The Financial Conduct Authority announced a range of measures earlier this year with the aim of protecting investors and ensuring they receive value from their fund investments. One of these remedies requires the board of an Authorised Fund Manager (AFM) to be comprised of at least 25% independent non-executive directors, with a minimum of two of these NEDs, by September 2019.
No doubt the FCA expects the NEDs to challenge, question and probe the investment manager on all aspects of the fund(s) – from trading and fees to investment strategy and decision-making – to ensure the best outcomes for investors. But while the FCA’s objective appears sound, it raises a number of issues for the industry, the least of which is to not underestimate the skill, risk and effort required to be a NED, and do this role effectively.
To understand what the responsibilities of the NED are, we need to look at why this role exists.
An AFM is the legal entity that is responsible for all management aspects of the fund, making sure this is done properly and in the best interests of investors. The board of the AFM, as for any company, is ultimately responsible for ensuring the company carries out its duties. In the UK, it is not uncommon for investment managers to use an affiliated entity as the AFM, though employing an independent AFM to take on this responsibility is becoming increasingly popular. One distinction should be made between the UK and other jurisdictions such as Ireland and Luxembourg; there is no fund board per se in the UK, but a board overseeing the entire AFM obligations – which often entails multiple funds and fund structures. A NED in the UK is appointed to the board of the AFM, not the fund.
By being part of the AFM board, the FCA expects the NED to play an active role in ensuring the board’s actions, and those of the investment manager by extension, are done properly. The NED is expected to act as a remedy to the conflict of interests that exists between the AFM and the investment manager, and as such to challenge decisions on behalf of investors. That makes perfect sense. In essence, the FCA wants to improve the level of governance across the industry, and safeguard investors’ interests.
Take a moment to think about the type of experience and relevant knowledge required to be a NED of an AFM. Unlike directors on some listed funds and trusts, or in other fund jurisdictions, a NED will have to take a much wider view and deal with a host of responsibilities.
To be effective, they will need to understand general fund management processes and have an in-depth knowledge on the range of investment strategies and asset classes a company runs. They should be up to speed with current industry regulatory rules and directives, market trends and the drivers around market movements, as well as the fund company’s strategy and distribution objectives with regard to the fund(s) it manages. Experience is also a key aspect for a NED, who will need to be able to spot potential issues, along with the confidence to challenge, when required, other board members or senior staff.
The investment firms themselves need to carefully study the impact these new NEDs may have on their overall business. The presence of (a minimum) two NEDs means inserting a senior level of independence and controlling oversight on the company and its activities. How these NEDs assert their authority at the highest levels of management to achieve the best results, and what impact this will have on the investment management firm, will be difficult to foresee.
In a situation where the AFM is affiliated to the investment manager, the challenge to the NEDs, who are in fact appointed by the AFM, is potentially amplified. Under company law, a corporate director (NED or executive) is required to safeguard the interests of the company’s shareholders. Now overlaying what the FCA expects of the NED role, these NEDs will have to balance this corporate obligation with their perhaps somewhat opposing role of protecting investors’ interests, and trying to remaining impartial when making decisions.
To say the least, this role will require someone with considerable confidence and negotiation skills. If they fail to spot – or fail to raise – an issue that subsequently harms investors, they potentially can be held personally liable. For anyone considering taking on this role, the personal risk should not be underestimated.
For smaller firms who use their corporate entity as the authorised fund manager, putting NEDs on their main board poses an even greater challenge. This situation puts the NEDs in a position where they would be responsible for the overall strategy of the business, its development, its expansion – and would require them to take a much more active role in the firm.
While individuals who take on these roles need a specific skillset and experience to be impactful – in less than 12 months they will have to been identified, recruited, trained and in place to fulfil the FCA’s requirements. Each of the approximately 200 fund management firms operating in the UK will need at least two NEDs by September 2019 – and finding them will not be easy.
With all of these factors in mind, investment firms recruiting for this role will need to appropriately value a NED’s worth, as will the individuals themselves.
While to some the FCA initial remuneration estimate of £35,000-£50,000 a year may seem large, the reality is quite different when one considers the scope and responsibilities of this role. And with competition and confidentially so important in this age, will it be a benefit to have an experienced NED who sits on multiple boards, or a potential conflict of interest?
With all this in mind, can the industry identify 200-400 people who understand all aspects of the fund management industry with a sufficient level of detail to add value – within the looming deadline?
The regulator has made it clear that it does not consider this to be a box-ticking exercise, as the countdown continues to September 2019.
Maybe a NED is worth more than you thought.
Peter Hugh Smith CFA is Managing Director of Link Fund Solutions, part of Link Asset Services. He has substantial experience infund governance and the UK Investment industry.
Link Fund Solutions acts as the Authorised Fund Manager forauthorised collective investment schemes of all sizes and structures.It takes on the fiduciary responsibility for the investment funds, leaving the investment manager to concentrate on their investment process and strategy.
Peter Hugh-Smith - Managing Director, United Kingdom, Link Fund Solutions
+44 (0)20 7954 9605