Gibraltar Funds & Investments Association - Fund Governance Masterclass

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1 Gibraltar Funds & Investments Association - Fund Governance Masterclass Opening Dear GFIA Executive and members, Opening Speech: Samantha Barrass It s a real pleasure to be invited by GFIA to open this Masterclass on Fund Governance, and to appear alongside our distinguished visitors, Dr. Cullen and Kevin McConnell. The GFSC very much welcomes your focus today on the governance of funds. Funds are a crucial aspect of our financial services offering in Gibraltar, and governance itself is an area which often sparks debate and requires further explanation and clarification. For those of you who I haven t met before (a rapidly vanishing group as I approach my second anniversary at GFSC in February next year), in terms of my background, I began my career at the Reserve Bank of New Zealand as an economist focused on monetary policy strategy and economic reform, before moving to the Financial Services Authority in London, where I was employed in a variety of regulatory roles spanning the delivery of new regulatory approaches and policy at both a domestic and international level. Before taking up the position of CEO of the Gibraltar Financial Services Commission, I spent 5 years as Executive Director of the UK s Solicitors Regulation Authority, leading (amongst other things) their regulatory reform programme for England & Wales. Fund governance vs. corporate governance The Alternative Investment Management Association s ( AIMA ) Fund Directors Guide defines fund governance as: the practices and procedures by which a Board manages and controls a fund with the assistance of the fund s service providers. It goes on to stress that these practices and procedures are established and overseen by the Board in consultation with key stakeholders with the purpose of ensuring that funds: operate optimally and in the best interests of stakeholders. Although I am aware that fund governance is distinct from corporate governance - in relation to their respective legal structures, strategic roles and target markets there are considerable areas of commonality. The broad duties of directors of any entity include fiduciary duties of loyalty, honesty and good faith. They also include duties of due care, skill and diligence. Page 1 of 5

2 More widely, governance is something which the GFSC and other regulators across the world place significant emphasis upon when assessing the variety of firms and individuals that we regulate, and I view this as being increasingly important to our work. Turning to the focus of my speech today, regarding the best practices for fund governance, it s useful to consider the notion of best practice itself. Best practice often consists of a set of guidelines, incorporating an ethical dimension, that represent the most efficient or prudent course of action. These practices usually act as a reference point for individuals or businesses. For instance, for accountants, the Generally Accepted Accounting Principles, such as UK GAAP represent best practices for their profession and both AIMA s Fund Directors Guide and GFIA s own Code of Conduct for Directors carry out similar functions. In practical terms, best practices can help individuals and businesses regulate their conduct and also raise awareness of expected standards. From a regulatory perspective, it is very important to me that we work to maintain and enhance Gibraltar s position within the funds market. It seems to me that there is much to play for when it comes to building the funds sector here, and attracting and retaining reputable players. To do this, as I have said before, it s necessary for there to be a credible regulatory regime, delivering international standards, that protects and supports investors, licensees and the reputation of Gibraltar. It is therefore through that lens that we regulate the funds industry in Gibraltar and identify examples of best practice in the way they are governed. Consequently, it is important that our regulation is not only right touch and avoids the now heavy reputational costs of being seen as light touch, but that we also avoid heavy-handed, bureaucratic regulation. That it is how we can support the safe and sustained growth of financial services and the funds market in Gibraltar. Regarding specific examples of best practice within fund governance, again we see a commonality in our work, but this time between the expectations of regulators and those of investors particularly institutional investors. What investors tend to expect, often so do regulators. Additionally, as the AIMA Fund Directors Guide states: In most cases, the protection of the Fund equates to the protection of investors. The AIMA guide is particularly useful in terms of conveying international standards and expectations regarding fund governance. It emphasises the basic standards for directors to act with reasonable judgement, skill, care and diligence at all times. The following examples of best practice can be usefully organised around five key areas capacity, capability, risk management, communication/documentation and ethics, which I will deal with in turn: 1 Capacity: in relation to capacity, regulators and investors would expect those who are involved in the governance of funds to devote sufficient time and resources to their relevant duties. A perennial issue is whether those with extensive directorship portfolios and other general obligations have sufficient time and resources to be able to focus on each fund - not just for business as usual, but also when something goes wrong. We have seen various examples of directors of funds who have not been able to fully understand and track the performance of the funds they are directors of, not because of a lack of knowledge or experience, but simply because they have not devoted sufficient time and attention to them. Conversely we have seen directors of funds who are able to manage their time very efficiently to maintain appropriate and up-to-date knowledge of the funds they are directors of. Crucial in this respect are organisation, planning and leadership, and it is paramount that the Board of a fund has independent, committed and well-directed leadership. 2 Capability: regarding capability, I cannot emphasise the importance of having capable directors when it comes to fund governance. The GFSC has encountered various directors of funds who are experienced, knowledgeable and effective professionals, who understand their role, duties and obligations. They are aware that they need to have sufficient knowledge of the nature and performance of the funds to which they are directors (and are committed to maintaining this knowledge), and that the governance arrangements that they have put in place are suitable and are appropriately monitored. This capability is Page 2 of 5

