight practices in the right direction by issuing guidance on the ‘Good governance of delegation by investment companies and management companies’ (Guidance) compiled by a Committee on Collective Investment Governance. It stated that it preferred to operate through
guidance rather than issuing rules specifying how fund managers and their boards should oversee their delegates and that if there is insufficient development of good practices, the CBI will reconsider issuing rules. The Guidance outlines principles which boards of fund managers should follow in the supervision of delegates and identifies certain tasks which should be retained by boards. It confirms that the board has ultimate responsibility for all aspects of management which are not reserved to shareholders, regardless of whether they are delegated either internally to employees or externally outsourced. It covers six tasks, including investment management, distribution, risk management, operation and administration, support and resourcing and boards of externally managed companies. A summary of the Guidance is available on pages 6–8.
ii. Streamlining designated managerial functions
The Consultation proposes to consolidate and refine the existing 15 managerial functions in the AIF Rulebook into 6, as set out in the table below, and to amend the rules for UCITS management companies and AIFMs to require them to identify “designated persons” for each.
The CBI has prepared a description on the role of each of the six designated persons to help explain the practical operation of the streamlined managerial functions. It suggests incorporating this into the Guidance, which will be revised to reflect the consolidated managerial functions. The CBI acknowledges that transitional arrangements will be required for already-authorised fund managers.
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Existing Managerial
Retained Function
Proposed Retained Managerial
Oversight Tasks
Selected features of the functions which must be carried out by the Designation Person - as set out in Appendix 1 of the Guidance
Risk ManagementLiquidity Risk
Operational RiskRisk Management
» Monitoring compliance with the risk management framework and its effectiveness, including the risk appetite statement and the quality of information being reviewed
» monitoring breaches of limits » identifying and reviewing the risks the management
company is exposed to by its delegates » due diligence and onsite visits.
Monitoring of Investment Policy,
Investment Strategies and Performance
Liquidity Management
Investment Management
» Monitoring compliance with the investment approach and the liquidity management limits
» considering departures from the investment approach » monitoring the performance of the funds including against
benchmarks » oversight of investment management activities
Monitoring Compliance
AIFMD Reporting Process
Remuneration
Regulatory Compliance
» Monitoring compliance with all legal and regulatory requirements applicable to the management company and investment funds including
» the reporting requirements » remuneration policies » escalating compliance issues to the board » maintenance of logs of breaches, errors, compliance and
compensation.
Complaints Handling Distribution » Monitoring compliance with the distribution strategy
including any arrangements with any distributor » monitoring complaints and complaint handling procedures
Monitoring of CapitalFinancial ControlRecord KeepingInternal Audit
Accounting Policies and Procedures
Capital and Financial Management
» Monitoring compliance with capital adequacy requirements
» the authorised signatory list and agreed payment processes » internal audit procedures » ensuring accounting records are maintained and available » monitoring the production of financial statements » performance standards of the fund administration function
within the management company and its delegates
Supervision of Delegates
Conflicts of Interest
Organisational Effectiveness
» Ensuing decision making is carried out in accordance with board approved procedures
» monitoring compliance with policies including conflict of interest procedures
» delegation of work to third parties » effectiveness of work delegated to third parties including
ensuring appropriate due diligence is carried out » monitoring the quality of data re delegation provided to
the board, overseeing the work of designated persons
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iii. Requirement for Irish resident directors
Current rules require Irish companies to have at least two Irish resident directors. The Consultation identifies two problems with this requirement: (i) residence is undefined; and (ii) there could be a scarcity of individuals with certain skill sets, for example risk management.
The Consultation proposes instead that boards of Irish resident fund management companies have two directors who are in Ireland for not less than 110 working days per year. They may substitute for one of these directors an individual who: (i) affirms that they are available to engage with CBI supervisors on request within any 24 hour working day period and is available to attend meetings at the CBI at reasonable notice; (ii) is unconnected to the depository or a service provider; and (iii) is competent in one of six designated tasks.
Note that CP86 does not define ‘service provider’. It remains to be seen whether the final rules on this area include the investment manager.
