“Why did nobody see it coming?” is one of the more polite questions the public asks about the 2007/8 financial crash. This sentiment is driving the professionalisation of business governance structures.
In the past, it was easy to see company governance as a tick-box exercise. Now, there is increasing pressure to look for all manner of potential risk: everything from cyberattacks to media campaigns. So as well as legal and accounting skills, ideally, boards of directors should include people with a broad range of business experience.
Funds under scrutiny
Investment fund boards in particular have come under increased scrutiny of late. Regulators at the European level have expressed their preference that funds based in international hubs (like Luxembourg and Ireland) should be substantial operations, and clearly not shell companies.
One of the responses in Luxembourg has been a circular (18/698) from the regulator CSSF published last August (see below). It describes clearly the expected governance structures and organisational steps to be taken by investment fund managers.
“The circular is broadly a codification of best practice,” noted Nicolas Deldime, partner with Arendt Regulatory & Consulting. There is also particular focus on anti-money laundering and counter terrorism financing rules. The CSSF has let it be known that fund structures either need to be compliant now, or to be acting on clear plans to become so. The regulator has also recommended that professionals should talk to them if they have governance concerns.
One of the most eye-catching aspects of the circular are the limits that have now been put on the number of board mandates any individual can hold. The maximum has been set at 20 mandates taking no more than 1,920 hours of work time per year. Some people see this move as part of Europe-wide moves to harmonise regulations, with the rules on directors’ mandates being in line with those in CRD IV related to the banking sector.
However, rather than being fixed thresholds, Deldime suggests professionals should follow a “comply and explain” approach. “A director might be able to demonstrate that a suite of mandates forms part of the same fund complex and that there are economies of scale,” he added. For example, related intermediaries or holding companies could be grouped together.
“Ultimately this is a basis for discussion which brings all directors back to the question of ‘Do I have enough time to do my job properly?’,” Deldime said. Each individual director or conducting officer has to complete a form released by the CSSF at the beginning of the year listing their duties. This rule is likely to apply to fund directors as well.
Comply and explain
There is also a consideration for those who are on boards as directors or conducting officers as part of their job. Yes, a senior executive will clearly have a good idea of many of the questions confronting the business, but still, potentially adding extra responsibilities onto a 50-hour a week job might be a stretch.
Some have argued that the new rules act against individuals with specialist insight contributing to numerous companies, but Deldime is sceptical. “Each director should be responsible for the whole company and this requires more than giving a short speech at a board meeting,” he said.
Nevertheless, the CSSF has underlined that they will consider the individual and collective expertise of directors when judging an application. This increases the pressure on individuals to secure professional qualifications and training certificates.
Additional independent board members may also be a way to meet the requirement since they can bring expertise and industry insight. This is a clear trend in Luxembourg, with the CSSF recommending two independent directors per board. This has become particularly relevant now as “over the last five years, fund directorship has become a real profession; the role has expanded and people understand better what is expected”, Deldime added.
Focus on efficiency?
However, rather than concerns about counting individual hours, perhaps more focus could be put onto increasing the efficiency and effectiveness of each director and the meetings they are required to attend. Efficient preparation before meetings would help, as would having information made easily available and in a digestible format. This requires investment in organisation and IT.
Part of the problem is that the current regulatory framework and practice has emerged piecemeal, and quite quickly since the global financial crisis. Often, there is a lack of clarity and logic for this reason. Also, technology is often not mature as each company will tend to have different needs, making it hard for developers to create universally useful solutions. Another difficulty is that regulators want to see that firms have the necessary staff, but this comes at a time of high competition for recruitment.
Also maybe there needs to be a strategic rethink. “The manco business is not necessarily fully integrated by the asset management practice,” Deldime noted. Often, asset managers and asset servicers see manco compliance as a burden, meaning the quality of information provided can suffer. It can be hard for the fund or management company to be heard, but the players need to listen to as this concerns key regulatory requirements. Also, there is widespread frustration with having to duplicate work.
So maybe there could even be an enhanced role for investment fund managers and boards in Luxembourg, with controls and decision making becoming more centred here.
Circular 18/698 key points
Circular 18/698 published in August 2018 seeks to clarify a range of rules around the “authorization and organization of Luxembourgish investment fund managers” (IFMs) and the fight against money-laundering and terrorism financing (AML/CFT). These include:
Clarification of what it means for board members to be “fit and proper”
Limits on the time spent (1,920 hours per annum) and number of mandates (20) for board members
Details on expected minimum staffing and internal control requirements
Clarification of risk management documentation requirements for funds
Implementing rules for AML/CFT within IFMs and reporting to CSSF
Clarification of delegation and oversight rules
Clarification of deadlines for the filing of regulatory reports