3 what investors and regulators expect as a minimum standard. When funds are not governed by sufficiently capable individuals, we see the significant consequences that can occur in terms of investor losses and also reputational damage to Gibraltar and the funds industry, as occurred with the Advolorem case. 3 Risk management: moving to risk management, in my experience, a firm with a robust risk management culture that is all pervasive, is unlikely to pose a risk to its shareholders, investors or systemically. A sound culture supports effective risk management, promotes considered risk taking and ensures that emerging risks or risk-taking activities beyond the agreed risk appetite that has been communicated to investors, are recognised, assessed and dealt with in a timely manner. The Board of directors and the senior managers either in the fund or service providers are particularly important to the delivery of a sound risk culture. It is critical that they are able to demonstrate adherence to sound risk management and integrity and competence in risk governance. This also includes dealing effectively with conflicts of interest, managing service providers (such as administrators/lawyers/promoters) and where necessary employing competent external auditors. 4 Communication/Documentation: in terms of best practice for how a fund communicates and documents its work, this is a broad area, covering communications with investors, other employees, regulators, shareholders and other stakeholders in various formats with differing purposes. What is crucial, however, is that all communications should be clear and appropriately targeted. Equally, all key decisions, processes and meetings should be adequately documented. The GFSC sees examples of key decisions failing to be communicated to all relevant stakeholders, and instances where decisions are made without any documented record. Communication is essential to avoid misunderstandings, and for audit purposes alone effective records management is a basic requirement. 5 Ethics: underpinning all of the basic standards to which ourselves and investors would expect in terms of how funds are governed, is the issue of ethics. Ethics relates to standards of good and poor conduct, but essentially it is about doing the right thing. A positive culture within a fund that places a strong emphasis on going beyond minimum legal requirements and industry standards is to be applauded. From a regulator s perspective we would look for a fund that displays strong leadership, is well-organised and directed towards promoting good outcomes for investors, as an example of best practice. We would expect sufficiently knowledgeable and committed directors who are planning, managing and adapting to their individual risk environments, and who have sufficient processes in place to document and communicate relevant information. In contrast to many other jurisdictions, Gibraltar has a greater proportion of funds activity that falls under the radar of the full requirements of various EU Directives, such as AIFMD. This is both a blessing and a curse. It's a blessing when it is used by reputable people to provide flexibility to innovate and manage costs. It's a potential curse if the greater freedoms allowed are abused. As a regulator, you would expect me to say how important it is that we all understand the benefits and importance of using the freedoms available responsibly from the perspective of two of the GFSC regulatory objectives - consumer protection and the protection of the reputation of Gibraltar's financial services sector - and I m saying that today, as I did in my speech to GFIA in May But I also really believe that this isn t just about regulatory objectives - it s also about building the funds sector in Gibraltar, so that it can fulfil its potential and be supported by the broader building blocks of a jurisdictional reputation for both strong governance, and an environment that is conducive to innovation and flexibility. As we are finding in our authorisation activity, reputable players look for reputation as well as speed to market, when choosing jurisdictions. EIF Regime On the topics of freedom and responsibility and the reputation of Gibraltar, I'd like to draw particular attention to the Experienced Investor Funds regime in Gibraltar, and in part to the reaction to our recent thematic work focusing upon the directors of EIFs. Page 3 of 5