The Consultation does not state how the 110 working days are to be calculated, other than that it will be by a simple measure and that it will not be related to tax residency. The expected first application of these rules would be for the calendar year 2015.
iv. Rationale for board composition
The CBI wishes to ensure that fund managers are striving to achieve an appropriate balance of skills and competencies on their boards. The Consultation therefore proposes introducing a new rule, as part of the authorisation process, requiring fund managers to document how a Board’s composition provides it with sufficient expertise. Post authorisation, this documentation will no longer be required; instead, the Board must update the CBI in the usual way of appointment and resignations. The person charged with the managerial function of monitoring organisation effectiveness is also charged with overseeing the effectiveness of the board and the fund manager, and ensuring that an appropriate balance is maintained.
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Questions for consideration
The CBI has also invited views on the following questions:
1. Is publishing a delegate oversight good practice document a good approach to encouraging the development of the supervision of delegates by Fund managers?
2. Is the breakdown of revised managerial functions correct? Should other managerial functions be provided for? What are your observations about what the operational effectiveness function might entail and how this might be performed? Do you see any obstacles to the Chairperson performing the operational effectiveness function?
3. Is relaxing the requirement for two Irish resident directors the correct approach? Will relaxing this requirement have an adverse impact on the ability of the CBI to resolve issues with distressed investment funds? If so, how could this be addressed?
4. What are your views on the proposed approach to measuring time spent in Ireland? Can you suggest any alternatives or any enhancements to the definition proposed by the CBI?
5. Is there a downside to requiring fund managers to document the rationale for the board composition? Will Fund managers require a transitional period during which they can alter their board composition to ensure they have sufficient expertise and how long do you consider would be a reasonable timeframe for such adjustments?
6. Are there any other elements which should be included?
Next steps
Responses should be submitted on or before 12 December 2014. We anticipate that respondents will stress the importance of striking an appropriate balance between maintaining the “substance” feature required by AIFMD and UCITS for funds while ensuring representation of skill sets on the boards of funds and fund managers. It will be very interesting to read the feedback on CP86 and to see how the CBI structures the forthcoming changes.
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Good governance of delegation by investment companies and management companies (“Guidance”)
The CBI invited the Committee on Collective Investment Governance (the “Committee”) to prepare the Guidance.
In the pre-amble to the Guidance, the Committee states that a more comprehensive guidance would benefit directors, for example the establishment of a body such as the Independent Directors’ Council in the United States and training and guidance such as that issued by that council.
The Guidance’s scope is wide-reaching, covering the boards of directors of ICAVs, investment companies established under Part XIII of the Companies Acts or under the UCITS Regulations, UCITS management companies, AIFMs and AIF management companies incorporated and authorised in Ireland. It emphasises that boards have ultimate responsibility for all tasks that are not reserved to shareholders, that although the board may delegate tasks internally to employees or externally, they maintain ultimate responsibility.
General observations:
» Relationship between the management company and its delegates
The Committee notes that the adoption by a board of the six principles will not alone achieve good governance; the environment and culture in which principles operate are also key. They list the following four features to being essential to fostering a good relationship between a management company and its delegates:
› Openness – full, frank and open dialogue between the board and the delegate
› Engagement – directors should dedicate sufficient time and attention to their duties; delegates should acknowledge director’s duties and facilitate the discharge by the directors of their ultimate responsibility for the delegated tasks.
› Co-operation – both the management company and its delegates should recognise their common interest in a well-run
management company that serves the interests of the investors in the funds under management.
› Dialogue – delegates should recognise that directors may need additional information in order to discharge their duties.
» Retained tasks and delegated tasks
The Guidance affirms that delegation is permitted and that responsibility remains with the board. The terms of delegation should facilitate the discharge by directors of their duties to the management company (including its obligations to funds under management) as well as other responsibilities assumed by them to other persons, for example to shareholders pursuant to a prospectus where it is a self-managed investment company. The Guidance also confirms that the Board should take all major strategic and operational decisions affecting the management company and any investment funds it manages.
