Irish fund management companies: Time to get serious about substance and oversight
This is the second in a series of four articles from the DMS Client Solutions Team, bringing you a unique perspective on the challenges and opportunities presented by the shifting European regulatory landscape. In last week’s article Daniel Forbes explored Why Cross-Border Fund Domiciles are Transforming into Fund Management Hubs. This week Pádraic Durkan continues this theme by looking at the evolving landscape in Ireland for fund management…
Over the last 30 years Ireland has evolved into a cornerstone of the Global Funds industry.
The first significant milestone in the development of Ireland’s funds industry was the launch of the International Financial Services Centre (IFSC) in 1987. The objective was to boost Ireland’s economy by attracting international financial institutions to the island with a promise of favourable tax rates and a supporting infrastructure.
This strategy recognized the increasing push towards cross-border harmonization for Financial Services within the EU and dovetailed with the first attempt at creation of pan-European market for management and distribution of Investment Funds thorough the first UCITS Directive which was adopted on Dec. 20, 1985.
The consistent commitment by Irish Government, Regulator, and Industry over the intervening decades to establishing Ireland as a best-in-class Financial Services hub has led to an Industry that contains over 7000 domiciled Funds and EUR3Tn in AUM, not to mention EUR5.2Tn in Assets Under Administration.
It is this commitment to the sustainable growth of the industry that requires the stakeholders to continually critically review the model to ensure it exceeds international best practice and maintains Ireland’s position as a Gold Standard jurisdiction.
While much of the economy remains under a cloud because of Covid-19, the Irish fund industry is thriving. Much of the influx is related to Brexit and specifically the need to be able to sell products and services within the EU after the UK’s exit.
According to Irish Funds, some 56 financial firms either entered the Irish market or expanded their presence in Ireland in the first half of 2020. In this context, groups such as Neuberger Berman, Eaton Vance, Morgan Stanley & Legg Mason all have one obvious point in common – they each had large fund ranges in Ireland before they began building up their Management presence.
The Irish Fund industry that was once the preserve of Lawyers, Auditors, Tax Advisors, Administrators, & Depositaries to service the Funds, is now being increasingly populated by Investment Management companies to provide local management to the Funds.
Evolution of the Irish Industry – From SMIC to ManCo
Prior to 2014 it was common to structure an Irish domiciled Fund as a Self-Managed Investment Company (“SMIC”). A SMIC is an authorised fund which has not appointed a Management Company but complies with management obligations in relation to capital requirements and organizational structure.
This structure was heavily favored by US & UK Investment Managers who were looking to leverage off Ireland as a Fund domicile without having to open a separate Irish Management Company. The time commitments related to the managerial functions were not significant and so, typically, the independent non-executive directors undertook those managerial functions, lending substance to the SMIC.
The evolution away from the SMIC gained traction with the introduction of AIFMD in July 2013. Unlike the UCITS regime, which is largely a “product” directive, AIFMD focuses on the regulation and ongoing supervision of the “Manager” (“AIFM”).
Although AIFMD permits both an internally managed Alternative Investment Fund (AIF) structure, as well as the appointment of an external AIFM, the rules around governance, supervision and the extent to which an AIFM can delegate duties are far more prescriptive than the UCITS regime and made the concept of an internally managed AIF far more challenging.
This increased focus on Management Functions prompted the Irish Regulator (“CBI”) to consider the effectiveness of the delegation structures by Irish Management Companies which, in turn, led to the introduction of “Consultation Paper 86” in 2014 with the stated aim of enhancing the effectiveness of fund management companies their boards and investment fund boards in the name of investor protection. CP86 focused primarily on Management Companies, including SMICs which are regulated as Management Companies.
When CP86 was issued by the CBI, DMS reviewed the various solutions for day-to-day management of SMICs and considered how they could be best delivered by appointment of individuals. In our CP86 submission in 2015 we set out our reservations as follows:
- We anticipated that most Funds would seek to have two individuals fulfill all six Designated Person roles. We recognized that in order to retain expertise in all management functions this would require a very diverse range of skills, therefore two “generalists” would be insufficient;
- We believed a third party or substantive in-house Management Company was therefore the best possible solution.
As it turned out in 2018 following the implementation of the CBI CP86 Guidance, our assessment was correct. CP86 introduced new rules in the form of a new organisational effectiveness role to be discharged by an independent board member, a new “location role” applicable to board members and designated persons and the streamlining of managerial functions to be discharged by Designated Persons. It also provided guidance on delegate oversight, organisational effectiveness and directors’ time commitments.
