On 20 October 2020, the Central Bank published the findings of its assessment of fund management companies' implementation of the organisational effectiveness framework.

Background to Central Bank publication

In July 2018, the Central Bank's organisational effectiveness framework for fund management companies (the Framework, commonly known as CP86) came into full effect for Irish UCITS managers, AIFMs and internally managed funds (FMCs). The publication of the Framework, encompassing a limited set of rules and an extensive set of regulatory guidelines, marked the conclusion of a lengthy iterative process which began in September 2014 with the launch of a three-stage industry consultation (consultation paper 86 or CP86) process on a range of 'initiatives [ ] designed to underpin the achievement of substantive control by fund management companies acting on behalf of investment funds, over the activities of their delegates'. Shortly after the transitional period for implementation of the Framework by pre-existing FMCs ended in July 2018, the Central Bank, no doubt cognisant of the passage of time and the evolution of the Framework since it first embarked on the adoption process, indicated its intention to undertake an assessment of how FMCs had implemented the Framework.

Central Bank Framework implementation assessment

In late 2018, the Central Bank commenced the assessment of how FMCs implemented the Framework. Over the course of 18 months, it carried out desktop and/or onsite reviews of all 358 active Irish FMCs, focussing on three areas of FMC responsibility; investment management, risk management and organisational effectiveness. Following delays resulting from Brexit and the current pandemic, the assessment concluded on 20 October with the publication by the Central Bank of a 'Dear Chair' letter to Irish FMCs setting out the findings of its assessment.

Central Bank assessment findings

The familiar regulatory themes of substance, delegate oversight and retention of FMC board responsibility are strongly in evidence in the Central Bank's 'Dear Chair' letter, which details deficiencies identified in FMCs' implementation of the Framework along with regulatory expectations for best-practice compliance with the Framework's rules and guidelines.

FMCs are mandated to review the contents of the letter against existing arrangements and adopt an action plan for any necessary remediation measures by the end of Q1 2021. To assist FMCs in undertaking this review, we have prepared the below analysis which tracks the Central Bank's categorisation of its findings under the headings of (i) resourcing; (ii) designated persons (DPs); (iii) delegate oversight; (iv) risk management framework; (v) FMC board approval of new funds; (vi) director for organisational effectiveness (OED); and (vii) governance and culture trends identified.

Resourcing

Identified Deficiencies Regulatory Expectations
Many pre-Framework FMCs (authorised prior to its adoption in 2017) do not have the appropriate levels of resourcing necessary to ensure effective implementation of the Framework.
  1. All FMCs, even the smallest and simplest of entities, should have a minimum of three, suitably qualified and appropriately senior, full time employees/equivalent to full time employees.
  2. Larger firms (term not defined) are expected to have a level and quality of resourcing determined by the nature, scale and complexity of its operations and DPs in such firms are expected to be full time roles.
  3. FMCs "must appoint locally based [DPs] and other staff with sufficient time dedicated to their roles in order to fulfil their duties, which include oversight of delegated activities".
  4. Inadequate levels of resourcing are considered indicative of an over-reliance on group entities and/or delegates and an FMC's growth should be reflected in appropriate resourcing.

Comment: While certain requirements for Irish-based DPs were anticipated in light of the Framework's 'location rule' for FMCs (which followed ESMA's Brexit Opinion of July 2017, both of which set out residency requirements for those performing senior management roles within FMCs), the opaqueness of the Central Bank's findings requires further clarification in order to provide certainty to FMCs as to their obligations. We are seeking to do this as a matter of priority.

Designated Persons

Identified Deficiencies Regulatory Expectations
  1. Inadequate review and independent analysis by DPs of periodic reporting from delegates.
  2. Poor quality DP reporting to the FMC board.
  3. Inadequate DP time commitments and/or insufficient allocation of support to DPs to allow for proper discharge of responsibilities.
  1. DPs should have enough time available to them to carry out their roles thoroughly and to a high standard.
  2. Evidence of constructive challenge by DPs and interrogation of information received from FMC staff and delegates.
  3. Documented FMC board reporting should clearly evidence the value the DP brings to the oversight of delegates.

Comment: Documenting the discharge of functions and interactions with both the FMC board and delegates is essential to evidencing compliance with the Framework's 'second-line of defence' function of DPs.

Delegate Oversight

Identified Deficiencies Regulatory Expectations
  1. Insufficient due diligence on delegates both pre-appointment and an ongoing basis.
  2. Lack of evidence of a formalised process for review and approval of FMCs' reliance on delegates' policies and procedures.
  3. Lack of engagement with delegate investment managers resulting in the untimely resolution of issues.
  4. Inadequate delegate reports particularly in the context of multi-manager structures.
  1. Delegate due diligence reviews to be conducted at initial take on and annually thereafter.
  2. Where reliance is placed on a delegate's policies and procedures, a formalised process for the initial and ongoing review of those policies and procedure should be established.
  3. Issues with investment manager(s) should be challenged by the FMC and where necessary further action taken and evidence of such challenge and action should be available.
  4. Delegate arrangements should be governed by formally documented SLAs.

