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| Financial Law Update | Back to article summary. |
| Management companies meet UCITS III conversion deadline | ||
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| Investment fund management companies had a busy April, preparing for the UCITS III deadline. However, having obtained their authorisation under UCITS III, it will be very important for boards to ensure that the company is actually operated on the basis of the model set out in the business plan, as this is a new process and there will no doubt be teething problems, writes Joe Beashel. | ||
The Financial Regulator, management company boards and their advisors worked very diligently in the closing weeks of April to meet the CESR (Committee of European Securities Regulators, pronounced ‘Caesar’) deadline of end April for the conversion, to UCITS III status, of management companies managing UCITS III Funds. At the time of writing, the Financial Regulator had not yet finalised all of the, circa 50, management companies that were required to convert, but it is expected that most, if not all, will meet the deadline or be approved very shortly thereafter.
The conversion process has been something of a long road. The Financial Regulator issued its first draft Guidance Notes on the Conversion of Management Companies to UCITS III status as far back as March 2004. The intention was, we believe, that as applications were made on the basis of these Draft Guidance notes, the Financial Regulator would further refine their requirements following an assessment of the applications received. Something of a chicken and egg situation developed, as managers held off converting until further guidance was obtained from the Financial Regulator and the Financial Regulator did not furnish further guidance until sufficient applications were processed. This ‘standoff’ was broken when in February 2005 CESR published its recommendation that management companies which manage UCITS III funds must comply with the management company directive by end April 2006. The Financial Regulator published Guidance on the Content of Business Plans in February 2005 and required existing management companies to file applications for conversion by the end of September 2005. Further ‘Final Draft’ Guidance Notes on the Conversion of Management Companies to UCITS III status were published in January 2006, some months after all the applications were submitted and against which the applications were actually reviewed. Business plan At the core of the application for UCITS III status is a document called a business plan. This is something of a misnomer as it is more a governance document or a regulatory compliance plan, setting out how the company will be run on a day to day basis rather than a more conventional business plan which will have a heavy focus on financials. Mind and management The key requirement of the business plan is the necessity to demonstrate that the mind and management of the applicant company is in Ireland. In the Irish asset management industry the vast majority of management companies delegate their day to day operational functions to service providers. The Management Company Directive provides that although such delegation is permissible it must not result in the company becoming a ‘letterbox entity’. The precise meaning of ‘letterbox entity’ was not clarified in either the Directive nor subsequently by CESR. It was therefore left to the Financial Regulator to develop criteria by which this standard would be met. It has set out a series of management functions, which it felt, must be undertaken by the Manager in Ireland, these are, Decision Taking, Risk Management, Monitoring of Investment Performance, Monitoring Compliance, Financial Control, Monitoring Capital, Internal Audit and Supervision of Delegates. Precisely how these management functions should be discharged was the subject of some debate, in particular, the extent of the involvement of Irish resident directors and whether other personnel below board level could be formally involved took some time to clarify. Two main business models have emerged, one where certain board members are designated and another where the whole board is designated. Business models Designate certain directors In this business model some of the individual board members are specifically designated as responsible for certain of the management functions. He/she would be expected to deal with issues which arise between quarterly board meetings subject to the escalation of material issues to the full board and he/she would report to the board on a quarterly basis. While the March 2004 Draft Guidance Notes did not specify any particular level of involvement by Irish resident directors the Financial Regulator did clarify its position in the course of January. While there is no requirement that 50 per cent of the functions be allocated to an Irish resident it is necessary to have a ‘proportionate’ amount of functions allocated to the Irish resident. It is possible to designate persons below board level as responsible for some management functions but such persons must be resident in Ireland. Many managers, in their original applications submitted in September 2005, sought to have key personnel within their organisation assigned these roles such as a Head of Compliance responsible for Monitoring Compliance, on the basis that the particular function was within their particular professional competence. Most of these functional heads were located outside Ireland. The Financial Regulator in its January draft Guidance Note clarified that in order to meet the ‘mind and management’ test, all persons below board level designated to be responsible for some management functions must be resident in Ireland. Whole board approach The Financial Regulator has also authorised an approach where the whole board is designated as responsible for all of the management functions. This means that reports prepared by service providers will be circulated to the whole board not just a particular director and the whole board will be responsible for determining how to resolve an issue. This is likely to mean more frequent, if not monthly, teleconference board meetings where issues raised in the reports are addressed by the board as a whole. Some management companies have sought to appoint a ‘co-ordinating director’ who, as a matter of practicality, collects and distributes the various reports in a consolidated pack to his/her follow directors. The Financial Regulator has resisted suggestions that such a co-ordinating director would first review these reports for any material issues or provide other editorial comment prior to onward transmission to his/her fellow directors. In this model, the Regulator is concerned to see that all directors do receive the same information, to ensure that they are all equally responsible and equally able to discharge their obligations. It remains to be seen how robust and scalable this model is in practice. Other issues Signatory lists One of the areas that the Financial Regulator has focused on, and which was not expressly outlined in its earlier guidance notes, was its expectations that the authorised signatory list of the management company would include the directors (of the manager) and senior personnel of the Irish based service provider responsible for the financial control of the company. The fact that management companies often leverage from other parts of their organisation by providing authorised signatories in centralised finance functions was not acceptable to the Financial Regulator on the basis that it failed its ‘mind and management’ in the State test. Code of conduct In its March 2004 Draft Guidance Notes the Financial Regulator issued a draft Notice UCITS 16 which is a Code of Conduct in relation to Collective Portfolio Management. Although many of its requirements are derived from the UCITS Directive itself the requirement that it be adopted did cause some issues. Some Boards were reluctant to agree to comply with a document that is still in draft form. Also the draft Code of Conduct is slightly out of date in that it refers to insider dealing rules contained in the Companies Act, 1990 which have now been replaced by the Market Abuse Regulations of 2005. Ongoing implementation Having obtained their authorisation under UCITS III it will be very important for Boards to ensure that the company is actually operated on the basis of the model set out in the business plan. As this is a new process there will no doubt be teething problems, practices and procedures will have to evolve and as such the business plan needs to be considered as a working document, maintained on an ongoing basis and not set in stone. In this regard one can draw lessons from the experience of US asset managers involved in the ‘market timing’ issues a number of years ago. Companies which had procedures to deal with market timing but who did not follow those procedures suffered significantly at the hands of the various Regulators involved. In addition, the Irish Financial Regulator now has greatly increased enforcement powers including the ability to impose administrative sanctions of €500,000 on directors and up to €5 million on regulated entities. While it will be a relief to have finalised the conversion, as outlined above, it would be a mistake for boards to forget about the conversion process and the business plans developed. These business plans need to be maintained and updated to continually and accurately reflect the way the management company actually organises itself and as such they ought to be considered a permanent part of the way of running a management company in Ireland from now on. |
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Joe Beashel is a partner in the Banking and Financial Services Department at Matheson Ormsby Prentice and is Head of the firm’s Regulatory Risk Management and Compliance Group. He can be contacted by phone: +353 1 619 9000 or by email: joe.beashel@mop.ie Further information on the firm is available at www.mop.ie |
