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The impact of regulation on board meetings

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ICG Management Limited ('ICG') is an independent director services provider. It was established in 2006 by Ralph Woodford (pictured) and Andrew Galloway. Along with Galloway and Woodford, the firm's two other directors, Brad Cowdroy and Greg Link, ICG provides director services to offshore funds. 

Speaking to Hedgeweek, Woodford and Cowdroy explain how the agendas and contents of board meetings are changing, principally in response to growing regulation, and the subsequent impact this is having on a Director's role. 

Fund valuations

Following the implementation of AIFMD, the responsibility for fund valuations has morphed from the Fund Administrator's responsibility, with board oversight, to the AIFM's regulatory responsibility and the Director's legal responsibility for the valuation of fund assets. 

This, says Woodford, has changed the way in which valuation policies are now constructed. 

"Under AIFMD, we as Directors interact more closely with the AIFM with respect to valuations. The board should firstly understand the AIFM's role and responsibility from an AIFMD perspective and how this interacts with the role of the Fund Administrator and their own internal approach and valuation processes. 

"The AIFM's valuation policy adopted by the AIF must then be reviewed regularly. We have always had a direct relationship with the AIFM, when it comes to pricing exceptions and evaluating the valuation policy, but under AIFMD, there is regulatory oversight and the board needs to review the AIFM's proposed valuation policy to ensure its appropriateness as applied to the AIF. 

"We would seek to receive the AIFM's Valuation Committee minutes confirming any valuation exceptions that arise from a fund's NAV process, generally at the end of any given month," explains Woodford, noting that it is imperative for the board to have clear communication lines in connection with the monitoring of the valuation process and NAV preparation.

AIFMD has resulted in AIFM's having to focus more on valuations. In a Pre-AIFMD world, the Directors would usually delegate the valuation role to the Fund Administrator to provide independent valuation as part of their daily operational work and NAV preparation process. 

"Valuation policies are not a new phenomenon, they have been in place for many years, but now Investment Managers under AIFMD, approach potential fair value changes or price adjustments in a more regulated and structured manner. Fund Administrator sourced prices are cross referenced with Valuation Committee findings before any price changes are applied," says Cowdroy. 

There are some instances where administrators will take on the delegation of pricing for Level 1 and Level 2 assets as an external valuation agent, with Level 3 assets (the most illiquid and difficult to value) remaining with the AIFM's Valuation Committee. The same overall AIFM checks and balances still need to apply, however, pursuant to the valuation policy in place. 

Woodford observes that by sitting on the board of a number of Cayman funds being marketed into Europe, he has seen substantial changes in the fund's offering & subscription documents, administration agreements, IMAs and valuation policies. 

"As a result, we would look to review the valuation policy of the AIFM on an annual basis. The review can be completed on an ad-hoc basis as required, but it also needs to be calendarised, so that if regulation or valuation processes do change, and the AIFM updates the valuation policy, the Directors have the opportunity to formally review and input at board level, into any policy updates.," says Woodford, who continues:

"Another important aspect is to have clear escalation provisions dealing with exceptions in the pricing and valuation policy. Directors have to be aware of "open exceptions" where for example there may be unresolved pricing issues between the AIFM and the Fund Administrator. The Directors would discuss the pricing issues with the Valuation Committee and, if required and pursuant to the Valuation Policy, appoint another external provider to offer an independent valuation service."

This, says Cowdroy, makes it easier to deal with anything potentially contentious "at the time, as opposed to waiting for the next quarterly board meeting. It's got to be a timely review, as opposed to a retrospective review." 

Impact of regulatory change 

The increased regulatory burden on hedge funds and the AIFM is taking up additional review time at board meetings. Directors need to monitor regulatory calendars for the AIF and be aware of the Investment Manager's regulatory filing obligations.

There are mounting regulatory reporting requirements, many of which are highly detailed i.e. Annex IV reports, Form-PF, FATCA, CRS, etc, some of which are fund specific and some relating to the Investment Manager. 

The size of an AIFM's AUM will dictate the frequency of regulatory reporting. Under AIFMD, for example, AIFMs with assets of between EUR100million (leveraged) or EUR500million (unleveraged) and EUR1billion are required to file on a semi-annual basis whilst those with assets in excess of EUR1billion are required to file quarterly.

Directors therefore need to be fully appraised of any changes in an Investment Manager's AUM. 

"That can obviously affect the timing of filings, so we want to make sure the Investment Manager is compliant with those filing deadlines. We need to check whether there have been any regulatory enquiries, any visits to the Investment Manager's office, or any feedback from the regulators. We need to follow up to see if there is any deficiencies in the Investment Manager's compliance function. It's just about being aware of the many moving parts that affect the regulatory environment." 

"Typically Investment Managers will appoint outsourced compliance firms to come in to overview and audit their compliance and regulatory functions, providing an executive summary of details and action points. This helps us, as Directors, to understand the Investment Manager's compliance process in more detail, monitor any deficits with resulting action points, which improves our oversight function as Directors," explains Woodford. 

It is perhaps no surprise that regulatory matters are taking up more time in board meetings. "The reporting calendar, as mentioned, is rather extensive now," says Cowdroy. "Also, the regulators are much better resourced and staffed than they were 10 years ago. Investment Managers are preparing for SEC investigations and hiring third party firms to conduct mock examinations and audits in anticipation of when the SEC comes knocking on their door. 

The review of regulatory, compliance and tax matters now fills a meaningful amount of time at board meetings."

Integrity of reporting

The SEC is looking more closely at issues such as cybersecurity and fund expenses and irrespective of whether or not an Investment Manager is SEC-registered, these are hot topics right now in the industry. In addition, there is UK FATCA to contend with alongside US FATCA, and Common Reporting Standards are now in force in Cayman, as an early adopter jurisdiction.

All of which has added, and continues to add, a greater deal of complexity to Fund Administration reporting. As such, Directors have to be sure that administrators have the right software and reporting tools in place to cope with that complexity. 

The integrity of board reporting is an important aspect of the corporate governance process at board meetings. As Woodford says, not all Fund Administration reporting "is created equal". The length, detail, and breadth of reporting can vary considerably and this is an area where value can be added by the Director in requesting additional information to be incorporated into reports and ensuring frequent monitoring of those enhancements at board meetings.

"It's particularly useful to provide that value add to start-ups and emerging managers," states Cowdroy. "The Investment Manager may not have that type of operational experience or have been exposed to that function previously. That's when a Director can really bring some value to the table and say, `I would normally expect to see X or Y in the Fund Administration report.'" 

Depending on their depth of knowledge and experience, a Director might be well-placed to suggest ways to enhance an Investment Manager's reporting capability; be it for risk reporting, as well as administrator reporting. 

As Woodford concludes: "If you are proactive as a board member and do not necessarily accept as standard what is presented to you, you can improve the level of detail in reports that come from third party service providers. At the end of the day, reporting has to be accurate, consistent and comprehensive."

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