To what extent should the Board of an AIF monitor the activities and level of compliance of its appointed AIFM?
This scenario may typically occur where an AIF within the scope of the AIFMD appoints an external AIFM as its manager. In this case there are a number of important activities which the Board of the AIF delegates to the manager, but which it must monitor in order to ensure that the AIFM is performing such tasks reasonably and in compliance with legal and regulatory requirements.
Important tasks delegated to the AIFM must include portfolio management and risk management, and will often also include administration and marketing. The AIFM may also, for example, provide support to the Board of the AIF in the performance of its duties. In addition, the AIFM commonly identifies and manages key service provider relationships on behalf of the AIF, such as depositories and auditors, and under the AIFMD has a responsibility to manage the valuation of the AIF’s assets and liabilities on behalf of the AIF to which it has been appointed. Clearly, the Board of the AIF has to be comfortable with the competencies and performance of the AIFM and will normally perform a degree of due diligence on the AIFM pursuant to this goal.
There are two key elements to this due diligence role:
- Initial due diligence
- Ongoing due diligence
Both initial and ongoing due diligence should be documented.
Initial due diligence
Before appointing an AIFM, the Board of the AIF should perform initial due diligence. The initial due diligence should, among other things, assess the ability of the proposed AIFM to perform the tasks to be delegated to it, and its ability to comply with the requirements of the AIFMD.
One of the key indicators for the Board of the AIF will be authorisation and supervision by the relevant supervisory authorities. Other typical factors which the Board of the AIF may consider may include:
- Scope of activities and experience of the AIFM;
- Knowledge, skills, experience and reputation of the Board, senior management and key staff, including the portfolio manager and risk manager;
- Organisation of the AIFM, including human and technical infrastructure, and the control arrangements of the risk management, compliance and internal audit functions;
- Delegation arrangements, and ability of the AIFM to perform adequate due diligence and ongoing monitoring;
- The identity and nature of the shareholders of the AIFM;
- Values statement or code of conduct, and how they are implemented in practice;
- Segregation of risk and portfolio management functions;
- Independence of the internal/external valuer.
From a practical perspective, the AIFM could provide the Board of the AIF with part or all of its application for authorisation to the supervisory authorities, and/or its handbook describing its organisational structure, policies and procedures, to assist the Board of the AIF in its assessment of the ability of the AIFM to comply with the requirements of the AIFMD.
Ongoing due diligence
The Board of the AIF should perform ongoing due diligence to assess whether the AIFM continues to have the ability to perform the tasks which have been delegated to it and to comply with AIFMD requirements. From an ongoing compliance perspective, the AIFM should provide the Board of the AIF with one or more reports covering:
- Risk management, including, among other items, KPIs on compliance with the risk limits and the risk profile of the AIF as disclosed to investors;
- Compliance with the regulatory requirements, including in particular KPIs on the compliance of the AIF;
- Internal audit reports, providing, among other items, an evaluation on whether risk management, control, and governance systems are functioning as intended.
Typically, each of these reports would be AIF-specific. In each case, the report should also cover remedial action to correct any deficiencies identified in the current or previous reports. The Board of the AIF should receive these reports at a frequency which is appropriate to the activities of the AIF, and at least annually.
In addition, when the AIF is appointing key service providers such as auditors and depositories, or providing representations to them, and when approving reports and accounts of the AIF, they are relying on the output of many of the key functions of the AIFM. Such reliance may be formally constituted in the form of reports and representations from the AIFM to the AIF.
- The Corporate Governance Module: principle number 7 refers to confidentiality and principle number 5 to transparency.
- The INREV Due Diligence Questionnaires (DDQs) touch on confidentiality in the assessment process.
- INREV provides a standard non-disclosure agreement (NDA) with the purpose to replace the wide variety of NDAs currently being used in the industry.
- There should be free flow of information between existing investors and the fund. The fund documentation should prescribe a mutually binding confidentiality undertaking.
- If there is a business need to provide information outside of the investor group – for example, to a potential new investor looking to buy a secondary position – then the manager should be able to refer to the fund’s documentation, which should state clearly under which conditions and circumstances such information should be provided.
- The condition could be to ensure that the investor would be qualified for admission to the investment vehicle (e.g. minimum net worth tests, tax position et cetera).
- The manager should then provide confidential information provided that the outside party has signed an appropriate NDA.
What are the advantages of the Corporate Governance Assessment?
The tool provides a practical way to measure the strength of a vehicle’s governance regime, by quantifying the level of compliance with the INREV Corporate Governance Guidelines. Compliance levels for different vehicles can be compared in a consistent way, and in future this can be set against the market as a whole – once a critical mass of funds have used the tool and agreed that their results can be aggregated for comparison purposes. It will also be possible to link a fund’s level of governance with other relevant INREV data, for example on the fund’s compliance with other Guidelines, or with its investment performance.
Why should a fund manager use the tool?
Managers can show the vehicle’s compliance with industry guidelines to existing and new investors. It forms a base reference for further improving the vehicle terms and reporting of vehicle.
Why should an investor use the tool?
Investors will be able to use the assessments during their due diligence process to facilitate a dialogue with managers about corporate governance and reporting issues. The results will help to compare the governance of existing and potential investments in vehicles.
In which phases of the life cycle of a vehicle should the assessment be used?
The tool is intended to be used right through the vehicle’s life cycle, but especially during the set-up phase and at times when new investors can enter. It will help managers to provide a statement of compliance that can be used in the vehicle’s annual corporate governance report to investors, allowing them to show the vehicle’s level of compliance with industry guidelines. It provides a base reference point for improving the vehicle terms and its reporting framework.
How often should the assessment be updated?
The Corporate Governance Assessment should be updated on an annual basis. If there is a significant restructuring of the vehicle, amendments in the side letters, or changes in the fund documents the assessment should be updated immediately.
How long does it take to fill in the questionnaires?
The time you need to fill in the questionnaire depends on your familiarity with the vehicle documents. Being properly prepared, the questions can be answered easily and additional information can be added easily by using the tool’s comment function. Going through the Corporate Governance Questionnaire is expected to take 15-20 minutes.