Comment: The Central Bank has consistently focussed on effective, interrogative, engaged and demonstrable oversight of FMC delegates, both throughout the Framework adoption process and since it came into full effect in July 2018. While the focus of the Central Bank's assessment on investment management (along with risk management and organisational effectiveness) is reflected in the above findings, best practice may be to analyse all existing delegate arrangements as against the above regulatory expectations in the context of the FMC review of existing arrangements on foot of the Central Bank's 'Dear Chair' letter.

Risk Management Framework

Identified Deficiencies Regulatory Expectations
  1. Absence of entity-specific framework, risk register and/or defined risk appetite.
  2. Over-reliance on group frameworks.
 Adoption of robust, FMC board approved, entity-specific risk management framework that is fit for purpose and regularly (at least annually) reviewed and which includes risk register and risk appetite statement.

Comment: While the Framework does not preclude reliance on delegate or group policies and procedures to meet FMC obligations to have in place policies and procedures, it does set down guidelines for such an approach to compliance. The Framework guides an FMC, intending to rely on a delegate's, or its group's, policies and procedures, to document the approach of reliance in its entity-specific policies and procedures including (i) how the FMC has satisfied itself that relying on its delegate's policies and procedures will ensure that it is complying with its regulatory obligations i.e. how the FMC has mapped its regulatory obligations against those of its delegate; (ii) how the FMC will test that the delegate's policies and procedures are being complied with; (iii) the frequency with which the FMC will review its policies and procedures; and (iv) the role of the relevant DP.

FMC Board Approval of New Funds

Identified Deficiencies Regulatory Expectations
  1. Lack of evidence of FMC board approval of sub-fund launches or approval only immediately prior to launch.
  2. No evidence of FMC board discussions to set or agree proposed fund strategies prior to Central Bank application.
  1. Evidence of robust FMC board discussion and challenge of proposed fund strategies/structures and attendant risks.
  2. Early FMC board involvement e.g. when first formulating fund strategy or prior to submission of fund application to the Central Bank.

Director of Organisational Effectiveness

Identified Deficiencies Regulatory Expectations

A range of weaknesses in how the OED roles is performed were identified across a large number of FMCs, including:

  1. No evidence of OED meetings conducted with DPs or the FMC board.
  2. No evidence of OED reports to the FMC board, particularly in respect of resource evaluation where there was no evidence of how resourcing levels were challenged or, where OEDs indicated satisfaction with resourcing (during Central Bank assessment), how they had reached that conclusion.
  3. OEDs failing to review key considerations of resourcing levels, conflicts of interest and personal transactions, along with an absence of formal reporting to, and challenging of, the FMC board on such matters.
  1. OED is a 'change leader' who makes proposals to the FMC board for improving effectiveness.
  2. Key responsibility of OED is monitoring the adequacy of internal resources and meaningful, regular interaction between the OED, DPs and the FMC board is necessary to meet this responsibility. Such interactions should be formally documented and available to the Central Bank upon request.
  3. Quarterly, or more frequent, OED/DP interactions.
  4. Annual OED reporting to FMC board on resourcing levels.
  5. OED is responsible for ensuring documentation of annual FMC board effectiveness evaluations (including findings and time specific actions).
  6. Ongoing consideration of conflicts of interest and personal transactions.

Governance and Culture Trends Identified

In addition to the above findings, the Central Bank cited the following matters not specifically covered by the Framework:

  • CEOs: the Central Bank expects, all but the smallest, FMCs should have a CEO such that they may demonstrate substance through the appointment of a senior executive with responsibility for the day to day running of the business.
  • Independent non-executive directors (INEDs): two-thirds of FMCs have at least one INED with a tenure greater than 5 years, while 28% of FMCs have at least one INED with a tenure greater than 10 years. OEDs are expected to consider tenure and ongoing independence as part of the review of FMC board composition related reporting to the FMC board. OED reviews must consider the appropriateness of the continued use of the INED designation where the INED is in place for such a prolonged period of time. This review, which must be documented and available upon request to the Central Bank, needs to consider how to achieve a sufficiently regular rotation of board members to ensure independent challenge at board level.
  • Gender imbalance: of the 1,654 directorships across 358 FMCs, only 266 or 16% of director roles are held by women. FMCs should consider gender diversity as part of the review of existing arrangements required in the 'Dear Chair' letter.

Next Steps

All FMCs will be impacted by the above findings of the Central Bank's Framework implementation assessment. While the Central Bank intends to issue risk mitigation programmes (RMP) to the FMCs the subject of specific concern, all FMCs must (i) assess existing arrangements as against the Central Bank's findings and (ii) if necessary, develop an action plan for any remediation measures required. Steps (i) and (if applicable) (ii) should be completed by end Q1 2021 and, at a minimum, should address the following:

  1. time commitment, skills and expertise of available resources;
  2. FMC retained and delegated tasks, including how ongoing independent challenge of all delegates can be ensured;
  3. required Framework tasks, including those that must be completed on a fund by fund basis;
  4. any uplift in resources and operational capacity necessary to take account of any increase in the nature, scale and complexity of the funds under management since authorisation or the last time the FMC critically assessed its operations;
  5. any uplift in resources and operational capacity necessary to deal with a market and/or operational crisis.

Originally published 22 October 2020

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