2020 has been without precedent. What started as a largely positive year for the asset management industry and service provider community was derailed in February and March as the seriousness of COVID-19 became increasingly acute. INDOS Financial reflects on the last 12 volatile months and explores some of the momentous changes which have swept across the financial services industry.
COVID-19: The moment the world changed
COVID-19 is a once in a century crisis, but asset managers have proven resilient. While some fund houses did struggle with the logistics of working from home initially, business has largely continued with limited disruption to operations. That the industry was able to navigate this sudden transition so seamlessly is reflective of its significant investment into business continuity planning (BCP). BCP and operational resiliency have been areas of scrutiny among institutional investors and regulators such as the UK’s Financial Conduct Authority (FCA) for several years now. Consequentially, many global asset managers had well-drilled BCP processes in place well ahead of the COVID-19 pandemic.
Longer-term challenges of COVID-19 still persist. Working from home and the ongoing inability to physically meet with or travel to prospective investors has made fundraising more difficult. Similarly, some institutional investors are not entirely comfortable with conducting operational due diligences on fund managers remotely through video links. This is particularly true in cases where there is no pre-existing relationship. As a result, the number of investment mandates being awarded during this period has slowed. Keen to avoid any additional unnecessary operational challenges, a number of managers have also delayed making changes to their operating and service provider models.
ESG given a boost
Few positives have emerged from COVID-19, although the continued rise in interest in ESG (environment, social, governance) investing is one of them. In fact, ESG-orientated investment products registered net inflows during the crisis. Data shows European sustainable funds attracted around €30 billion in the first three months of 2020, whereas European-based funds overall shed €148 billion. It is projected that investors will continue to allocate into ESG products as a result of COVID-19. Federated Hermes found 85% of its UK independent financial advisers had reported a jump in clients asking to allocate capital into ESG products since the beginning of COVID-19. These impressive inflows come as ESG funds reported outperformance during the pandemic, evidenced by recent BlackRock data which found 94% of sustainable indices beat their parent benchmarks in Q1.
The governance focus continues
Despite the market dislocation, regulators have been keen to stress the importance of robust fund governance. In 2020, the Cayman Islands pushed ahead with its Private Funds Law, which subjects private equity firms to regulatory registration requirements and depositary provisions effectively modelled on the EU’s AIFMD (Alternative Investment Fund Managers Directive). COVID-19 has highlighted how important it is for asset managers to embrace best practices when it comes to fund governance and oversight. Irrespective of the pandemic, it is critical that managers and fund boards do not let standards slip otherwise the interests of investors risk being compromised during this difficult time.
Delegation under review
As Brexit rapidly approaches, UK asset managers are concerned that the existing delegation framework could be materially altered for the worse by EU regulators. Right now, third country managers can appoint an EU management company, who will outsource investment management back to the manager allowing them to distribute their products cross-border without impediment. In a letter penned over the Summer, the European Securities and Markets Authority (ESMA) made public some of its objections about delegation, warning that the current set up carried operational and supervisory risks. Although it is unlikely delegation will be outlawed, there is a possibility it could be restricted making it harder for third country managers to sell their funds inside the EU. Any attempt to limit delegation will, however, result in pushback across an industry that is keen to ensure an open global market for asset management.
Facing the new reality
Asset managers demonstrated remarkable agility and quick thinking when COVID-19 struck. With the pandemic now approaching its ninth month, the industry has adjusted to the changing circumstances. At the same time, the crisis has reaffirmed the role of ESG as an investment strategy in its own right and the continued importance of effective fund governance.
Cayman Islands Mandatory AML Training Requirements 2020
As the year moves towards a close, it is important to remember that Directors and Senior Managers of Financial Service Providers (FSPs) (including Funds and SIBL-Registered Persons) operating in the Cayman Islands are required to undertake annual Cayman Islands specific Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT) training.
The Guidance Notes, in conjunction with the AML Regulations, state that Directors and Senior Managers should understand the statutory duties placed upon them, their staff and the firm itself given that these individuals are involved in approving AML/CFT policies and procedures. In addition, senior management (including Board of Directors) should receive a higher level of training covering all aspects of AML/CFT procedures, including the offences and penalties arising from the relevant primary legislation for non‐reporting or for assisting money launderers, the procedures relating to dealing with production and restraint orders and the requirements for verification of identity and retention of records.
