Fund Governance Insights

The art of governance

6 minute read time

Asset managers have had to absorb a plethora of new rules and regulations in recent years. How have they adapted?

  • In the second year of value assessment reporting, the focus moves from establishing a governance framework to the quality of the information provided
  • The 2020 UK Stewardship Code includes ESG reporting for the first time and the FRC wants asset managers, asset owners and service providers to up their game
  • A 2020 target for women on boards has been exceeded, and the FCA thinks its ethnic representation goal for 2021 is within reach

ESG (environmental, social and governance) investing has turned from niche to mainstream. The most recent of Russell Investments’ annual asset manager surveys shows how ESG factors are now universally seen as an important part of the analysis of potential investments.

At the same time, asset managers’ own ESG performance is under review. Shifting expectations at regulators, investors and clients have put asset management governance under the spotlight – scrutiny that shows no signs of diminishing.

Creating value for investors

The Financial Conduct Authority’s asset management market study heralded the start of recent changes to industry governance. Following this review, authorised fund manager boards now need to have a minimum of two independent directors; they also have to produce annual value assessment reports.

These requirements were brought in to address concerns that investors may be getting poor value for money, says Chris Day, Assistant Director, Funds Regulation & Governance at NatWest Trustee and Depositary Services (NWTDS). “Having independent directors and value assessment reports helps ensure that firms focus on delivering value to the end investor,” he says.

Firms spent the first year of reporting developing their own template, putting their governance framework in place, and linking this with the work of the independent directors. During the second, and current, year of reporting firms are focusing more on the quality of the information published.

There is pressure from the FCA for the quality to improve, says Day. “There’s no template for these reports as the FCA doesn’t want firms to see this as a tick-box exercise: they want them to think carefully about the value they are delivering and the information they are providing to investors.”

Market matters

MiFID II, the EU’s second Markets in Financial Instruments Directive, introduced significant product governance requirements into the asset management industry. Some of the more important rules include developing, marketing and testing specific types of products to ensure they can meet customer objectives and requirements, and testing fund fitness over the entire product lifecycle.

The FCA’s recent review of the implementation of these rules, which was published in February, found that some asset managers had failed to comply with certain requirements. Specific problems included potentially misleading disclosures to investors, and insufficient due diligence being exercised in product distribution – just the sort of issues the rules were designed to counter.

The conclusion, not surprisingly, was that the FCA would continue to look into product governance. “We expect firms to ensure their activities prioritise good customer outcomes and that they comply with the relevant regulatory rules and requirements,” its report states. 

Governance in stewardship

The Financial Reporting Council significantly revamped its Stewardship Code in late 2019. The code’s scope was widened and now features 12 principles for asset owners and managers, many of which revolve around themes such as purpose and governance. For the first time, reporting requirements include ESG factors, reflecting their growing importance to investors.

Expectations have been raised with the new code, says Peter Flynn, Associate, Funds Regulation & Governance at NatWest TDS. “Asset managers are expected to report not just on policy but on activities to follow up on that policy, and on outcomes – on what’s been achieved. Some aspects of the code, such as introducing ESG reporting, have proved to be particularly timely and relevant.”

“There’s a greater level of accountability and scrutiny. I hope that responsible voices will be asking how fair and balanced disclosures are, and do they reflect what’s being done”

Claudia Chapman, Head of Stewardship, Financial Reporting Council

The FRC recognises the difficulties for reporters of attributing the impact of their actions, says its Head of Stewardship, Claudia Chapman. “But we need to move away from the bland statements of intent we saw before, which were often not backed with any evidence of activity,” she says. “Now we’re asking firms to demonstrate how they have implemented their policies in the reporting period.”

The FRC carried out a review of early reporters, and the findings, published in September 2020, stated that asset managers needed to up their game in reflecting on the effectiveness of their approaches, demonstrating continuous improvement, and disclosing outcomes. The first full reporting window for asset managers closed on 31 March 2021 and the FRC is currently reviewing this batch of reports.

The overarching idea behind the code is that what gets reported gets done, says Chapman. “There’s a greater level of accountability and scrutiny,” she says. “I hope that responsible voices will be asking how fair and balanced disclosures are, do they reflect what’s being done, and question whether good practices in one asset class can be extended to another.”

Extending responsibility

The Senior Managers and Certification Regime (SMCR) has been making its way through the financial sector. What started with banks and insurers had by late 2019 extended to asset managers. They now have to identify which individuals have what management responsibilities within their firm, document their responsibilities, and ensure that those people and other staff in their organisation comply with new regulatory requirements, including conduct rules.

SMCR revolves around individual responsibility at many levels of the asset manager, says Elizabeth Budd, Partner at law firm Pinsent Masons. “Good governance isn’t just tone from the top,” she says. “Strong governance also comes from middle management – these are the people who deal with most of the day-to-day governance issues.”

The FCA understands that this middle management level is critical, says Alexandra Green, Partner at law firm Macfarlanes. “Over the years we’ve had a focus on culture and boards, but often middle management is at the centre of projects and decision-making. SMCR is not just about raising standards but broadening the reach of those standards. The challenge for firms is how to instil strong leadership and a robust approach to good governance and cultural values while allowing genuine space for challenge and diversity.”

Diversity and looking ahead

Increasing expectations on board diversity have been directed at all the UK’s largest companies, including asset managers and those they invest in, for some years. The final Hampton-Alexander Review, published in February, found that FTSE 350 boards had exceeded the target of 33% of women in leadership and on boards, a target that had been set in 2016 (with reasonably low expectations of being met).

Meanwhile, the Parker review update in March reported that 74% of FTSE 100 companies had ethnic representation on their boards by late 2020. The target is for them all to have at least one director of colour by the end of 2021, a goal the review committee thinks is in reach. In a speech in March, FCA Chief Executive Nikhil Rathi made it clear that the regulator has diversity in its sights. “We care because diversity reduces conduct risk and those firms that fail to reflect society run the risk of poorly serving diverse communities,” he said. “And, at that point, diversity and inclusion become regulatory issues.”

This is a strong message to come from the FCA and feeds into its non-financial misconduct agenda, says Budd. “Good governance is a journey, and great distance has been travelled in the past five or six years. Societal attitudes have changed significantly, and that in turn drives changes in behaviours to reflect expectations.”

The debate around governance sits alongside advances in other areas of concern, such as the societal and environmental impacts of investing. Sustainability, for instance, is becoming mainstream in asset management circles and the FCA is working on a number of principles to help guide applications to authorise sustainable investment products. “Monitoring funds effectively from an ESG point of view is going to be an emerging area of governance, and we expect further developments this year,” says Day.  

By Caroline Biebuyck