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Fund governance in the spotlight

Fund governance in the spotlight

Fuelled by growing competition for institutional mandates and investor pressure, asset managers running both traditional and alternative strategies are strengthening their corporate governance practices.

In addition, regulators, including those in key offshore jurisdictions, – continue to introduce changes which enhance governance. Once deemed to be a peripheral issue for many asset managers, fund governance is now being taken very seriously.

Major markets ramp up the pressure on governance

Recent announcements by the European Commission suggest there is likely to be a stricter application of some of the Alternative Investment Fund Manager Directive (AIFMD) rules.

While caps on delegation have not materialised (thereby enabling non-EU managers to continue marketing into the EU through ‘Manco’ arrangements), it appears likely that firms leveraging the so-called ‘reverse enquiry’ route could face additional reporting requirements, as European Securities and Markets Authority (ESMA) looks to capture more information about managers who are adopting this ‘non-marketing’ approach.

Accordingly, this will require firms to ensure they have solid governance procedures in place to ensure they are not breaking any of the rules. Some firms – nervous about the implications of falling foul of some of AIFMD’s strict reverse enquiry provisions – might choose instead to build up definitive substance in the EU by appointing a Manco to manage an EU fund and avail themselves of the European marketing passport or by registering under NPPR to market non-EU funds.

The US has also recently proposed new rules designed to increase protection and transparency for investors in private funds. The Securities and Exchange Commission (SEC) is proposing, amongst other things, that private fund advisors provide regular transparency on the fees charged to investors.

The rules also prohibit certain types of charges and introduce restrictions to ensure preferential treatment is not granted to one investor over another. Some of the proposed rules will apply to all private fund advisors, regardless of whether they are SEC registered or not.

If they do come to fruition, these reforms will require alternative asset managers to implement changes to their governance and compliance procedures.

Offshore hubs make good governance a priority

Elsewhere, offshore fund jurisdictions have been introducing new rules which enhance fund governance.

Introduced in 2020, all private funds in the Cayman Islands must now register with the country’s regulator – Cayman Islands Monetary Authority (CIMA). Under the provisions, investment firms must:

  • appoint two fund directors
  • implement consistent valuation procedures
  • appoint a custodian to hold custodial fund assets in a segregated account
  • verify ownership and title of all other assets
  • monitor cash flows

CIMA’s rules broadly mirror some of the depositary requirements outlined in the EU’s Alternative Investment Fund Managers Directive (AIFMD) – albeit managers can perform these obligations in-house and do not need to appoint a depositary as they do in the EU.

Nonetheless, some CIMA-registered funds are now thinking about outsourcing some of these requirements to third parties to address potential conflicts of interest issues and enhance their fund governance model.

The application of these rules to private funds will help ensure the Cayman Islands continues to be an attractive domicile for funds, while simultaneously providing reassurance to end investors – many of whom will welcome the added oversight.

It’s all about governance

Once again, corporate governance and good operational process is in the spotlight.

Increasingly regulators and institutional investors are requiring firms to raise their standards focusing on key areas of perceived weakness.  Firms that prioritise governance tend to be stronger businesses, and this will ultimately help managers differentiate themselves from their peers.

INDOS Financial and the wider JTC Group have expertise and solutions which enhance the governance of asset managers and their funds, including third party management company services, depositary and private fund oversight and fund/company secretarial services.

INDOS Financial (Ireland) Depositary Limited Supports First Irish Investment Limited Partnership (ILP)

INDOS Financial (Ireland) Depositary Limited Supports First Irish Investment Limited Partnership (ILP)

INDOS Financial (Ireland) Depositary Limited (INDOS) will provide depositary services to its Irish Investment Limited Partnership (ILP), Adit Global Growth, ILP.

It is the first ILP product to be supported jointly by INDOS and Ballybunion Capital Limited (acting as AIFM) since both companies joined JTC Group in 2021. Dillon Eustace provided legal services for this ILP.

