The Board’s role in achieving compliance with CP86, Fund Management Companies Guidance - Michael Hodson, Director of Asset Management Supervision

Good morning ladies and gentlemen. I want to thank you for the invitation to speak at today’s event which has been kindly organised by Mazars.

My plan this morning is to address a number of important topics relevant to the Irish asset management industry including fund management company effectiveness in the context of European developments following the United Kingdom’s decision to leave the European Union and the Central Bank’s supervisory priorities for 2018. I will also address, more broadly, the role of directors from the Central Bank’s perspective.

Management Company Effectiveness

The Central Bank’s work to enhance fund management company effectiveness, under the banner of CP86, has been well documented. I do not propose to detail the requirements here today.  However, I would like to briefly recap on the background for these proposals and look forward to future considerations. The fund management company effectiveness work has been an extensive journey for industry and the Central Bank alike.

In 2014, the Central Bank consulted on a number of proposed initiatives to further underpin substantive control of fund management companies over their delegates. This work was informed by a report from the Committee on Collective Investment Governance.  This was a group of industry experts established by the Central Bank to advise it on how the boards of fund management companies should oversee the activities of their delegates.¹ The feedback from stakeholders was broadly positive and supportive of an approach whereby the Central Bank provided more guidance on its expectations of directors.

The Central Bank then prepared Delegate Oversight Guidance drawing extensively on that report and published that guidance for public consultation in June 2015. In order to address the questions raised about the new “organisational effectiveness” role, which was part of the 2014 consultation, the June 2015 publication included guidance for fund management companies on the objectives and key tasks to be undertaken by the role-holder, an independent board member.  

The third consultation followed in June 2016.  This time the focus was on guidance related to managerial functions and also on some new rules designed to ensure that the Central Bank could effectively supervise fund management companies. The managerial functions guidance dealt with issues concerning compliance, taking into account the substantial regulatory burden now placed on fund management companies under the UCITS and AIFMD regimes and indeed rules imposed under other legislation, both EU and domestic. New rules related to the location of directors and of fund management company records were designed to allow the Central Bank to carry out its engagement model without undue constraint.

Following the conclusion of this body of work, there are a number of obligations that fund management companies must be mindful of.  Namely, a deadline which has now passed, of 30 June 2017, to have a dedicated regulatory correspondence email address in place. A Fund Management Company may choose to maintain a single email address for the fund management company and all investment funds under management or as separate dedicated email addresses for the fund management company and for each investment fund under management.

Of course Irish authorised funds may have non-Irish fund managers and I draw your attention to  recently issued Q&As² which clarify the position in that instance.   The Central Bank’s expectation, in order to facilitate effective and efficient communication, is that a designated email address should be provided for each Irish UCITS or AIF.

Looking forward, there are also a number of key obligations to be mindful of, such as managerial functions, organisational effectiveness and retrievability of records. The deadlines applicable are dependent on when the relevant fund management company was established. Ultimately, fund management companies need to be mindful that all obligations introduced as a result of CP86 will be applicable to them from 1 July 2018.

I will return to this work on fund management company effectiveness a little later in the context of European developments in the context of Brexit and the Central Bank’s supervisory priorities for 2018.

The role of the board of directors

Let me now speak briefly on the important role that board of directors’ play, not just in the context of fund service providers but across the wider financial services sector.

I think we can all agree that there are many changes on the horizon that will impact the Irish financial services sector;  Brexit, the new Money Market Fund Regulation and MiFID II to name a few. As a result, boards of directors have a critical role to play in ensuring that entities are able to adapt and respond quickly to opportunities and challenges presented.

We aim, in the context of the Central Bank’s mandate, of protecting consumers and safeguarding stability, to authorise and supervise firms that provide suitable products, have durable business models and are well governed. As supervisors we engage with firms, seek to understand their business, mitigate risks that are considered above our tolerance levels and ultimately drive industry towards compliance with regulatory standards.

