In v e s t m e n t F u n d G o v e r n a n c e
fill the time gap Robert DeNormandie, Founder of The Directors’ Office, compares the evolution and practice of the investment fund industry governance in both the USA and in Luxembourg/Europe. The governance of investment funds in Luxembourg/Europe and in the USA may appear to be very similar. However, specific differences have played an important role in each environment, such as: - a single market throughout the USA; - significant individual investor retail base versus cross-border global distribution; - oversight by one regulator in the USA versus 27 national regulators within the European Community framework in Europe; - and 67 years of regulatory development in the USA as opposed to barely 20 years in Europe. Another factor to keep in mind when comparing the USA with Luxem bourg/Europe is the issue of a principle-based versus rule-based approach. We would suggest that this is a misleading debate as each environment relies upon both principles and detail-driven rules or guidance. In today’s investment product environment, where innovation, dynamic imagination and fast-paced development of new investment strategies and products are the norm, regulation and governance need to incorporate flexibility and be able to move quickly to adapt to the constantly changing marketplace. Principles offer each environment a way to fill the time gap between when an issue arises and when regulators can address the ramifications with specific interpretations and/or guidance. What does this mean as we compare governance of the investment fund industry in the USA and in Luxembourg/Europe?
Common recognition in the investment fund industry First, we would suggest that while each environment has a well-developed scheme of corporate governance, there has been a common recognition of the specificities of the investment fund industry resulting in a tailoring of principles, regulation and accepted practice to this industry’s particular requirements. In each case the initial approach has often been revised and adjusted over time to reflect the evolution of the marketplace. The current discussions on how to adopt international accounting standards to the specifics of investment funds is a current example in Europe. Second, for boards of directors of investment funds in each environment, we would suggest there are several essential principles that form the foundation of the activities of the board as a whole and the board members as individuals. These would include: board member quali fication and experience; availability to appropriately fulfill board member responsibilities; recognition of the benefit of independent, non-executive, board members; and recognition that responsibility for a well-organised and supervised control framework rests with the board; and finally that this control framework incorporates all aspects of fund operations, including delegations to service providers as well as an
understanding of strategic direction and the risk management processes in place to identify, assess, measure and manage the variety of risks impacting the investment product and portfolio environments. Following on from these principles, there are many specific elements that the board will typically take into account during its deliberations. While not an exhaustive listing, these would typically include: - recognition that protection of the end investors’ interests is the primary objective of the board; - an awareness of the various elements of the control framework and recognition that controls will be undertaken at many levels (promoter, distributor, depositary, fund administrator, external auditor, fund legal counsel, etc.); - an understanding of how such controls are coordinated, integrated and supervised, including periodic reporting to the board; - oversight and management of conflicts of interest that may impact an investment funds’ operations; - periodic receipt and review of complete, timely financial and operating information, including contractual renewals, trend analyses, exception reports, and breaches of fund policies/procedures; - receipt and review of various risk metrics dealing with the investment portfolio as well as operational matters; - and an indication of how the fund is carrying out its fiduciary responsibilities as a shareholder of companies. In both environments, the board will clearly rely upon the work of others to fulfill its responsibilities. In addition to the fund promoter’s oversight activities and management reporting to the board, the assistance of others overseeing the control framework such as the chief compliance officer in the USA or the conducting officers in Luxembourg will be very useful to the board. The interest of service providers, who report regularly to fund management and to the board, to offer error-free service is a key element for the board together with the periodic oversight of the external auditor. An annual programme of the board listing the various responsibilities and the frequency of review is often useful to assist to clearly define the scope of board activities as it focuses its attention on the various service providers and individuals assisting the board in one fashion or another. Such a programme also ensures an efficient coordination of various control activities that are brought to bear upon a particular area of operation or risk when under consideration at the board level. “One size does not fit all situations” is an understatement. Careful attention to a specific investment product’s strategic direction, portfolio trading complexity, operational challenges and the investor base to which it is being distributed will be required to ensure the development of an appropriate mix of oversight and reporting procedures at the board level relating to the objectives of the product as defined in its prospectus.
40 PAPERJAM – Special ALFI & NICSA Forum
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13.09.2007 15:05:41 Uhr