Alternative Investment Management Association Representing alternative asset managers globally
Conflicts of interest continue to rise up the regulatory agenda on both sides of the Atlantic. In the UK, the ‘Dear CEO’ letter published by the then Financial Services Authority in November 2012 drew specific attention to the sometimes inferior management of conflicts of interest at UK-regulated fund management firms. Indeed, the Financial Conduct Authority clearly stated at its Asset Management Conference in London that conflicts would remain on the agenda for scrutiny in 2014.
In the US, the SEC has also made it clear that it, too, recognises that conflicts of interest have become an issue. The asset management industry including hedge fund firms have been responding to these demands.
In the first half of this year, Carne carried out a survey of major investors, including pension funds, pension consultants, sovereign wealth funds and insurance companies in Europe, North American and Asia Pacific, representing over $9.5 trillion in assets under management, including alternative investments. We wanted to gauge their awareness of conflicts of interest at both the investment manager and fund level, how they saw fund boards playing a role in the management of conflicts, and gain some indication of how they felt a solution might be found.
Of the investors interviewed for the study, 90% said they would like fund boards to consider and address conflicts as a matter of routine. They indicated that a majority of independent fund directors on the board and fully independent service providers were the best means of managing conflicts at the fund level [see Figure 1]. Indeed, 83% of those interviewed said they would like to see fund boards with a majority of independent directors, and 62% would like to see boards with an independent chairman.
Investors were asked to define which areas constituted a potential conflict of interest [see Fig 2]. Group-level conflicts emerged as the most likely source of conflicts: at particular risk are funds managed by larger financial organisations like banks, where directors and service providers are often appointed from within the same financial group. Incentive systems and remuneration, principal trades and personal account dealing were also considered open to potential abuse.
How to go about managing conflicts at the fund level in the future? The vast majority of investors (95%) approved of a code of fund governance for the asset management industry to adhere to. They were largely against further regulatory intervention, and many of those we spoke to recognised that fund managers were already having to cope with a large regulatory burden. The contents of such a code are covered in Figure 3. One of the biggest concerns remains the lack of independent fund directors on fund boards, and it was suggested by some respondents that there be a formal definition of independence as part of this code to enable effective judgement of whether or not a particular director is sufficiently independent.
Figure 4 illustrates some of the difficulty being faced by investors when assessing whether directors are independent. While the universe was in agreement that employees of the investment manager or its parent group were not sufficiently independent, there still remains some disagreement over directors appointed from the fund administrator. Of enormous importance to investors remains the issue of board transparency – i.e. being able to assess the relationship between the investment manager and independent directors.
When asked to rate the level of governance on a scale of 1 to 10, with 1 being most inferior, a regional breakdown by origin of investment manager shows Asia still trailing substantially. Big strides have been made in fund governance since Carne’s first study on this topic in 2011, but overall satisfaction ratings for both onshore and offshore funds, at 5 to 6, still remain well below the 8 to 9 level funds should aspire to [see Fig 5]. It was interesting to note that US allocators rated US-based managers as having higher levels of governance than non-US investors allocating to US managers.
Investors are obviously looking at fund boards as a key platform for protecting their interests as stakeholders. They would like to see established guidelines regarding the management of conflicts of interest and a clear set of factors to help them to identify whether a fund director should be treated as independent. Another solution is to maintain a written conflicts policy at the fund level as well as the investment manager level.
The FCA has recognised already that UK investment managers are responding to its ‘Dear CEO’ letter, but conflicts policies should also now be extended to the funds themselves. In this, properly constituted boards, with a majority of independent directors, can play an important role.
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