Investment Fund Governance

Investment Fund Governance Date: October 11, 2023 Presented by: Dr Margaret Cullen Key Take – Aways Regulatory policy should reflect the practical reality of the sector it is trying to regulate: otherwise, it will never achieve its objectives and fund boards & INEDs are being set up to fail. Investment fund boards should be evaluated against a role set consistent with the practical realities of investment funds in meeting the objectives of investment fund governance (Cullen, 2011, Cullen and Brennan, 2017). Investment fund governance is not just about regulatory compliance: An oversight framework that is risk led, not regulatory led, but in a regulatory compliant way is what will protect investors, the IM's brand, the reputation of the jurisdiction and you as a director. >80% of funds domiciled in Europe have non-EU FCA IMs must fight for regulatory equivalence so that we can move away from regulatory fantasy Reality VS Regulation Reality: Reality % IM 85 SP's 10 Professionals 4 Fund Board <1 Regulation: Reality % IM 9 SP's 5 Professionals 1 Fund Board 85 Woodford Equity Income Fund (WEIF)  Andrew Bailey, Chief Executive of the FCA, wrote to Rt Hon Nicky Morgan MP, Chair of the Treasury Committee in response to Mr. Morgan's request for information from the FCA regarding issues relating to the suspension of Woodford Fund.  Mr. Bailey wrote: "In the case of WEIF, which was first authorized by the FCA in 2014, the fund manager is Link Fund Solutions ('Link'). Subject to certain restrictions, our rules allow fund managers to delegate functions such as investment. management to appropriate third parties. Link has appointed Woodford Investment Management ('WIM') to manage the assets within the fund in line with the investment mandate it has given to WIM (though we do not approve WIM's appointment by Link). As an FCA authorized investment manager, WIM can undertake the regulated activity of 'managing investments', by for example, making investment decisions and buying and selling securities in a fund. WIM is not, however, the authorized manager of the WEIF itself. The fund manager has the regulatory responsibilities in relation to operating the fund and therefore, for WEIF, Link is accountable to the FCA".  How much did Link earn for that regulatory risk? How much did the INEDs earn? Understanding Context 1. Investment funds are products of investment manager organisations (IMs): have unique characteristics a. A legal form (trusts and OEICS/ICAVS/SICAVS) that create a legal pecking which does not reflect the reality.... who really appoints who?....US 1940 Act order b. Regulatory overlay (FCA, CBI, SEC) that exacerbates the situation 2. Investment fund industry often viewed by regulators as a mirror of the corporate governance model: a. Promote governance solutions equivalent to those for corporate entities...challenged by US Academic research since the 1960s c. Lack of global, consistent regulatory approach to fund governance: jurisdiction by jurisdiction challenge for IMs (e.g. FCA AOV v ESMA's undue cost!!) d. Unrealistic expectations on INEDs....fiduciary risk 3. From a governance perspective, investment funds do not and cannot operate isolation from the IMs that establish them: IMs, like any other organization, must have a robust corporate governance framework in place, which includes product/fund governance.... think of a mortgage! 4. Investment fund governance is all about investor protection: this must happen within the IM and, at the level of fund itself (extra layer of governance). Why do some regulators put all their eggs in the fund or management company board? 5. IM representatives and INEDs on fund board share the same fiduciary duty: dual board structure is a strength, not a weakness 6. Conflicts of interest are inherent in doing business and in an agency relationship: must be managed; cannot be eliminated For Fund Boards and IMs: 1. IMs have a significant influence on the role and effectiveness of the boards of their investment fund products and management companies: this is why the governance and culture of the IM is pivotal. Is this an organization that can demonstrate to you that it takes produc governance and investor protection seriously? Do your due diligence! 2. It is critical that IMs and investment fund boards are clear as to the objectives and principles of investment fund governance: speak a common language...... industry. wide What does investor protection mean to you? 3. The dominant role of the investment fund board is oversight.... not control (Cullen and Brennan, 2017; Radin and Stevenson, 2006) Risk to you as a director and to investors in asserting you are the controller 4. Understand: the risk, the contractual arrangements, SLDs, polices in place and ultimately WHO MANAGES THE RISK THAT THE INVESTOR HAS BOUGHT INTO ON A DAY TO DAY BASIS? a. Oversight role impels fund directors to ask whether the IM and the b. service providers have appropriate systems and processes in place for identifying, analyzing and managing risk: Fund Directors should understand how risk management system works within the IM and service provider organizations c. Clarity on respective liabilities/accountabilities, role and responsibilities of the various stakeholders d. Have we agreed KPIs /KRIs related to this? From where do we get assurance? Objectives of Investment Fund Governance: IOSCO  The ultimate goal of the governance framework is investor protection  Does not equate to protecting investors from market-related losses (parenthesis added by Cullen)  Objective: 1. To enable investors to understand the risks attached to investment fund products (transparency); 2. To prevent misleading or fraudulent practices (risk management/internal control); 3. To prevent investor loss due to the malfeasance or negligence of fund promoter organizations (risk management/internal control); and 4. To minimise conflicts of interest (objectivity)