INDOS Financial delivers annual “in person” rather than electronic AML/CFT training as an inclusive part of its AML Officer services to Cayman Islands fund clients. We would be pleased to provide equivalent training to other firms that may be considering upgrading their AML service provision, or outsourcing the AML officer duties for the first time.
Please contact Matthew Queree, Head of AML Services at INDOS Financial, if you would like to find out more.
INDOS provide AIMA Fund Manager Briefing on Developments in Fund Governance
On Monday 9th November, as part of the AIMA Fund manager briefing series, INDOS was pleased to present to members, covering developments in fund governance, noting how it has evolved over recent years and why it is such a key area for regulators and investors alike, particularly given perceived failings in governance which have led to a number of high-profile fund suspensions such as Woodford last year. Below is a summary of some of the key messages from the presentation.
Following the 2008 financial crisis, there have been two key drivers behind improved governance within the alternative funds industry; new regulations such as AIFMD and Senior Managers & Certification Regime (SMCR) and investor focus on operational due diligence including the role and composition of fund boards. A fund board which is diverse and independent, and which can perform robust oversight and challenge will add value.
In the UK governance and culture are clear FCA priorities; a key outcome of the SMCR is to improve the standards of fund governance and recent FCA Dear CEO letters to the asset management industry deliver a very strong message; overall standards of governance generally fall below FCA expectations.
On a global basis, we are also seeing regulators take actions and increase regulatory oversight to continue to improve manager and fund governance and therefore investor outcomes.
The Depositary is viewed by the regulators as a cornerstone of good fund governance and regulators are also keen that processes have real substance both in locations and in reality. However, the role of the Depositary can sometimes be interpreted as a tick the box exercise. Often the Depositary is affiliated to the Fund Administrator which presents a conflict of interest given a core role of the Depositary is to oversee many of the outputs of the fund administration process.
Increasingly we are seeing awareness increase amongst managers, fund boards and investors of the advantages of an independent solution where the Depositary acts without potential conflict and in the best interests of investors thereby enhancing the governance structure. In addition, forward thinking managers are taking a more holistic approach to compliance and governance and leveraging the role performed by their service providers, such as the depositary, as a core part of their governance and oversight model.
Governance will continue to evolve. The core building blocks of good governance are in place but firms should always ensure they have the right service providers that add value, highlight risks, and enhance the governance structure.
INDOS Financial appointed to provide independent depositary services to Triple Point Energy Efficiency Infrastructure Company plc
Independent depositary and fund oversight provider INDOS Financial has announced it has been appointed to provide AIFMD depositary services to Triple Point Energy Efficiency Infrastructure Company plc (the “Company”), an investment trust which was admitted to trading on the Specialist Fund Segment of the London Stock Exchange on 19 October 2020.
The Company will invest in a diversified portfolio of energy efficiency assets in the UK, which have a positive environmental impact and which facilitate the transition to a low carbon economy in accordance with the UK government’s overall environmental targets. The Company’s investments will focus on the core sectors of low carbon heat distribution; social housing retrofit and industrial energy efficiency; and distributed generation.
Commenting on the appointment INDOS Financial CEO, Bill Prew, said “We are delighted to extend our relationship with Triple Point Investment Management by providing AIFMD depositary services to the Company. The appointment marks a new milestone for INDOS, becoming our fifteenth LSE listed client and taking the value of listed funds under our oversight above £2.5 billion”.
Jonathan Parr, Partner and Head of Energy at the Company’s Investment Manager, Triple Point Investment Management LLP, commented “The INDOS team have done an excellent job setting up the depositary services to support our new launch, and we look forward to our continued relationship”.
About INDOS Financial
Founded in 2012, INDOS has grown organically, developing solutions recognised as industry-leading within the fund oversight and depositary service space. As of September 2020, client assets under depositary oversight had grown past $35 billion and a further $10bn which form part of the INDOS AML (Anti-Money Laundering) service clients. INDOS also provides a range of Environmental, Social, Governance (ESG) services for asset managers and their funds.
Global Custodian Feature: Managing the risks of trading in digital assets
How can institutional investors assess and manage the risks associated with digital assets and the new market space, and what role does a depositary play in this ecosystem?