CP86 “Solutions” vs CBI Expectations
In practice, a further significant factor emerged in the roll out of solutions from the market to Funds utilizing Designated Persons to comply with CP86 Guidance. Competition by firms offering Designated Persons services saw prices for this service set at a considerably lower level than the market initially expected. Service providers therefore sought to make the offering profitable by limiting the day count of the commitment. This coincided with a marked increase in expected day count commitment from the CBI.
In 2018, after careful consideration, DMS decided to withdraw our Designated Persons service from the market and advised the SMICs for which we acted that we were resigning from the designated positions held. We did not consider it fair to put our individual staff members in a position where they were taking personal exposure in an effort to meet ballooning regulatory expectations to maintain an obsolete structure. We facilitated such clients with the more viable long-term solution of restructuring away from the SMIC and engaging DMS as Management Company to the Fund.
At the time we made it clear that DMS welcomed the approach being taken by the CBI, which viewed as a positive step for the industry, and we still strongly maintain that view.
What has happened since?
CP86 was only the beginning.
To signal this continued focus on substantive Governance and Oversight in the Irish Fund industry, Deputy Governor Ed Sibley at the Irish Funds Global Conference in May 2019, on the subject of Governance said the following:
The reputation of the Irish funds industry is built on the foundations of strong governance. And that is why I am concerned that we are still seeing inadequacies in board oversight and wider governance issues across too many firms.
In 2019, we will be undertaking a thematic review to assess how firms have implemented the package of Fund Management Company Effectiveness measures introduced on foot of CP86. The broad aim of this work will be to identify standards of industry compliance, to inform our supervisory approach and to ensure that management companies have systems of governance in place to protect investors’ best interests. We will use our full suite of tools to address any failings we identify.
The CBI was making very clear that it was time to get serious about Governance and Oversight. A further CP86 thematic review was commenced in September 2019 in order to assess the typical level of substance and time commitments within existing SMICs and ManCos. This included Questionnaires and desk top reviews of SMICs and ManCos.
Dear CEO Letter 2020
Following on from this period of Thematic Review, on 20 October 2020, the CBI issued a "Dear CEO" Letter to industry outlining the findings of its review of the implementation by Irish fund management companies of the Central Bank’s CP86 framework for effective governance, management and organisation.
While further clarity is going to be required from the Central Bank in a number of areas, it contains significant developments which will require prompt action.
The Letter addresses many of the same topics as were raised in ESMA’s 18 August 2020 letter to the European Commission on its review of the Alternative Investment Fund Managers Directive (the “ESMA Letter”) in relation to substance and delegation of managerial functions and ESMA’s July 2017 Opinion to support supervisory convergence in the area of investment management in the context of the United Kingdom withdrawing from the European Union (the “ESMA Brexit Opinion”).
These findings have brought the Irish funds industry to a point of inflection. It signals the end for SMICs & light touch Management Companies with insufficient resourcing from a governance and risk expertise perspective.
As set out in the CBI’s findings, all but the smallest of ManCos are expected to have a CEO responsible for the day to day running of the business. The letter also notes that three full time employees is the minimum potentially acceptable number of employees for authorisation. However, based on our interactions with clients the number being communicated is a multiple of this figure. Correctly, there is a correlation between number of funds, complexity of strategy and level of AUM to number of required full time employees.
The expectation of a CEO for these entities clearly sets out the path forward for ManCos in Ireland. These entities will not be simply there to tick a box but need to be substantial independent operations with responsibility for oversight.
A core function of the ManCo is supervision of delegates, the CBI noting a failure of many ManCos to conduct initial and ongoing due diligence. ManCos failing to conduct appropriate delegate oversight will need to prioritise this as an immediate concern.
Notably the CBI focus on the Director for Organisational Effectiveness sets a clear onus on ManCos to continually evaluate their own resourcing from quality and quantity perspective, which is of interest when launching products for new strategies and asset classes. Many of the larger Investment Managers in the market have evolved into multi-strategy groups, and the CBI will be ensuring the skill set / technology within the ManCo is sufficiently broad to account for proper oversight of each strategy.
DMS is in the fortunate position of having over 120 Irish based employees to support our fund clients, with a very well established and scalable process for all prescribed functions. In concluding whether SMICs or under-resourced ManCos should be allowed to exist, the Regulatory & Industry view is clear – they should not be allowed to exist in their current form.