Relatively little of the huge amount that has been said and written on the AIFM Directive has focused on its implications for fund boards.
But the Directive, which is now in effect, is likely to have a significant impact on European corporate governance in general and on board selection in particular.
Risk governance issues have of course been gaining importance anyway, irrespective of the Directive. This is a subject that has become more prominent in the US, as well as Europe. But AIFMD includes stipulated responsibilities for the boards of Alternative Investment Funds (AIFs) on risk. Directors have a specific portfolio management supervisory responsibility under the Directive.
Of course they always did have responsibilities in this area but, if they were not ignored, then it would at least be fair to say that lip service was at best paid to them. In future that won’t be the possible. In the AIFMD era there will be many lawsuits against the directors of self-managed AIFs, if they collapse, and the directors are not able to demonstrate that they really were on top of what going on. This is a whole new world.
If something does go badly wrong they will have to explain to the fund’s investors, the regulator, etc. exactly what happened and what steps they took to solve the problem. Directors will be well advised to keep in very close touch with the fund’s investors and the regulator at the first hint of difficulty. If they don’t then they will almost certainly be in an awful lot of trouble.
What will not work in these circumstances is to say they relied upon information from the fund’s portfolio management team. If something has gone wrong directors will need to be able to demonstrate that they had independent reports on the fund’s risk exposure including counter-party risk and other operational issues as well as portfolio risk. They will be well advised to make sure that they have adequate independent reporting mechanisms in place from the outset, not just when the problems begin to occur.
Until the advent of AIFMD, boards tended to rely upon reports from parties connected to the fund such as those from the investment advisor and its administrator. In future that won’t be so easy. Boards of self-managed AIFs must demonstrate that they are exercising real independent judgement and this includes independent reporting mechanisms to confirm that the fund is in compliance with its risk parameters.
Another, related, issue that needs to be addressed is qualifications and suitability for board positions in the AIFMD era. Very many of those that serve on boards of offshore alternative funds have a service provider background. What is in very short supply in the jurisdictions where these funds are located are people with a commensurate level of knowledge of risk and portfolio management. Every board in the AIFMD era will need one of these – whether they are located in the jurisdiction where the fund is domiciled or, perhaps more likely, back onshore in the UK or US, for example. Either way it will change boards.
It is hoped that all this will give investors confidence to allocate more to alternative funds covered by the Directive in future. But there is a paradox. According to research conducted by The NED it is likely that institutions will pay less attention to board issues connected to the funds that they invest with if they are covered by this new measure. This is because the Directive covers the operational and risk issues too. For some institutional investors interest in board issues looks likely to wane. A large Swedish alternative institutional investor, responding to a survey conducted by The NED, said that as a result of AIFMD’s implementation alternative governance issues “won’t be such a big deal” in future. Institutional investors believe that the role and purpose of corporate governance is to protect their interests. But that is also the purpose of the Directive.
The concept of risk fund governance is in its infancy. But it is likely to growing up very quickly indeed. AIFMD requirements around risk management bring new, additional responsibilities to the boards of AIFs. The responsibility for risk management sits firmly with the board. That responsibility cannot be ducked. Risk management functions will be tested by boards’ ability to implement policy in an efficient and timely manner during periods of stress.
You might say that general risk management is what directors are doing in any case. It always has been, of course, part of their general oversight. But now boards will need to be able to demonstrate that they have the systems, independent reporting and expertise to really be on top of this. It is a whole new world.
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Simon Osborn is Chief Executive Officer of IFI Global Ltd. IFI Global Ltd is a fund management research and media business, focusing primarily on the alternative side of the asset management industry.
IFI Global Ltd publishes The NED, a monthly publication on fund governance. It is also the owner of FundDomiciles.com the only media entity dedicated to providing news and information fund domiciliation issues. Its research department conducts qualitative research studies in the asset management industry on behalf of fund managers, fund administrators, banks, law firms, technology companies and governmental agencies. IFI Global also hosts seminars for the fund industry in Asia, the Gulf, Europe and the US.
Simon Osborn is a regular speaker at international fund industry conferences. He was appointed General Secretary of the Fund Governance Association, a recently formed industry body dedicated to improving standards of alternative fund governance.
Prior to launching IFI Global Simon Osborn was an Associate Director of the International Herald Tribune (IHT), based in Paris, where he was responsible for the development of the IHT’s asset management coverage. Before joining the IHT he was with HZI International, a media consultancy that specialised in advising and investing in business, financial and medical publications in the developing world.
Simon Osborn is a graduate of the London School of Economics. He was awarded the Bassett prize for the top degree in the LSE’s Government Department.