Digital assets, which first emerged more than 11 years ago with the creation of Bitcoin, have historically been the preserve of retail investors. However, interest and investment in digital assets by traditional fund management firms has grown as the industry slowly matures. Earlier this year, Paul Tudor Jones announced he was buying Bitcoin as a hedge against inflation. Elsewhere, Fidelity launched its Fidelity Bitcoin fund in August while MicroStrategy recently purchased more than 21,000 Bitcoins. The estimated total market capitalisation for digital assets, principally cryptocurrencies, is in excess of $350 billion, of which an estimated $6 billion is managed by digital asset focused funds. The market continues to see growth month over month.
Unlike traditional asset classes, the often-opaque nature of the digital asset market presents many unique challenges. More than 350 digital asset exchanges currently operate in a globally fragmented market with varying degrees of security, operational integrity and regulatory standards. Headlines about exchanges losing client funds or facing regulatory scrutiny are common. It can be difficult to know what providers in the market are safe and trustworthy.
So how can institutional investors assess and manage these risks? Evaluating the quality and transparency of digital asset exchanges is critical to managing the risks of trading in digital assets. Once invested, institutional investors can also take comfort from the independent oversight role performed by a fund depositary that monitors transactions and verifies ownership of the digital assets.
When evaluating digital asset exchanges, there are several qualitative and quantitative factors institutions need to consider.
Qualitative factors
Due to the global nature of this market and the lack of strong regulatory oversight in many jurisdictions, qualitative factors – like robust KYC/AML policies – need to be examined closely. Such policies are designed to keep bad actors out and provide the basis for effective market surveillance. Unsurprisingly, exchanges with nonexistent or insufficient AML/KYC policies have been found more likely to disseminate what appears to be fake trading volume data.
It is also important to evaluate an exchange’s track record on safeguarding assets. A history of hacks, frequent unplanned downtime or a lack of transparency about operational security are indicative of vulnerabilities.
Firms should also verify that digital exchanges have transparent governance structures, a qualified leadership team, routinely updated business continuity plans, uniformly enforced fee structures, sound banking counterparts and decent insurance policies.
Quantitative Assessments
Manipulation in the digital asset spot market is a practice well known to both market participants and regulators. The US Securities and Exchange Commission has repeatedly said that the lack of a price that is free from manipulation is among one of its top concerns in the market, and a primary reason for its continued refusal to authorise a Bitcoin ETF.
Many exchanges will report large volumes, but a closer look reveals trading patterns and order book data that does not correspond with those volumes. The ability to flag suspicious trading patterns can help address concerns over wash-trading, inflated volumes or manipulated data.
Correlation testing is one example of a quantitative metric that can flag outlier behaviour. The digital asset market, while globally fragmented, is, in large part, an integrated marketplace with consistency of market activity across legitimate exchanges. By comparing the volumes and prices across exchanges of different sizes, jurisdictions and user profiles, it is easy to spot erroneous practices. Having a trusted source of transparent data in the digital asset space is key to spotting red flags.
The role of the depositary
Under the Alternative Investment Fund Managers Directive (AIFMD), EU and some non-EU based asset managers marketing alternative investment funds in Europe are required to appoint a fund depositary. The depositary is responsible for performing independent oversight of the fund, monitoring cash flows daily, verifying the ownership and existence of assets and ensuring the fund is managed in accordance with its prospectus.
To date, only a small number of digital asset funds have been set up which are subject to AIFMD depositary oversight. Due to the complexities of digital assets, few depositaries have invested the time to develop the necessary systems and procedures to take on these mandates. This lack of engagement has held back the development of the digital asset fund sector.
The depositary to a digital asset fund will independently oversee the trading and settlement activity of the fund, monitoring transfers to and from exchanges, movements of assets between exchanges and the fund digital asset custodian, while reconciling assets to the relevant blockchain and overseeing the valuation function of the fund. Asset managers and investors can take significant comfort from this independent oversight, which is performed on an ongoing basis.
The case for independent oversight of exchanges
Digital assets are a novel concept and the absence of effective oversight is a major factor impeding the sector’s growth. By leveraging depositaries – who have a robust track record in safeguarding investor protection under AIFMD and UCITS – the digital asset funds industry could enjoy exponential inflows moving forward.
By Bill Prew, CEO, INDOS Financial and Erin Friez, COO, Digital Asset Research