The investment limited partnership, which will be distributed to a number of European countries and the UK, is expected to raise up to $50million.

The ILP regime in Ireland was updated in 2021 to attract increased private capital into the country with managers obtaining several benefits including tax treaties which Ireland has negotiated with various third countries.

Padhraic McLaughlin, CEO of INDOS Financial (Ireland) Depositary Limited said:

“INDOS recently acquired its specialised depositary licence in Ireland building on our leading offering for alternative investment funds. Depositaries form a crucial ongoing monitoring function for fund structures and we are very pleased to act for this ILP and to be working closely with Ballybunion as AIFM for the first time.”

To find out more about ILP developments, INDOS and the broader solutions by JTC Ireland, please contact Padhraic McLaughlin [email protected] or Jon Masters (Head of Business Development) [email protected]

Ireland more attractive to Private Capital following new ILP structure

Ireland more attractive to Private Capital following new ILP structure

Despite Ireland being among one of the largest asset servicing hubs for alternative funds, its track record relative to other EU domiciles, namely Luxembourg, in supporting private capital strategies such as private equity has been somewhat lagging behind.

ILP – Strengthening Ireland’s reputation in private capital circles

Ireland sought to redress this imbalance in 2021 by updating its Investment Limited Partnership (ILP) regime, a reform, which if enacted successfully could attract more than €20 billion in private capital assets per year by 2025, according to Irish Funds.*

With Ireland hoping to capitalise on the spectacular growth of private equity – an asset class now managing in excess of a record US$4.5 trillion, and private credit, the amended ILP regime creates a more flexible regulatory (i.e. the ability to launch multiple sub-funds in a single ILP structure) and tax environment for general partners (GPs).

One of the principal benefits of the latest ILP iteration is that managers leveraging the structure can avail themselves to a number of tax transparency benefits together with the tax treaties which Ireland has negotiated with various third countries. This is likely to prove particularly enticing for US managers, many of whom will be familiar with ILP structures in fund centres such as Delaware and the Cayman Islands. Investor protection is also at the heart of the Irish ILP.

Furthermore, the ILP is subject to stringent Central Bank of Ireland (CBI) oversight and the Alternative Investment Fund Managers Directive (AIFMD), something which investors will find reassuring. To many, the ILP will be yet another avenue for private capital firms to market seamlessly into the EU.

Having been launched less than one year ago during a period marred by extraordinary market turbulence, the ILP is still finding its feet among GPs and investors. However, Ireland has enjoyed remarkable success launching a number of other fund structures in the past, most notably the Irish Collective Asset Management Vehicle (ICAV) which has proven incredibly popular.

Many are therefore confident that the ILP will reap similar rewards as well. In addition to new fund launches, the ILP could be an attractive proposition for GPs looking to re-domicile, especially as more EU institutional investors increasingly demand that private capital managers locate their funds in regulated onshore centres like Ireland as opposed to offshore hubs. So what do GPs now need to consider when setting up an ILP structure?

Getting to grips with the ILP

An ILP can be operated by a GP which is resident in any recognised centre for GP operations but may also be resident in Ireland. As with asset managers subject to AIFMD, the ILP allows GPs to delegate investment management functions to a third party located either within or outside of the European Economic Area. In short, this means ILP funds can utilise the existing AIFM Management Company (Manco) model currently available to Alternative Investment Funds (AIFs).

Elsewhere, it is also required that ILPs appoint a depositary, a service provider which will be entrusted with on-going independent oversight of the fund such as monitoring of cash flows, asset ownership verification and ensuring managers are not deviating from their investment mandates.

*Irish Funds – December 17, 2020 – Game changing Irish funds legislation to create 3000 jobs

It is crucial that GPs, who are considering unveiling ILPs, look to qualified service providers that are capable of supporting them with their governance obligations, chiefly AIFMD and depositary oversight.

