03 Sept 2013
Effective fund governance is becoming increasingly important. Following the financial crisis, regulators and investors focused on the conflict of interest between an asset management company’s desire to maximise its own profits, and its duty to maximise fund returns. This scrutiny has since led to a spate of law suits, enforcement actions and new governance codes, significantly increasing the risk for those that do not have strong governance structures and processes.
In the United States, both litigation and SEC enforcement actions have shone a spotlight on governance for Investment Company Act of 1940 funds. And in Europe, some pension funds now require a strong independent board before they will invest in a hedge fund. Illustrating the trend towards tighter governance, the Association of the Luxembourg Fund Industry updated its governance code in July, following the Irish Funds Industry Association’s new code published in late 2012.
Regulators, trade associations and investors alike are concentrating on ways to manage the asset manager’s inherent conflict of interest between profit and fund returns. At the heart of this drive to ensure fair treatment for the investor lies the independence and effectiveness of the fund board and committees. Once in place, these bodies need to look into a number of long-standing and emerging areas where governance dangers are particularly acute.
If funds don’t have strong governance in place across all of these areas, the damage to the asset manager can be substantial. Direct costs include investor compensation following litigation and regulator fines following enforcement action. Indirect costs include the impact of negative publicity on a brand and the loss of prospective and current investors. And once lost, investor confidence is very difficult to regain.
What’s clear is that the importance of sound fund governance is rising. Effective boards or committees acting independently of management are the starting point, followed by oversight of a range of specific areas. Our work with boards, and studies of their activities, shows they’re rising to the challenge, although some areas need improvement.
As fund governance enters a new era, so boards of directors must stay abreast of evolving best practices. They need to monitor emerging investment, operational and regulatory/compliance risks, as well as specific issues such as third-party services and distributors’ activities. Benchmarking studies of their peer group’s activities are one way to help evaluate leading practices.
Asset management’s inherent conflict of interest is here to stay. But if appropriate structures and processes are in place, the task of fund governance will become easier, and the dangers arising from these inherent conflicts can be effectively mitigated.
 ALFI Code of Conduct for Luxembourg Investment Funds, published July 2013; IFIA Corporate Governance Code for Collective Investment Schemes and Management Companies, published December 2012.