Post the financial crisis, delivering better investment outcomes and stronger governance has been a theme for regulators globally. MiFID II, for example, has implications for asset managers and fund boards in areas such as product governance. The FCA’s Asset Management Market Study is the latest piece of regulation in this area, extending the focus on governance, which includes:
- The introduction of iNEDs (Independent Non-Executive Directors): UK-authorised mutual fund boards will need to appoint a minimum of two iNEDs to their fund boards by September 2019.
- Value for money assessment: UK-authorised mutual fund boards are required to oversee the reporting of the annual assessment of ‘value’ that help determine if customers are receiving value for money.
We take a look below at the rising focus on governance and more specifically, the impact of introducing iNEDs on UK-authorised fund boards.
Regulators are not the only ones pushing for stronger governance. Customer and institutional investor expectations are rising too.
There is now a greater focus on sustainability and governance across all levels of business. For example, according to PWC, fund directors are spending more time preparing for fund board meetings as corporate governance levels across Luxembourg-domiciled funds have increased. Post financial crisis, individual investors are also increasingly expecting stronger independent oversight as they seek to regain their trust in financial services.
The subject of governance has been developing for some time in the institutional channel, which is steadily looking at mutual fund solutions. A growing number of empirical studies show a positive relationship between ESG factors (Governance being the central driver for the Environmental and Social considerations) and corporate financial performance, which supports the premise that managing ESG risk factors, especially Governance, improves financial returns for companies. Implementing sound governance practices in corporate boards puts companies in a stronger position to manage their risks and make good decisions and this way of thinking is attracting institutional investors. This is supported by a recent research study of 161 pension plans, conducted by Create Research, highlighting that 60% will expect their ESG allocation to increase.
As a result, organisations are increasingly held to very high standards by investors and their customers. This focus on governance will only grow. The institutional investors of tomorrow – today’s Millennials – will be demanding even higher standards of governance as they look for companies emphasising their social responsibility. Alongside this, the strong directional push, driven by client drivers and expectations, coupled with a regulatory focus on governance within asset management that has been steadily growing post the financial crisis, will keep governance at the top of the agenda.
The complexities cannot be understated
The current structure of UK Authrorised OEICS (Open-Ended Investment Company) is well-developed and today serves thousands of different funds and millions of investors. However, this structure does not require an independent board of directors in the same way fund structures in other jurisdictions do (such as Dublin or Luxembourg).
The ACD (Authorised Corporate Director) runs the day to day operations of an OEIC and heads up a board of directors, which have a broad range of responsibilities and typically includes experienced staff members from within the asset management company that established the OIEC and ACD. They usually have a strong understanding of their business, which brings many advantages, especially in navigating and managing complex issues. The right experience and knowledge aligned to these activities becomes critical and this has always been an important consideration for senior management, legal, compliance, product, distribution and operational functions within asset management firms when overseeing their UK Authorised OEIC structures.
We think the requirements outlined in the FCA’s Asset Management Market study stipulating that fund boards overseeing UK-Authorised OIECs appoint a minimum of two iNEDs by September 2019 is more of an evolutionary change for the asset management industry. This is because a considerable amount of knowledge already exists in the way independent directors work on fund boards – US, Dublin and Luxembourg domiciled funds already require independent non-executive directors. For example, in the US, the minimum allocation to independent non-executive directors on mutual fund boards is set at 40%. Some asset management companies also operate investment trusts, which have a separate board of directors, some of which are independent.
Furthermore, many of today’s UK-authorised OIEC structures were converted from unit trusts, which was the main fund structure for UK authorised funds fifteen years ago. With unit trust structures, fund managers are responsible for managing the assets, while trustees (a separate, specialist company) are responsible for the overall governance of the unit trust. The trustee is independent from the asset management company and provides separate oversight, ensuring that fund managers run the unit trusts in line with their investment goals and objectives. This is an independent form of governance.
If managed correctly, we believe that the introduction of iNEDs will make an important contribution to UK-authorised fund boards. Given the structure of an ACD and the expertise required, we believe that the responsibilities of an iNED for UK fund boards will be more comprehensive than an equivalent role in other jurisdictions. This is because the ACD takes on legal and regulatory responsibilities for a fund. As a result, the list of ACD responsibilities is lengthy and incorporates areas such as governance, risk management, compliance, platform agreements, target clients, the provision of data (and resultant requirements, such as GDPR to follow), monitoring outsourcing, fund accounting and monitoring of investment parameters. The FCA has also indicated that iNEDs should provide input into the value for money assessment, making it more important to ensure these individuals bring the right level of value, ideas and knowledge to fund boards. For this reason, recruiting well-trained and high-calibre individuals for iNED positions will be a key focus for UK-authorised fund boards. We also feel this creates opportunity for fund boards to benefit from a more diverse talent pool across gender, experience and age, bringing a range of perspectives in that will be important in navigating a more competitive environment.
Governance has never been more important
Given the increasing complexities across the asset management industry, the role of fund boards has never been more important. Bringing in more diversity with relevant knowledge and experience can help position fund boards to navigate the increasing regulatory and competitive challenges. It also helps strengthen their focus on governance, which will continue to remain a growing and important client driver.