JTC group can assist in project managing the establishment of an ILP and providing AIFM and Depository services via its Ballybunion Capital and INDOS Financial entities. In addition JTC can assist with the operation of GP structures in a variety of jurisdictions to suit a fund promoter’s needs.

AIFMD 2 – Little in the way of change, with an AML twist to the story

7 years after the AIFMD was first introduced, proposals are now in for an AIFMD 2 after an extensive industry-wide consultation by the EC.

Seven years after the Alternative Investment Fund Managers Directive (AIFMD) was first introduced, proposals are now in train for an AIFMD 2 following an extensive industry-wide consultation by the European Commission (EC).

The contents of AIFMD 2 do not represent a radical departure from the existing provisions although they do contain some potentially important changes. INDOS takes a look at what AIFMD 2 could mean for the industry.

Tweaks to the NPPR

Under Article 42 of AIFMD, non-EU alternative investment fund managers (AIFMs) can market their alternative investment funds (AIFs) to European Union (EU) investors through national private placement regimes (NPPRs).

In order to leverage NPPRs, non-EU AIFMs and non-EU AIFs cannot be located in countries that are identified by the Financial Action Task Force (FATF) as being high risk in relation to money laundering and terrorist financing. AIFMD 2 tightens this provision even further stipulating that non-EU AIFMs and non-EU AIFs cannot be based in high-risk jurisdictions under the EU’s Anti-Money Laundering (AML) Directive, nor are they allowed to operate out of countries on the EU’s list of non-cooperative tax jurisdictions.

In practice, major asset management hubs such as the UK and US will not be affected while none of the offshore fund centres are currently on the EU’s proscribed AML or Tax lists. Despite this, the Cayman Islands was put on the EU’s tax list briefly in 2020 and, more recently on 7 January 2022, the European Commission adopted a draft regulation to add nine countries including the Cayman Islands to their AML list. If the Cayman Islands were to remain on the list in 2024 (when AIFMD II is due to take effect) it would impact a Cayman fund’s ability to be marketed into Europe through NPPR.

Despite indications when AIFMD was first introduced that the EU-wide marketing passport might one day be extended to non-EU managers and funds, there are no intentions in AIFMD 2 to do so. The good news, however, for non-EU managers and funds is that marketing via NPPR is set to continue.

An updating of delegation arrangements

Concerns had been expressed that AIFMD 2 might introduce significant changes to the current delegation model where EU managers delegate portfolio or risk management to entities outside the EU. One of the EC’s biggest fears around delegation was that it could potentially result in letterbox entities, or companies with limited physical substance, cropping up inside the EU.

The European Securities and Markets Authority (ESMA) is looking to contain this risk by requiring member state regulators to notify ESMA on an annual basis when an AIFM “delegates more portfolio or risk management to entities in third countries than it retains”. ESMA will be required to conduct a member state peer review every two years and a five year letterbox review. In order to demonstrate substance, AIFMs must appoint two EU residents to conduct the business of the AIFM. As this is already a standard market practice, the changes will have limited impact. 

Largely status quo for the existing depositary regime

AIFMD 2’s impact on the current depositary set-up are not material. An original AIFMD concession allowing AIFs located in countries, where the number of depositaries is lacking, to use providers outside of their home jurisdictions – will continue. The EC added an assessment will be made in due course on establishing a pan-EU depositary passport, an issue it has been grappling with for many years now. The rules also said that central securities depositories (CSDs) can be delegates of depositaries with no additional due diligence checks being needed as part of their appointment – again, this has little bearing on the wider industry.

Much ado about nothing?

The old adage that ‘no news is good news’ generally rings true for AIFMD 2. The EC’s amendments did not contain any nasty shocks meaning there is little cause for alarm at managers, although they should keep vigilant for any long lasting revisions to the EU’s AML and tax blacklist of third countries lest it unduly impacts their marketing arrangements once AIFMD II takes effect.

