Ahead of the Financial Conduct Authority resuming its scrutiny of the role of independent directors on the boards of authorised fund managers, managers need to address two questions: how effective have been FCA reforms introduced last September for independent directors on their boards? Have the reforms instead led to a “tick box” minimalist compliance?
A recent Fund Boards Council (FBC) survey indicates that, in at least four out of five authorised fund manager (AFM) boards, there are just two independent directors: a survey based on a sample of about 100 AFM board member responses. This points to a substantial “tick box” minimalist compliance with a key requirement of the FCA reforms introduced in September for boards of AFMs managing open-ended FCA-authorised funds. The requirement is that 25% (or at least two) of the AFM board needs to be independent.
The FCA has been considering independent governance as part of its broader asset management market study. The FCA reforms are aimed at ensuring that AFM boards will balance the interests of their fund investors and shareholders. One finding of its market study was that boards are generally staffed exclusively by executives of the firm. Hence, the FCA felt the need to rebalance in order to help ensure that the best interests of investors are subject to greater scrutiny and challenge.
The FCA stated it will monitor and, if necessary, introduce a higher threshold of independence including the requirements for majority independent boards and independent chairs: the FBC survey indicates that only a third of AFM boards adopt independent chairs. The current reforms represent a one-size-fits-all mandatory requirement, for example, it applies irrespective of the size of the AFM business, how long the AFM has been operating, its investor base and/or the underlying fund investments.
A particular benefit of independent directors is providing input and challenge to the AFM’s assessment of the value to investors of each fund. The FCA expects meaningful challenge at AFM boards on proposals made by the executive – including on costs, fees and product design. An AFM must conduct an assessment of the value at least annually for each fund it manages. The assessment of the value focuses on fund charges in the context of the overall service delivered. The AFM board must take sufficient steps to address any instance where charges are not justified.
In carrying out the assessment of the value, as a minimum, the board should consider: the quality of service provided to investors, fund performance, the general costs of the authorised fund manager, sharing economies of scale, comparable market rates, comparable services and classes of units (subject to higher charges than those applying to other classes).
What is the right balance for board representation and is there meaningful input and challenge in the assessment of the value process, given the duty on AFMs to act in the best interests of fund investors? These are dynamic questions which, I suggest, should be regularly reviewed by the AFMs as part of good governance. In light of its own review, each AFM should self-reform and rebalance any independent representation governance issues.
Earlier this year, the FCA signalled its intention to scrutinise the effectiveness of the current asset management market study reforms – though the scrutiny is now paused on account of the lockdown.
In the case of each AFM, there are judgment calls to make on a variety of issues related to independent board representation. Some issues will no doubt evolve on account of market developments, and could include:
– Cost benefit analysis. This includes independent directors being properly remunerated for their responsibilities and access to specialist advice.
– Independent director selection. Are they truly independent taking into consideration how they were selected and their backgrounds in the context of diversity expectations? FBC evidence suggests that most current directors have asset management backgrounds focused on portfolio management, distribution and product management/governance.
– The fund management business. This includes its size (that is, assets under management) and for how long the business has been operating. On the latter, the FCA takes the view that the challenge independent directors bring is particularly important in a firm’s formative years when its strategy and culture are set.
– Investor base and nature of the underlying investments. Should the proportion of independent directors be higher for AFMs managing funds marketed to retail investors and holding less liquid investments?
AFMs should take the initiative, consult with investors and other stakeholders and implement effective governance solutions. They should proactively consider, for instance, initially the appointment of independent chairs and then greater independence on boards.
Each AFM should progress with appropriate self-reform, and pre-empt the FCA needing to impose further one-size-fits-all mandatory reforms!
Melville Rodrigues is part of the UK funds services team at Ocorian
