Fund Governance: A glance at the past, a glimpse of the future
Over the past decade the Fund Industry in Cyprus has experienced a considerable reshaping, both on a regulatory and on a market perspective. As the industry is evolving governance reform is fundamental in achieving an effective and prudent management by all parties involved. Throughout the years the market participants, including the Industry Regulator, Managers, Administrators and Depositaries became better equipped for the proper functioning of their duties and have increased their awareness over the perceived risks.
While the professionals within the industry enhanced their expertise at the same time the Investors became better informed in assessing investment opportunities. Prior year significant failures of Financial Institutions, that resulted mainly by the lack of proper management, proper supervision or fraudulent behaviors, have increased the investors alertness on evaluating investments. The investment community is no longer valuing an investment solely on the merits of its historical performance but rather on various other criteria. Board Composition, Expertise of Managers, Reputation and Experience of service providers, and regulation regime of their jurisdictions, are among the criteria that are equally important for investors.
Investor Education and Fund Regulation Perspective
In light of these changes, alongside the increased regulation scrutiny and the growing competition in the sector, we have seen a shrink in market inefficiency. Last decade’s significant failures of Madoff, Weavering Capital, Galleon Group have expedited this transformation. The focus on fund governance has developed into a center stage, not just for the Investors and the Fund Managers, but across the whole sector. Regulators and industry associations, were keen to address this issue. The implementation of the AIFMD was the beginning, but further developments were followed. The continuous improvement in regulation has educated both investors and the rest of the participants on better understanding the risks involved within the Industry. It is clear, that the sensitivity shown by the regulator on aspects related to Fund Governance, such as suitability of governing bodies, constant reliance in independency and on greater transparency and personal liability, had a crucial role in the development of this market.
Governing Bodies and Building new Norms
The market participants have realized the importance of fund governance. In doing so, they have concentrated on forming a stronger board that can facilitate this change. Nowadays, the board composition needs to have collectively, sufficient experience, proper qualification and reputation and to have the ability to oversee the activities of the fund manager and the rest of the service providers.
In addition, the board needs to demonstrate independence so that they can keep all parties accountable for the proper performance of their duties. Directors that are independent, knowledgeable upon the activities of a fund, with a good reputation, can safely ensure that they will serve the best interests of the investors and hence limit the likelihood of deviating from the Fund’s objectives.
Typical roles of Governing Bodies that are constantly addressed and further analysed by the Fund community are the following:
- Meeting Substance Requirements;
- Implementing Board Level Process;
- Achieving appropriate balance in the composition of the Board;
- Managing Conflicts of Interest;
- Due diligence practices and ongoing monitoring of delegates and services providers;
- Education and Training.
While these topics are important for setting a proper Fund Governance Framework, the need of a solid organisational structure, well written policies and procedures and most importantly a culture within the fund, the manager and the rest of the service providers, are of equal importance.
Although, the directors of both the Fund and the Manager maintain the key role in forming a solid fund governance, we should not underestimate the important role of the other professionals. Key service providers such as custodians, prime brokers, administrators, delegated portfolio managers, valuers and other professionalsare all crucial in establishing a proper synergy.
Future of Governance in the Fund Industry
The European Fund Industry is constantly evolving. As the market is becoming more transparent, so does investorsknowledge develops. A well-educated investor means more scrutiny on their part, ergo stiffer competition for Fund Managers on attracting new capital.
Meanwhile, the regulator will continue the supervision upon Managers, as they place significant reliance on them for the proper, effective and transparent operation of the market. A suitable board composition, an effective organisational structure and overall governance framework within the company should be the focus of the Managers aiming to achieve a prudent and efficient market.
As new regulations will come into force (i.e., EU SFDR or FCAs Annual Assessments of Value), will entail greater participation from the Governing Bodies on those institution to better comply and effectively control their organization.
Important topics that should be tackled by professionals in the future are the following:
- Promotion of best practices in the field of Fund Governance.
- A formation of an independent body, analogous with the Institut Luxembourgeois des Administrateurs – the Luxembourg Institute of Directors (ILA), that will be dedicated upon promoting best practices in the field of corporate governance, organising governance research, guidance, training, conferences and discussion forums.
In my view, co-ordination among Fund community members is the key for setting new norms/best practices for the industry, benefiting at the same time Governing Bodies and the rest of the market.
by George Eleftheriades, Director Chief Risk Officer Fortified Capital Ltd