Global code of fund governance urged amid regulatory clampdown on conflicts of interest

28 Oct, 2013

Ninety-five per-cent of institutional investors would like to see the introduction of a global code of fund governance as regulators including the UK’s Financial Conduct Authority (FCA) and Securities and Exchange Commission (SEC) continue to take a growing interest in issues surrounding conflicts of interest at asset managers, according to a Carne Group study.

These investors, which include pension funds, sovereign wealth funds, insurers, wealth advisers and consultants, collectively managing $9.5 trillion in assets, told the Carne Group survey they would like a standardised governance template, adding any industry code be flexible and applied at a high level. Investors said the code should formalise the powers and responsibilities of the board and have systems in place to mitigate conflicts of interest. 

“I am confident that investors, managers and directors which are interested in improving corporate governance standards will get involved in creating the basic principles for a code of conduct. The most important function of any code is that it serves the interests of investors,” said John Donohoe, chief executive officer at Carne Group.

The emphasis on managing conflicts of interest effectively at the board level comes following the FCA’s “Dear CEO” letter which was sent to the heads of major asset management firms in London asking them how they managed conflicts of interest. The SEC is also becoming increasingly attentive towards conflicts of interest albeit not as intensely as their counterparts in the UK. Predictably, the regulatory furore has prompted investors to take note with 90% of Carne Group’s respondents stating they wanted fund boards to address conflicts of interest as a matter of routine.

“Actions and statements by regulators regarding conflicts of interest in the fund management industry on both sides of the Atlantic have demonstrated that this is an issue that needs to move up the agenda of investment managers. Investment managers should not ignore investors' and regulators' concerns. The “Dear CEO” letter warned CEOs they would be held accountable if regulators went into their businesses and discovered shortcomings, and I suspect regulators are looking for a big scalp. However, managing conflicts of interest is at the heart of governance, which is why independence is crucial,” commented Donohoe.

Any industry led initiative on governance would reduce the risk of regulatory intervention. Regulatory interference on governance issues is something investors, managers and directors generally view as counterintuitive. There are fears regulators, buoyed by the inertia of managers actually doing something about their governance shortcomings, particularly around the number of boards their directors sit on, could impose hard and fast caps limiting the number of boards a director can occupy.

This would have unexpected consequences since no rule can take full account of the complexity and diversity of the hedge fund industry. Sitting on the board of a straightforward European or American focused long/short equity fund probably requires fewer man hours than sitting on the board of a complex, esoteric hedge fund running a large number of bespoke swap transactions.

“While investors obviously do not want directors having too many board relationships, costs remain a factor. Investors certainly do not want regulators going to fund managers telling them how they should run their funds and the type of governance procedures they should adhere to because that could lead to an even bigger burden. I am sure the industry can come up with standards on its own without regulatory interference,” said Donohoe.

Some regulators, however, are taking proactive steps, particularly the Cayman Islands Monetary Authority (CIMA). CIMA is currently in the process of revamping its corporate governance standards in a move that has been welcomed by institutional investors. CIMA is proposing an accessible database listing directors and the fund boards they sit on in what should make operational due diligence on these service providers far more straightforward.

However, the reforms have been delayed following a judicial review against CIMA by DMS, a Cayman Islands-based professional services firm. The judicial review has angered investors, which accuse DMS of delaying implementation of the proposals.  “There appears to be a tug of war going on with CIMA’s governance reforms,” acknowledged Donohoe.

Investor awareness of corporate governance has risen since the financial crisis with 71% of respondents telling Carne Group it had become a more important issue over the last four years. Eighty-three per-cent of investors said they would like fund boards to be comprised of a majority of independent directors and 62% stated it was essential to have an independent chairman to mitigate the risk of conflicts of interest and misdemeanours at the fund level.

In terms of corporate governance shortcomings, lack of independence and experience were cited as investors’ biggest concerns in the Carne Group study, with a number of respondents wanting directors to have greater expertise in risk management as opposed to a legal background. “Regulators and operational due diligence teams are putting an enormous emphasis on risk management. Therefore it is obvious there will be a renewed focus on employing directors who can approach their oversight duties from a risk management perspective,” said Donohoe. 

Progress still needs to be made. Just 11% of investors surveyed by CIMA said corporate governance was fit for purpose and no single investor rated hedge fund governance standards as being outstanding. Seventy-one per-cent said major improvements were required.  Ignoring these problems is not an option for managers. A Deutsche Bank study of operational due diligence executives at institutional investors with $2.13 trillion in assets highlighted a quarter had vetoed an investment because of governance concerns while 34% acknowledged they would devote more resources to this area over the course of 2013.




corporate governanceCarne GroupFCAconflicts of interestDear CEOSECDMSCIMADeutsche Bank