On 20th October 2020, the Central Bank of Ireland (CBI) published a letter to all UCITS management companies, authorised Alternative Investment Fund Managers (AIFMs), self-managed UCITS investment companies and internally managed Alternative Investment Funds which are authorised AIFMs. The letter sets out the CBI’s conclusions of its thematic inspection of compliance with its Fund Management Companies Guidance, which concluded the three-part CP86 consultation process.
The review found that when applied correctly by firms, the rules and guidance provide a framework of robust governance and oversight arrangements. However, it also found that a significant number of previously authorised FMCs had not fully implemented the framework.
Background
In December 2016, the CBI introduced final guidance on Consultation Paper 86 which is commonly known as CP86. The Guidance sets out that the board of the Fund Management Company should design its governance practices so as to be appropriate and commensurate to the business of the relevant company and, where applicable, the investment funds it manages.
The requirements came into full effect on 1 July 2018. From this date, the Central Bank supervisors began accessing how Fund Management Companies had implemented and embedded the new requirements and related guidance into their organisations.
The review which covered 358 active FMCs and spanned 18 months has now been completed.
Key Findings
Some of the key issues identified in the review related to:
Resourcing
CBI Concerns
A large number of FMCs authorised before the framework have not appropriately increased resources to ensure effective implementation of the framework.
The CBI review also found that where an FMC employs less resources, this is often symptomatic of an over-reliance on group entities and/or delegates, resulting in deficiencies in the legal entity specific second line of defence.
CBI Expectations
- All FMCs should have a minimum of three suitable qualified full time equivalents.
- The number of FTE should reflect the nature, scale and complexity of the firm and must ensure that sufficient resources are in place.
- FMCs must appoint locally based persons who conduct managerial functions (Designated Persons) with sufficient time dedicated to their roles in order to fulfil their duties, which include oversight of delegated activities.
- Resourcing levels should be kept under review.
Designated Persons
CBI Concerns
Significant shortcomings were also identified in relation to how some Designated Persons discharged their roles. Failings included inadequate:
- Reviews carried out on the monthly reports received from delegates
- Levels of independent analysis
- Quality of the information provided to the board
- Time committed by Designated Persons and support provided
CBI Expectations
As outlined in the Guidance, Designated Persons should have enough time available to them to carry out their roles thoroughly and to a high standard.
Designated Persons should also be able to clearly evidence the value they bring to that oversight through documented Board reporting.
Delegate Oversight
CBI Concerns
Many FMCs failed to fully implement the Guidance in the area of delegate oversight. Failings identified included:
- Insufficient evidence that appropriate level of due diligence on their delegates had been conducted
- A lack of appropriate review and approval of delegate/group policies and procedures
- A lack of effective engagement with delegated investment managers
- Issues identified not being resolved in a timely manner
- Delegate reports received not being of sufficient quality to allow for a meaningful review of the situation by the FMCs
- Some FMCs not have documenting Service Level Agreements (SLAs) for each of their third party arrangements
CBI Expectations
The Central Bank expects that:
- Ongoing due diligence reviews are conducted of delegates
- Where reliance is placed on delegates’ policies and procedures, the FMC should have a formalised process to review all delegates’ policies and procedures.
- All delegate arrangements should be governed by way of formally documented SLAs.
Risk Management Framework
CBI Concerns
Deficiencies were identified for a significant number of FMCs, with many firms not having:
- An entity-specific risk management framework,
- Entity-specific risk register, and/or
- No defined risk appetite in place.
In many cases, this was a result of overreliance on group frameworks.
CBI Expectations
The Guidance specifies that all FMCs are required to have a robust Board approved, entity specific risk management framework which should include, inter alia:
- Risk register and
- Risk appetite statement
The Board should be satisfied that the risk management framework is fit for purpose and reviewed regularly but no less than annually.
Board approval of new funds
CBI Concerns
Not all FMCs could evidence approval by the Board of the launch of sub-funds.
Board approval of the investment fund / strategy just prior to launch.
CBI Expectations
The Central Bank expects:
- Evidence of robust discussion and challenge by the Board in relation to proposed new fund strategies/structures and their attendant risks.
- The Board to be involved early in the process, for instance when first formulating the investment strategy of a new fund or prior to the submission of a fund application to the Central Bank.
Organisational Effectiveness Director (OED)
CBI Concerns
Issues identified concerning OEDs, included:
- No evidence that meetings had been conducted.
- No formal records were kept of meetings with Designated Person.
- No formal reporting to the Board, particularly in the area of resource evaluation.
CBI Expectations
A key responsibility attributed to the role of OED is monitoring the adequacy of the FMC’s internal resources.
The CBI expects there to be meaningful, regular interaction between the OED, the Designated Persons and the Board.
All of these interactions should be formally documented and available to the Central Bank upon request.
Interactions between the OED and the Designated Persons should be at least quarterly or as necessary.
The OED should report to the Board at least annually and this report should include detail on how conclusions with regard to resourcing were reached.
It is also expected that the OED ensures that a documented Board effectiveness evaluation is conducted on an annual basis. This review should include findings and time specific actions.
Gender Balance
CBI Concerns
The review found a significant gender imbalance on the Boards of FMCs, with only 16% of Director roles held by women.
CBI Expectations
Firms should consider gender diversity as part of the governance review.
CEO Appointment
CBI Concerns
The vast majority of FMCs have not appointed a CEO. It is especially unclear how larger firms can be considered to have appropriate demonstrable substance while lacking a senior executive with responsibility for the day to day running of the business.
CBI Expectations
The Central Bank expects that all but the smallest FMCs should have a CEO.
Next Steps
The conclusions when considered against the recently issued ESMA review on AIFMD and specifically the observations on delegation, coupled with the continuing risk of no deal Brexit of the UK, make this review very significant.
Regardless of whether an FMC receives a specific risk mitigation requirement or not, the Central Bank expects all FMCs to critically assess their day to day operational, resourcing and governance arrangements against all relevant rules and guidance.
The assessment and implementation plan should at a minimum consider the following:
- The time commitment, skills and expertise of available resources;
- The FMC’s retained and delegated tasks, including how ongoing independent challenge of all delegates can be ensured;
- The tasks required by the framework, including those that must be completed on a fund by fund basis;
- How resources and operational capacity will need to increase to take account of any increase in the nature, scale and complexity of the funds under management since authorisation or the last time the FMC critically assessed its operations;
- How resources and operational capacity will need to increase to deal with a market and/or operational crisis.
Analysis should be completed and an action plan discussed and approved by the Board by end Q1 2021.
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