A Second Wipe at Board Structures?
In this second instalment (see here for the first published last month) JB again draws on the role of corporate structures and how they can lead to conflicts or support for iNEDs. Do single or multiple fund boards engender better governance?
For my pars duo, I continue on the theme of corporate structures. A two-for-one roll of ultra-absorbent soft velvety comfort, a hygienic journey that gets us to the very bottom of the issue. To continue then for fund managers, will it be one board or two? The answer might depend on size.
There is a big distinction to be made between complex businesses with multiple layers, several boards, committees and working groups, versus smaller firms. There are also those firms that outsource to an authorised corporate director (ACD). Recall that single boards were typical for fund firms of smaller size and ilk, operating their own ACD. These were internal management committees (often, but not always, owner-controlled) with no iNEDs. To all of these – big and small – the industry regulator, the Financial Conduct Authority (FCA), has required a minimum two iNED (25%) rule along with the new Assessment of Value (AoV) regime.
In most cases iNEDs reside on a single board for any given company. That board may be the legacy company board or the fund/product subsidiary, and in some cases an iNED may reside on both. The FCA has recently cast doubt on this latter category. What conflicts should iNEDs thus be aware of?
In a single company board all matters of the day will be tabled. You are an iNED of the company, not just the fund range. Accounts and financials, annual report, audit, compliance, risk, sales, wider regulations, remuneration, dividends, marketing strategy, restructures, and so on and so on. The iNED thus is tasked with far more than the FCA’s narrow presumption of the Assessment of Value. They may also sit on subcommittees across the business – all positive for integrating better governance and oversight.
Clearly, all of these interests are not necessarily harmonious or mutually exclusive. You cannot discuss reducing fund fees to improve value and somehow disregard or segregate the impact that such reduction has on earnings. iNEDs must thus compartmentalise the Board agenda with care.
While a single board structure could give rise to conflicts of interest, these are highly visible and thus should be easily managed (or at least minuted). This is not to say a single board is superior to a dual board set-up, or vice versa. There are pros and cons to each. Yet as an industry – with the exception of smaller unit trust managers and investment trusts – we have largely moved away from a single board structure. Today this breed of firm is on the endangered species list, with many smaller fund firms outsourcing to external ManCos. Outsourcing is a debate for another day.
Last month I noted Parkinson’s Law – the idea that ‘work expands to fill the time allotted’ – as it relates to size and pyramidal decision making. Parkinson applies to fund boards just as it does to large insurers, pension schemes or banks. Does Parkinson infer a single board is superior to multiple boards?
(For those unfamiliar with Parkinson’s Law, described by C Northcote Parkinson in his 1958 paper, it is available here: https://www.panarchy.org/parkinson/parkinsonlaw.html)
From an NED point of view, generally speaking, there are pros and cons to residing on a single board. Currently, the positives just outweigh the negatives in my opinion – when it is a simple small business.
A single board improves visibility of all issues and risks that may affect the value to the customer. In addition, the NED can escalate issues at the most senior level, while a single board also reduces the risk of fund boards being isolated from the rest of the group. I for one am all for NEDs being able to access across, up and down the business to understand better and be more intrusive.
In a single board there are no regulatory cracks or ambiguity in decision-making, as the board has to visibly deal with all issues, as minuted. This is quite different to an NED that has to sit on multiple boards with multiple terms of reference, and is then asked to balance those interests and conflicts – for example, a NED simultaneously on the investment manager board and fund board, as the FCA has mooted. This phenomenon appears to be more prevalent among larger firms from what I have encountered.
The negatives could be the very primacy of director duties. Legally, a company board NED’s first duties are to the firm, as the FCA (incorrectly in my view) made these roles subject to the Companies Act – despite coining an ‘iNED’ moniker, which itself doesn’t exist in the Companies Act. These duties apply to group level NEDs and fund board NEDs.
A director’s duties are not easy to ring-fence, which I think some chairs or executives assumed early on. The FCA compounded this by subordinating the legal duties of a fund board ‘iNED’ by removing them from the Senior Managers & Certification Regime (SMCR) unless a chair.
The NED will also be more exposed to commercial discussions, strategy and financials on the company board. They are exposed to firm-wide liabilities and this can act as a disincentive, especially as most UK fund board NEDs are not compensated like their executive colleagues. I think the industry is wrong to be so concerned with proportionality – the danger is not being paid too much, but being paid too little!
Related to this, in a dual board structure, the ACD will pay the investment manager fees and there is more obvious scope to challenge those fees paid.
Arguably fund board NEDs have (in practice) more opportunity to focus on fund level governance and the Assessment of Value, ignoring their wider duties. I can see merit in this, particularly for larger fund ranges or for iNEDs of external ACDs with multiple fund managers and fund ranges.
Lastly, absence of a separate fund board removes the potential for natural tension between the fund board and company board. However, in reality, this just does not happen due to the executive structures in place. An independent chair, as I discussed last month, would help. Even then, the chair can be called in by the chief executive and persuaded to be less intrusive. This is why aspirations of culture will unlikely defeat the commercial DNA of the industry. Most of what is put out is about as plausible as a Trump tweet.
Some might see single boards as fertile conditions for conflicts to emerge. However, discharging director duties is fiduciary and aligned to treating customers fairly and promoting fundholder rights. Executives face similar duties under SMCR. Yet iNEDs cannot afford to wait for SMCR to bring about what should be positive long-term benefits to culture.
Ultimately for larger firms there is a scalability issue that might demand more than one board. The test should be: do multiple boards lead to more effective decision making, or do they simply make accountability less clear? I support the idea of NEDs from different committees engaging across committees, helping to improve information lines and short-cut management intransigence. Typically, in many large firms, NEDs are not formally encouraged to conduct such discussions and thus it tends to be ‘on the QT’.
For single boards, conflicts can also arise and perhaps, without the glare of other committees, these may not be fully resolved. Here NEDs must be vigilant. They need to consider where conflicts might arise for the executive and themselves, and challenge accordingly. As NEDs, we should thus remain sufficiently aloof from the rest of the board’s consensus but close enough to the information to be effectively constructive and critical. With an independent mandate from the outset, a NED shouldn’t find themselves conflicted within the firm – they should seek to manage any conflicts that might arise outside. The industry has not fully resolved the question of conflicts between NED roles held within a portfolio, nor will I attempt here.
As I discussed in part 1, this is a big issue ahead for Independent Governance Committees (IGCs). It is also a big issue for fund boards, especially if we see regulatory convergence on issues such as product governance, cost, value for money, liquidity, suitability and sustainability.
On the QT: An FCA reboot leading to fully independent committees devoid of director duties and conflicts, while logical, appears unlikely anytime soon. For that, we may need to wait for a new regulatory regime altogether.
Until next time. Quae Tacenda
1“Off the record, on the QT, and very hush-hush.” Danny De Vito as Sid Sugens, LA Confidential, 1997.
In his monthly column, Diary of an iNED, JB records his experiences on the boards of two very different organisations as he navigates the highs and lows of a plural career at a time when the fund industry is beset with challenges and opportunities in equal measure.
JB can be contacted at firstname.lastname@example.org.