› Retained tasks - should include issue of the prospectus, review and approval of financial accounts, temporary suspension of redemptions, internal governance, launches and closures of funds/sub-funds/share-classes.
› Delegated tasks – a board should exercise skill, care and diligence when identifying and approving the appointment of a delegate, and continue exercising same when overseeing delegates. Delegates should provide regular reports on their policies and operating procedures noting any breaches, compliance with legal and regulatory requirements, error reporting. Boards should take remedial action if any of the delegate’s actions fall below the required standard. Boards should receive reports from their delegates on the development of their own businesses, including regulatory inspections, client base, external and internal audit reviews, business continuity programmes.
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The six areas of responsibility for fund management boards identified by the Guidance
1. Investment management The Board of the Fund Manager should seek a report or presentation from the investment manager prior to the issue of the prospectus and launch of the investment fund or sub-fund, and should approve the investment approach which the investment manager proposes to take. Following the (sub)fund launch, the board should oversee the investment manager’s compliance with this approach. The Board is also asked to seek comprehensive annual presentations from the investment manager regarding the investment manager’s performance and investment team. The directors are required to have a good understanding of the investment manager’s business, which may necessitate due diligence visits to their premises.
2. Distribution The Board are required to review and approve the proposed distribution strategy prior to a (sub) funds’ launch, and to receive regular updates on distribution including patters of distribution, sales flow and any legal, regulatory or tax issues.
3. Risk managementAlthough a management company may delegate (internally or externally) many day to day risk management tasks, its board retains ultimate responsibility for risk management. It should adopt a risk management framework, including identifying risks and risk mitigants, confirming the risk appetite, and incorporating appropriate policies for measurement and management of risk. It sets out specific requirements for each of investment risk, operational risk and enterprise risk and business continuity.
4. Investment operations and administrationWhen appointing a delegate to undertake operational and administrative tasks, a board should establish that the delegate has sufficient capacity and flexibility to manage varying levels of business, operational resilience and suitable procedures for confidentiality and data protection. It should regularly receive reports on operational matters including depositary reports, administrator reports, performance, and operation of anti-money laundering procedures. The Board should adopt an appropriate valuation policy and a budget for payment exceeding the investment management fee.
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5. Support and resourcing Management companies must have sufficient resources to enable them to carry out their functions properly, taking into account the nature, scale and complexity of their business. The Guidance suggests that matters which may require support include proactive monitoring of developments between board meetings, management of board meetings, a regular review of the management company’s suite of policies and procedures. It also suggests that individual directors may be designated with particular roles in the oversight of certain functions. In that case, the board should ensure that that person is sufficiently experienced and qualified for the role, s/he has sufficient resources to enable them to undertake that role and their nomination for that role does not comprise either their or the board’s independence.
6. Boards of externally-managed companiesThis section of the Guidance caters for externally managed investment companies (EMIC) (including ICAVs and VCCs) which are not regulated as management companies. It emphasises that the board of an EMIC retains ultimate responsibility for its management including the appointment and oversight of the management company which is its principal delegate. The EMIC Board also
remains responsible for issuing the prospectus and publishing audited annual financial statements. It should receive regular reports from the management company describing its compliance with the sections 1 (investment management), 3 (risk management) and 4 (administrative tasks) of the Guidance, developments in the distribution of the funds, and the extent of its delegation of any tasks and its control framework for oversight of the delegates’ performance. The Guidance asks the Board to consider whether it considers it appropriate to receive reports from any of the delegates of the management company.
The Guidance acknowledges that some AIF management companies (AMC) may appoint external AIFMs. These AMCs are not regulated as AIFMs, however, they remain responsible for the AIFs under management, the oversight of the AIFM, issuing the prospectus and publishing audited financial statements. The AMC’s Board is also required to apply the same principles to the oversight of the AIFMD as described above for EMICs.
To avoid doubt, the Guidance clarifies that this section (6) is limited to EMICs, to AMCs with external AIFMs, and that it does not apply to other forms of investment fund or management company.
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