Reinforcing your vertical integration

ASIC has made some important observations about conflicts management practices in the funds management sector which have broad relevance not confined to fund managers.

It has found that among organisations reviewed, documented procedures were generally followed but were often too high level and practical implementation was not consistently applied or embedded.

ASIC's report outlining its findings of an extensive review of the conflicts management practices in vertically integrated businesses in the funds management industry was released on 21 March 2016. A copy of the release can be found here and a copy of the report can be found here.

Summary

ASIC uses 'vertical integration' in a very narrow way in the report. ASIC's review focused on groups with a vertically integrated business operating at least two of the following businesses: investment management; responsible entity or wholesale trustee; superannuation fund or PST; platform; investment administration; custody. By this definition, practically every funds management business will be 'vertically integrated' whether or not they are part of a bank or have a financial advice business. The only exceptions will be fund managers who only provide investment management services and who outsource all other activities.

The review over the period from 1 July 2013 to 30 September 2015 involved 12 significant participants in the funds management industry.

The report was prepared to inform the financial services industry about ASIC's observations of 'good practice' in relation to conflicts management, including what ASIC considers to be appropriate systems and approaches to ensuring a culture that promotes compliance.

While ASIC was encouraged that many organisations appear to take their conflicts management obligations seriously, ASIC concluded that:

  • businesses may be adopting a set of policies without sufficiently embedding the expectations of the policies in the business; and
  • in some instances, conflicts of interest may not have been adequately managed, leading to concerns that it may be necessary to restructure business units, roles and remuneration structures to prevent conflicts of interest arising.

Background

The principal obligation of an AFS licensee is set out in s 912A(1)(aa) of the Corporations Act 2001 (Cth), which states that a licensee must:

have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken by the licensee or a representative of the licensee in the provision of financial services as part of the financial services business of the licensee or the representative.

ASIC's findings: Types of conflict of interest

ASIC asked the 12 funds management groups to provide examples of the types of conflict of interest they encountered as part of their business. The following examples were identified and intended to provide broad rather than exhaustive coverage:

  • product manufacturing versus product distribution
    • concerns included pressure to include and retain products on a product disclosure statement
  • outsourcing services to related companies
    • concerns included proper assessment of capability, arms length terms and fee levels
  • fiduciary duties versus duties to shareholders
  • benefits and remuneration
    • concerns included short-term sales incentives and targets, benefits not available from unrelated parties and employee remuneration
  • director and responsible person duties
  • ownership interest in the group
  • situations requiring the creation of an information barrier.

ASIC's findings: Conflicts management

In general, ASIC found that financial services organisations demonstrated a commitment to maintaining and reviewing policies and information barriers, with some focus on training. However, ASIC found many policies were high level and generic and not focused on specific risks of the business. Further, on matters of outsourcing (e.g. ensuring terms complied with), product selection, remuneration (e.g. linkage to compliance outcomes), board membership (e.g. ensuring knowledge and skill is not compromised if a director cannot participate due to conflict and conflict registers), there may be areas where financial services organisations could demonstrate a better commitment to managing and, where appropriate, avoiding conflicts of interest.

Good practice recommendations

ASIC recommended that conflicts management policies are effectively embedded into all financial services business operations, with a commitment from the board and senior staff to develop and maintain a culture of awareness of conflicts of interest.

As an example, ASIC suggested that entities use standard templates for board agenda and committee papers that include prompts to identify and consider conflicts of interest.

Further, ASIC suggested that businesses takes into account the ‘Four Cs’ elements of managing conduct risk:

  • Communication — The conduct expectations of the conflicts management policy are communicated to all levels of the organisation to ensure it is ‘front of mind’. The communication strategies ensure the message is embedded from the level of the CEO and board to each level below. It is not sufficient to adopt a policy without communicating and enforcing the requirements of that policy.
  • Challenge — Organisations are continually re-thinking and, if appropriate, changing business models, board and employee roles, and incentive practices that create conflicts of interest, to ensure that conflicts do not result in poor conduct.
  • Complacency — Policies and conduct are continually reviewed, enforced and validated to address key risks.
  • Consequences — There are consequences for both appropriate or exemplary conduct and for poor conduct.

ASIC made further observations as to what would constitute 'good governance processes' which is elaborated upon in the report.

Consequences for licensees

ASIC encourage all licensees, not only those that are vertically integrated or within the funds management industry, to consider their arrangements in light of this report, specifically the good practice recommendations.

ASIC also suggests that it may be appropriate for an industry standard or other guide to be developed to help industry to identify and manage conflicts of interest, as well as to drive a cultural response to conflicts management.