4 The EIF regime is a very popular element to Gibraltar's marketing of its financial services, due to the opportunity it offers to be swift to market without prior approval by the GFSC. I see the EIF market in Gibraltar as one with a lot of potential to grow and develop, providing real choice to investors in a world where regulation has become so prevalent. Whilst some regulators view the post-registration of EIFs as problematic and dangerous, I believe that we can have a fund regime for experienced investors that can continue to use this unique calling card to attract investors to Gibraltar. Many regulators don t believe this kind of regime can work, but I believe that they are wrong. I base this belief particularly on my experience of regulating outside of the financial services sector, where I am used to placing reliance on the quality of individuals to protect and uphold the integrity of regimes, allowing a significant amount of freedom then on product and market development. Looking at our supervisory work in this area, it is clear that we are having to do quite a lot of work to manage the risks arising from some EIF directors not properly taking account of the inexperience in practice of investors, insufficiently managing the risks I described earlier, and not ensuring they possess sufficient knowledge for the funds to which they are directors - particularly with respect to investments in more esoteric and illiquid markets. To elaborate further - and this is a pretty crucial point - the majority of our current enforcement cases relate to funds comprising 13 of our 17 current enforcement investigations - and it is therefore clear that together we need to raise standards. These relative figures have been more or less a constant and, as I said in a speech 18 months ago to the GFIA annual conference, we cannot continue in this way. This is bad for the regime, bad for investors, bad for the reputation of Gibraltar and importantly dismal for those directors who do an excellent job. And I would like to stress to those directors today, worried about being tarred by the reputation of the poorer directors, that I view these problems we have encountered as shared problems: shared by the GFSC, with GFIA and the EIF directors themselves. Shared in the sense that the reputation of the EIF regime and EIF directors depends upon getting a turn-around in the proportion of problem cases, working with us and GFIA to maintain appropriate standards, in terms of skills, knowledge and commitment. On this point, and in order to assist with managing these types of risks, I would like to reiterate our support for the GFIA Code of Conduct for Directors, which sets out some very helpful material for licensees seeking to understand how to meet standards of good conduct. Together we can lift the standards to where we and investors would expect. Regarding the reaction to our EIF director thematic work, I must say I was surprised by the furore that the publications created. I was surprised because the standards to which we refer are, in the main, basic fiduciary obligations, similar to those found in the AIMA Fund Director s Guide and the GFIA code. Additionally, we have issued similar materials as far back as 2009 and more recently via our 2013 and 2014 Dear CEO letters regarding EIFs, and historically via the EIF section of our website. We have trailed these publications informally within the industry and consulted with both the GFIA executive and the minister before publication. So the reaction has been a surprise. I also made it clear in my speech at the GFIA Annual Conference in May 2014, that there were too many EIF related problems, and that we needed improvements. I want to be really clear on this issue - an awareness of the responsibility on all (not just some) EIF directors to take their approach to the governance of their funds particularly seriously is crucial, and particularly where they are involving investors who despite their 'experienced' status, in practice, are heavily reliant on strong governance of the fund to ensure their interests are protected by directors who take their duties of fiduciary and due care skill and diligence, seriously. This includes acting effectively in the place of the GFSC, to make sure that ill-founded funds do not get up and going in the first place. Because in their hands is the reputation of the regime and the reputation of the financial services regime in Gibraltar - including the ability to offer safe swiftness to market. I m grateful for the letter GFIA delivered to the GFSC this week regarding our EIF director publications. We are always keen to hear from GFIA and look forward to working through the various issues with them. Page 4 of 5

5 Having made it clear before that the problem is long standing and goes beyond the Advalorem case perhaps it may be useful to pick up a couple of the points raised in the letter. Regarding the expectation that EIF directors should carry out sufficient due diligence of their funds. The question of what is sufficient will of course vary depending on the nature and size of the fund. This is a responsibility that can only sensibly rest with the individual EIF director, rather than be directed by the GFSC - it is not the GFSC s role to hand-hold directors: directors who are able to bring funds to market without prior regulatory approval, should be sufficiently capable to make these kinds of decisions themselves. I also want to be clear that, as with any governance regime, we are not bringing an expectation that directors will carry out every task relating to their funds personally, but rather to have oversight and take responsibility for them. For example, expectation 17 in our Policy Statement states that EIF directors must understand and oversee the NAV calculation. This does not equate to the EIF director s having to do the NAV calculation themselves (it can be calculated by the fund administrator for instance), but that they simply understand and take responsibility for it. These duties to understand and take responsibility for also apply to expectation 3 regarding service providers and expectation 18 with respect to responding to the market. To be frank, I m slightly taken aback that we need to spell this out because this is familiar territory in the way governance structures work, but if we need to, we will provide further clarification, however this underlines further the need and usefulness of us doing this thematic review. It s important to emphasise again that I do not want to move away from the post-registration regime, I do not think that should be necessary - indeed it would be a shame and an admission of defeat to go down that path when it has so much potential. However, in order to minimise the risks, we need to work together to resolve the current problems, because I believe the regime can succeed and become a strong and credible offering for Gibraltar. Upcoming GFSC work I also wanted to take the opportunity today to remind GFIA members that in January 2016, we will be holding a number of workshops for all EIF directors, involving case-study based exercises and a Q&A panel. These workshops will be followed by interviews for all EIF directors to assess competence and discuss any concerns. The details regarding these workshops will be ed to EIF directors today. Closing I m happy to take any questions you may have or if you would prefer to follow-up with either myself or the various GFSC teams following this event, don t hesitate to contact us. We are keen to hear from you all and engage in an open and constructive way with all of the sectors we regulate. Thank you. END Page 5 of 5