It is important to note that it is not our role to decide on the business strategy or operational arrangements of a firm. To that end, it is the board of directors that is on the front line when such decisions are being made. In my view, it is therefore paramount that those who serve on boards embrace the responsibility this brings and make every effort to fulfil their role. Boards are at the heart of overseeing a firm’s strategy and its implementation. To do this effectively, board members must understand the business, stay well informed and be able to provide robust and challenging discussions. The risk management oversight role that boards have is essential; boards should articulate a clear risk appetite and ensure that each risk the firm is exposed to is in line with this appetite.

Board diversity can also be a significant pillar to an effective board and governance structure. Recent research³ suggests a number of benefits from increased levels of diversity on the board of directors. These benefits include a reduction in the levels of groupthink and improved governance practices such as preparation for meetings and succession planning.

Furthermore, as highlighted by the Central Bank’s Deputy Governor, Ed Sibley in a keynote address⁴ last year, the culture within an institution “drives the values and beliefs which govern how individuals treat others, perform their tasks, take decisions, assess risk, and do the right thing to ensure they operate in a safe and sound manner”. In this regard, board members play an important role in shaping the culture and embedding one that is orientated towards staff doing the right thing even when nobody is watching.

European Regulatory Landscape

Turning to the European regulatory landscape in the context of Brexit, I would like to spend some time speaking about the Central Bank’s approach to Brexit related issues and the broader European dynamic in that context. As has been mentioned publicly on a number of occasions, the Central Bank continues to engage with applicant firms seeking to establish in Ireland.  In the asset management sector, the Central Bank is currently engaged with a large number of potential applicants. The Central Bank’s approach in processing any application for authorisation is centred on transparency, rigour and pragmatism.

In addition, the Central Bank’s authorisation process and approach more broadly, is embedded in the work of European System of Financial Supervision. The ECB / Single Supervisory Mechanism, the European Securities and Markets Authority (ESMA) the European Insurance and Occupational Pensions Authority (EIOPA) and, in recent days, the EBA have issued Brexit related guidance or opinions. These set out principles aimed at fostering consistency in the authorisation and supervision of entities, activities and functions proposing to relocate from the United Kingdom. The Central Bank has been proactively engaged in and is supportive of these initiatives.

In addition to being proactively engaged in the development of the different opinions, the Central Bank is also an active participant and supportive of the work of ESMA’s ‘Supervisory Coordination Network’.  This network was established to provide a forum for exchanging views in relation to relevant Brexit applications received by national authorities.  The intention of this forum is to ensure that regulatory standards are not diminished in the context of Brexit.  This aim is fully supported by the Central Bank. 

As Ireland’s representative at the Supervisory Coordination Network, I have presented to the group setting out the rationale for the Central Bank’s approach to particular authorisation applications.  The fact that the Central Bank applies an open and transparent approach to its authorisation policy greatly assists this dialogue.  We publish our rules and guidance, including application related guidance in a structured manner and this now includes the guidance for Fund Managers resulting from CP86.   When discussing the funds sector, that guidance and the related obligations I mentioned earlier, provides clear evidence that the Central Bank has long considered potential challenges with effectively supervising a funds industry with pan-European and global interlinkages.  Taking all together, it demonstrates that the Central Bank has taken steps to mitigate these challenges.  The Central Bank is bringing this experience to bear in the ongoing dialogue at a European level on these matters.  These contributions can, we believe, shape the direction of travel in this regard.     

Provision of ancillary MiFID Services

If I can now turn to a practical matter which the Central Bank has had to engage with, particularly as firms have considered their options following the United Kingdom’s decision to leave the European Union. This concerns AIFMs and UCITS fund management companies that, in addition to managing/marketing AIFs and UCITS, seek authorisation to carry on other activities that amount to the provision of MiFID investment services.⁵ 

This could include, for example, acting as portfolio manager to individual managed accounts or managing the assets of funds for which they do not act as the AIFM/UCITS manager.  Where a management company proposes to perform individual portfolio management (IPM), the application process requires that certain information is included in the firm’s business plan.

