The corporate governance of fund management companies has been a key area of focus for the Central Bank of Ireland over the past number of years. In a recent speech, Michael Hodson, Director of Asset Management and Investment Banking at the Central Bank, considered some of its key expectations of the board and directors, with particular reference to Fund Management Companies (“FMCs”), the role of INEDs, regulatory developments and Brexit.
As is the case in other sectors, the board is responsible for ensuring that a fund management company is being run properly. While a fund management company can delegate the carrying out of certain activities, it remains responsible for those activities. Consequently, the board must ensure that all the necessary processes, policies, procedures and resources are in place within the fund management company to allow the firm to carry out its obligations and that they are operating as expected and delivering their intended outcomes.
An INED that is part of a well-functioning board can bring objectivity to discussions and offer fresh ideas while also availing of his or her wide breadth of experience and knowledge to ensure a firm is effectively governed and operating a sustainable business model with a client-centric focus.
To fulfil this role effectively, an INED must be able to demonstrate that he or she can:
The Central Bank’s focus on corporate governance is at least partially attributable to the fact that the success of the Irish funds industry is heavily dependent on the delegation model of fund management, whereby self-managed investment vehicles or their management companies appoint third party investment managers and advisors to undertake key fund management tasks, such as portfolio management and fund administration.
According to Mr Hodson, Ireland must be in a position to demonstrate that the FMC model works effectively and in order to do this:
it is necessary to show that any delegation, including the delegation to an investment manager, can be carried out in such a way that the management company is able to robustly oversee the activities of the delegate and challenge if any deviation from the requirements emerge.
The Central Bank’s Fund Management Company Guidance (the “Guidance”), has applied to all firms since July 2018. In early 2019, the Central Bank commenced a thematic review of the Guidance, partially to see how it is being implemented and partially because of the uplift in authorisation cases as a consequent of Brexit. According to Mr Hodson, reviewing these applications for authorisation against the backdrop of a funds sector that continues to grow in nature, scale and complexity, has given the Central Bank a more detailed insight as to what is required of Designated Persons and boards under the Guidelines. This has in turn accelerated the need to undertake the thematic review this year.
In the first phase of the thematic review, the Central Bank issued a questionnaire to over 300 FMCs in scope firms, including UCITS management companies, AIFMS, self-managed UCITS and self-managed AIFs. Following its analysis of the questionnaire responses, the Central Bank then progressed to the desk-based review phase and it expects to commence a series of onsite inspections in November 2019. According to Mr. Hodson, this body of work is likely to be completed in H1 2020 and he expects that the Central Bank will be communicating with industry in some form in the second half of next year. As with any thematic review undertaken by the Central Bank, this could include further consultations in terms of the domestic regulatory framework and the issuance of an industry letter outlining good or poor practices identified in the review. There may also be firm specific Risk Mitigation Programmes should the Central Bank identify critical risks that require mitigation action.
Mr Hodson referenced a number of live industry topics that directors need to consider. According to Mr Hodson, a number of these topics will be the subject of regular supervisory engagement over the coming months.
Brexit is likely to be one of the main topics discussed at board meetings this month and when engaging with the executive team. Such discussions should be underpinned by a clear focus on the material risks presented by a hard Brexit, business continuity post-Brexit and the duty of care that the firm has to its clients and investors.
It is of vital importance that each board keeps accurate written records evidencing the issues it has considered and demonstrating robust challenge from individual directors on all aspects of the firm’s business.