Although it is disappointing the AIFMD passport has been kicked yet again into the long grass, most managers will be quietly relieved that the amendments are limited. Accordingly, the proposals will now go through the EU’s legislative process, meaning AIFMD 2 is unlikely to become law before 2024 or 2025. It remains to be seen if the UK’s Financial Conduct Authority will implement any of the EU changes to its own AIFMD requirements.

ESG Measuring and Reporting: Transparency and Standards

INDOS Financial at BVCA Summit

Ahead of the COP26 Climate Change Conference, Bill Prew, CEO at INDOS Financial, a JTC Group Company, moderated a panel at the BVCA Limited Partner [LP] Summit 2021 which examined how institutional investors are obtaining and measuring environmental, social and governance [ESG] data from their private equity holdings and asset managers. But what were main discussion points at this year’s LP Summit?

Transparency improvements are still needed

Although disclosure of ESG data by private equity managers to LPs has improved over recent years, investors noted that procuring information can still be a challenge.

The reticence of some GPs to share ESG data is compounded by the fact that it can be difficult to gather post investment information such as carbon emissions from private businesses, at least in comparison to publicly listed companies. Moreover, understanding how companies manage carbon emissions and other ESG risks can also be quite challenging. Assuming private equity managers are happy to share their various ESG metrics, there is also an absence of standardisation in how this information is collected and reported, creating further problems for LPs, especially those invested across multiple funds and asset classes.

One LP highlighted the lack of harmonisation is partly a result of the “alphabet soup of standards” and ESG frameworks being promoted by various industry bodies and supranational groups. Elsewhere, ratings agencies often do not deploy the same methodologies when scoring companies on ESG, meaning that it is not uncommon for the same company to have multiple – or occasionally conflicting – ESG ratings.

All of this makes it difficult for GPs to report accurately on ESG – and in turn enable LPs to obtain a good grasp of ESG risks across their portfolios. Panellists agreed that there could be greater investor collaboration on ESG issues noting that it would help GPs focus more on gathering the right data to report to investors.

Obtaining standards are key

In order to mitigate these challenges, experts at the LP Summit said there needed to be industry-wide agreement on how ESG information is reported to end clients. Some believe GPs should leverage the template being developed by the Institutional Limited Partners Association [ILPA] and other initiatives such as the PRI ESG Due Diligence Questionnaire.  Having introduced a common set of principles for GP fee disclosures, ILPA recently launched its ESG Assessment Framework, a toolkit designed to help LPs benchmark their GPs’ ESG credentials. Speakers concurred that the new ILPA ESG Assessment Framework will help support the drive towards greater ESG standardisation.

In addition to industry-led initiatives, Prew noted that a number of regulators are also looking to bring about clarity around how GPs report ESG data.

Although the EU is widely considered to be an ESG reporting trailblazer, one speaker said regulators in the US and UK are also taking a close interest in the issue, adding that TCFD [Task Force on Climate-related Financial Disclosure] reporting requirements will increasingly apply in the UK to pension funds,  asset managers, listed companies and other businesses.  With TCFD reporting now becoming a regulatory and compliance obligation, there will be greater accountability on asset managers around ESG.  Speakers cautioned, however, that GPs need to do more than treat ESG reporting as a compliance exercise and concentrate on integrating ESG into risk and investment management processes to ensure there is tangible progress being made towards achieving net zero.

Service providers can support the industry

Panellists agreed there is a role for service providers to support the industry. While some investors have established their own in-house ESG teams, there are many institutions which need to consider ESG matters and will be reliant on external service providers, particularly in areas such as carbon assessments and collection together with analysis of data.

Pressure on private equity managers will continue 

With sustainability now becoming a critical component of the manager selection process, the private equity industry will need to continue to improve its ESG reporting and disclosure to LPs. Regulation and industry-led initiatives such as the ILPA ESG Assessment Framework are likely to play a major role in facilitating this.