In addition, it is important to note that an applicant seeking to provide such services is required to make a submission to the Central Bank prior to submitting a formal application for authorisation.  The Central Bank will assess any submission for a fund management company seeking to provide IPM services by applying standards equivalent to those that would apply to a similar investment firm seeking authorisation.  

The intention of the Central Bank’s assessment is to ensure there is no potential for regulatory arbitrage in the provision of IPM services. The provision of such services may expose the fund management company to different risks than would be the case for collective portfolio management.  Any applicant proposing to provide such services should ensure it has allocated appropriate resources to account for this. 

Of course, a case-by-case assessment will be required to determine what these resources will be.  However, broadly speaking, the Central Bank would consider such resources should be equivalent to those which would be required for similar activity in an investment firm.  The Central Bank’s approach in this area has not changed. However, it has become apparent that a greater number of fund management companies are now seeking to provide ancillary MiFID services.   

2018 Supervisory Priorities

Before I conclude, I would like to say a few words about our 2018 supervisory priorities in the context of asset management supervision. First and foremost, the deliverance of high quality risk based assertive supervision, inspections and a robust approach to authorisations will remain a key priority.

We will continue to be open and engaging with firms that are considering applying for authorisation in Ireland in light of Brexit. As I have alluded to in previous speeches, the Central Bank has considerable experience in dealing with authorisations and where, we are asked to consider the authorisation of a firm in Ireland, we will want to be satisfied that we are authorising a business or line of business that will be run from Ireland and which we can effectively supervise.

MiFID II applies on 3 January 2018 and so over the coming months we will continue our engagement with firms to determine how they are progressing with their MiFID II implementation plans. Our engagement to date has entailed a heat-mapping exercise, issuing a questionnaire to firms, providing keynote addresses and participating in industry roundtable events. This has provided us with some useful insights and the outputs from our heat-mapping exercise, in particular, will guide our supervisory strategy in 2018. I want to be clear that in 2018 we will be proactive and challenge our supervised firms over their MIFID II implementation. We will also look to determine how firms are preparing for Brexit and on that point, firms should be asking themselves the hard questions now such as how will Brexit impact current business models and revenue streams.

Looking more in depth at our 2018 priorities for the fund services providers sector, the safeguarding of investor money will remain a key focus area next year and we will be engaging with fund service providers to discuss the extent that the Investor Money Regulations are embedded in their processes and procedures.  

Furthermore, firms should be fully compliant with all aspects of the Fund Management Company Guidance issued in December 2016 by 1 July 2018. Following this date, our supervisors, through themed inspections and ongoing engagement, will assess how firms have implemented the standards and final package of measures as set out in the Guidance.

Next year the Central Bank will also continue its focus on reviewing the arrangements in place regarding the Outsourcing of Administration Activities in relation to Investment Funds.

In addition to this, the Central Bank will maintain its programme of full risk assessments and engagement with Fund Service Providers. This will be coupled with themed inspections in areas such as governance to ensure that Fund Service Providers are striving to maintain the highest possible standards in this regard.

Conclusion

At this juncture, let me conclude. I hope my remarks this morning have given you a sense for the overarching rationale in terms of having prescriptive guidance for fund management companies. This work, to support the effectiveness of fund management companies, has involved a substantial journey for both industry participants and the Central Bank.  For some time, it has been possible to look back on how CP86 has developed.  It is now possible to look forward on how this guidance may shape discussions at a European level in the months and years ahead. 

Nearer to home, I expect compliance with the guidelines to be a regular discussion item for the majority of firms present here today. As you might imagine, the Central Bank’s priority is to ensure compliance with this extensive guidance. 

For those of you here today who are directors, you should remain alive to the significant responsibility you have taken on.  You are at the front line in ensuring that the firms have robust governance structures, operate within their defined risk appetite and meet their regulatory obligations.  This is no small task and you need to dedicate sufficient time and effort to achieving this task for every board you sit on.  

Thank you again to the organisers of this morning’s event.

With thanks to James O’Sullivan and Adrian O’Mahony for their contribution to these remarks.