Castle Hall Alternatives and Orchard Harbour have published a new white paper, "Redefining corporate governance: towards a new framework for hedge fund directors".
"Corporate governance has become one of the most discussed issues in operational due diligence,” says Chris Addy, Castle Hall’s CEO. "Investors – especially institutions – are increasingly dissatisfied with the traditional governance model. These changing expectations create a clear opportunity to respond to investors’ concerns and implement a new framework of best practices".
The paper introduces six criteria – the "6 C’s of Governance" – which act as a roadmap for managers, investors and directors working to enhance the quality of hedge fund governance:
Competence: Hedge fund directors should have appropriate professional qualifications and experience, be free of conflicts of interest and be able to offer a sufficient time commitment to each board.
Capacity: Each director should restrict themselves to a plausible number of board positions, although the maximum number of appointments will vary dependent on the role of the director. To add meaningful value, an investment professional will likely work with only a small number of funds. A corporate administration director, supported by administrative staff, may be able to maintain a somewhat larger portfolio. In all cases, the number of directorships held by each individual must be transparent to investors.
Composition: An optimal board should be multidisciplinary, bringing together, at a minimum, a representative from the manager, a corporate administration provider, an investment professional and a business management professional. This structure can hold the manager to account from both an investment and operational risk viewpoint.
Choice: Both the appointment and termination of directors is typically controlled by the hedge fund manager. Looking forward, investors will require greater input in the selection and ongoing appointment of board members.
Compensation: Current governance discussions have focused on capacity and the limitations of the "quantity over quality" directorship model. If boards are to attract more experienced directors, each with fewer appointments, then compensation levels will increase.
Control: A more experienced board will still be ineffective if it does not increase its level of involvement and assume more control over the activities of the hedge fund. We expect boards to become more active and assertive, impacting both managers and service providers.
Alex Wise, Managing Director of Orchard Harbour, says: “Actions undertaken by boards during the financial crisis, and more recently the Weavering case, have dramatically increased investor awareness of the importance of good corporate governance within hedge fund structures. Improved governance standards will only make the industry more attractive to institutional investors, and initiatives to increase investor confidence should be broadly welcomed."