In this article a fund administration veteran who also used to audit insurance funds looks at the consequences of financial regulators’ increasing insistence on good corporate governance at fund management firms.

The job of director at a fund firm is becoming a more and more demanding one as the burden of compliance increases. At the same time, more and more groups of HNW investors are making judgments about the decisions of the boards of fund administration firms and the standards of the governance that lies behind them. Financial regulators are also taking more interest in the types of people who sit on these boards, how they make decisions and how their companies record the process.

Some recent media stories indicate that there is some room for improvement when it comes to corporate governance at fund firms. Their boards today need to comply with a multitude of rules while still concentrating on ways to produce the best results for shareholders. When it comes to governance, the buck really does stop with the board.

Points for regulators to consider

What ought regulators to consider when determining whether board members are obeying the rules and governing their banks effectively? The starting point is the composition of the board itself. A key area that the board should consider is whether its non-executive members have enough of the right skills to understand and, if necessary, challenge the executives' decisions. It is the chairman's remit to provide non-executive directors (NEDs) with the right information to do this.

'Independence' from the CEO, from the company and from the rest of board, is also particularly important for the right calibre of NED. It is no longer acceptable for NEDs to be friends of their CEOs. For certain types of (listed) fund, regulators expect the majority of members of boards of such a listed fund ought to be independent in this way.

It is also important to note that a firm should not see to it that its NEDs are independent as a mere one-off measure. Every fund firm ought to monitor such independence by using a "conflict register." This is a register on which the directors can declare conflicts. In many jurisdictions (including both Guernsey and the UK) they have a fiduciary duty to avoid conflicts. Such declarations depend absolutely on the honesty of the directors, who should make their disclosures at the earliest possible board meetings.

'Diversity' is another modern watchword and regulators expect boards to guarantee this in their composition. At present, their efforts seem to concentrate on gender, i.e. the desirability of striking a good balance between males and females on boards. The term has now, however, extended itself to call for wide varieties of skills, backgrounds, ethnic origins, experience, expertise, education (it would be a good idea if not all directors came from the same school) on listed boards or the boards of financial firms that adhere to the Financial Reporting Council's Code of Corporate Governance. (The FRC sets the UK’s corporate governance and stewardship codes and listed companies on the island of Guernsey are subject to its dictates also.)

A fund firm of this kind must be able to show the regulators (who are the only authorities who will want to look) that it is complying with this requirement. One way of presenting such evidence is for the company secretary or the nominations committee to draw up a 'skills matrix' of the board (a table that displays people's proficiency in specified skills and knowledge of specified things, along with their interest in using those skills while working on assignments). This can help the fund firm spot gaps and improve its recruitment process. Each board should also think about setting up a process for finding and nominating potential new directors that is both appropriate and effective.

'Substance' has become the topic of the day in offshore circles. At its core, it obliges the board in question to show its regulators that it is effective in overseeing the business of the entity that it governs in the jurisdiction in which it is registered. The board ought to take good advice (from a law firm or a tax advisor) to find out whether it is obeying, or whether it can obey, the companies legislation. In terms of composition, the company secretary should ensure that the board can hold quorate meetings in the right jurisdiction, which may entail an evaluation of the number of resident/non-resident directors.

Bulging board packs

Directors also ought to ensure that they are receiving the right amounts of information from the fund administrators or other service providers. They are obliged to consider regulatory matters on a quarterly basis. When this happens it is easy for every board meeting to become a compliance exercise which sidelines commercial considerations. Among the new things that fund firms in Guernsey must consider are the island's 'substance' legislation and its new anti-money-laundering handbook (effective on 31 March this year). On this latter note, the handbook calls for a revision of all business risk assessments for money laundering. These usually happen annually but more and more firms are tabling them more and more frequently in response to pressure from Guernsey's financial regulators.

This process often leads to an unwieldy number of papers being tabled at these meetings. The company secretary is responsible for the preparation and dissemination of the 'board packs' that contain these papers and the chairman is responsible for taking the whole board through every point. The ever-growing size of these bulging board packs does not always lead to good governance.

Regulators expect firms to look constantly at whether the company secretary is submitting relevant and concise information. The board may also want to consider whether it wants to consider topics by rotation, i.e. by making every meeting thematic. The typical way in which it does this is for the company secretary and chairman to meet first and delineate the things that the board might look at on a rolling calendar that runs throughout the year so that it can explore every important subject in a proper session that lasts a long time. Of course, some things might not lend themselves to this process; the firm ought to look at regulatory compliance every quarter and it might have to look at management accounts every month because its financial statements are often monthly, although a typical fund management board in Guernsey does this quarterly.

Minute-taking ought also to be comprehensive in terms of discussion and deliberation. There are two schools of thought here, however, as the minutes of meetings are traditionally restricted to the actual decisions that the board takes. Financial regulators, however, favour (but do not yet insist on) the former approach. The board should not approach this exercise by replicating large tracts of text that already exists in other board papers.

Evaluations

The third area that boards should consider is their 'evaluation process.' The FRC code for listed companies dictates that each company should have an external evaluation every three years. In between years, internal evaluations are fine.

Many boards may be operating effectively, but all can improve their performance and ought to consider some form of internal or external evaluation. There are considerable advantages in doing so, particularly when an independent external firm carries out an evaluation. Such an assessment certainly has its benefits.

Firstly, it assesses the skills that members of the board have. This assessment extends to any committees of that board and ultimately is a gauge of how effective they are. Fund firms may change their strategies and their performance can fluctuate, so any assessment of the skills that board members have may be needed now. An evaluation often calls for a regular audit of skills.

Second, an evaluation can concentrate on ‘diversity,’ in the widest sense of the word, encompassing gender, ethnicity and background as well as skills. ‘Diverse’ boards are often thought to make more effective decisions but, whatever the situation, regulators and others are concentrating upon this area and firms ought therefore to keep it under review.

Third, an assessment provides the regulators with the opportunity to look at the dynamics around the boardroom table. Skills are important but dynamics are more so – if a bank has all the right skills in the boardroom but five people do not work well together, it is likely to have a dysfunctional board. An evaluation might reveal this and answer other questions into the bargain. Is the chairman a good facilitator who provokes discussion, or does he dominate every meeting? What contributions do other people on the board make? Do people listen to each other? It is fair to say that interviews organised by an external third party – along with its eventual appraisal – are often the most important components of any evaluation.

Fourth, the evaluation should consider the matters being discussed. 'Agenda management' may sound dull but it is vitally important to the effectiveness of a fund firm. Is the board discussing the right things, and is it setting the right priorities?

Finally, an evaluation is bound to look at the quality of the management information (defined as information that a firm collects during a period of business activity that it can use it to measure performance and spot risks) that comes before the board. Independent directors, in particular, depend heavily upon the quality of this and too many boards receive heaps of data and not enough meaningful information. Do the papers highlight the matters on which directors should concentrate, or do they just swamp the board with information?

Spotlight on effectiveness

The workloads of directors and the many groups that support them have increased considerably over the years. Regulatory scrutiny – but also scrutiny from investors and others – has also increased. It is therefore more important than ever for fund firms to ensure that their boards work effectively. Boards also need to think about how they monitor their effectiveness, through the use of self-assessment processes and through external assessments. Regulators are concentrating more and more on effectiveness, going beyond a mere look at whether this-or-that fund firm has the right procedures of governance. This trend is going to continue.

* Hubert Nicolle can be reached on +44 (0) 1481 747814