The Central Bank of Ireland’s CP86 Consultation Process on Fund Management Company Effectiveness has been a hot topic in the Irish funds industry over the last two years. The proposals in their June 2016 CP86 consultation have proven to be the most controversial, in particular, what has become known as the location rule and the multi-location rule.
The Location Rule
With a view to ensuring effective supervision of fund management companies (“ManCos”), the location rule proposed the following regulatory changes.
The Proposed Location Rule
The Proposed Location Rule was controversial because 40% of Irish funds are promoted by US managers who are outside of the EEA and another 37% are promoted by UK managers who may soon be outside of the EEA. In Ireland, most UCITS and a lesser proportion of AIFs are self-managed and, accordingly, are subject to the ManCo effectiveness requirements. While these ManCos complied with the regulatory requirement to have 2 Irish resident directors, they would typically have a majority of non EEA “promoter” directors. As reflected in the many responses received to the consultation, many industry participants felt that the governance model was not broken and that it did not need fixing. The Proposed Location Rule would have fundamentally altered, and in many cases reversed, the balance of fund board composition. The Central Bank feedback statement explained that it was anxious to strike a balance between effective supervision (in Ireland) and availability of expertise (outside of Ireland).
It did so by recalibrating the location rule as set out below.
The Final Location Rule
The Central Bank’s impact analysis suggests that the impact of the Final Location Rule will be minimal with changes of no more than 2 board directors being necessary. Empirical evidence suggests that the impact will be greater for some ManCos and the impact of a 2 director shift in terms of board composition should not be underestimated as it alters the balance from promoter control to independent control. For these reasons, it is likely that most will see the Final Location Rule as being a case of the glass being half-empty.
The Final Location Rule will likely lead to boards comprised of even numbers of directors with the consequent need to include “deadlock” provisions such as a Chairman’s casting vote.
The Final Location Rule may also accelerate an emerging trend (already well established for AIFs) towards the use of external or third party ManCos. As the preponderance of CP86 Guidance applies to ManCos and not to externally managed UCITS or AIFs, such structures will not be subject to the Final Location Rule at fund level. Similarly, third country ManCos who are permitted to manage Irish UCITS and AIFs will not be subject to the CP86 Guidance.
Proposed Multi-Location Rule Abandoned
In addition to the Final Location Rule, the June consultation also proposed that where Designated Persons were not working in the same location, they must be employed by the same group of companies and must be able to co-ordinate their roles effectively. This proposal would have impacted models that sought to combine the use of promoter/third party consultant hybrid models and the Central Bank has opted not to retain it.
The Central Bank’s consultation coincided with the unexpected result of the Brexit referendum and, as 37% of Irish funds have UK promoters, the impact of the Proposed Location Rule was greatly increased. While the Final Location Rule still references the EEA, the Central Bank’s feedback statement provides a broad hint with regard to the thinking of the Central Bank with the statement that:
“A number of respondents raised the issue of how the proposed exit of the UK from the EU will affect the Central Bank’s approach. In formulating this feedback statement and the final rules, we have been cognisant of this aspect. Clearly, the UK’s exit from the European Union has not yet occurred and the terms of that departure and the subsequent arrangements remain the subject of major negotiations to come. It is not possible for us to predict the outcome of those negotiations. In this feedback statement we have set out in some detail the factors which are relevant to our assessment of the extent to which an authorised entity can be considered to be subject to effective supervision. These factors should allow interested parties to assess the likely impact, if any, of different forms of Brexit on the application of our rules.”
These factors include: physical proximity; demographic, cultural and historical ties; ease of travel; homogenous legal and regulatory environment; common supervisory network; similarities of approach to regulation, supervision and enforcement; and commonalities of legal system.
It would appear relatively clear that the Central Bank is favourably disposed towards including the UK (in addition to the EEA) to the list of permitted countries for the Final Location Rule (if permitted!) and this signal should be sufficient to assure UK directors that no immediate action is required on their part.
Retrievability of Records
The feedback statement also confirmed the Central Bank’s intention to proceed with the less controversial measure of requiring ManCos “to keep all of its records in a way that makes them immediately retrievable in or from the State.”
Dechert has developed an online, password protected support portal – DSL Portal – to provide real time company information and document management support to assist clients with the implementation of this rule.
Implementation and Transitional Arrangements
In addition to the Final Location Rule (which related to effective supervision) and retrievability of records, the June 2016 Consultation also covered managerial functions and organisational effectiveness and the final guidance is largely unchanged from the consultation.
The Fund Management Company guidance is now complete and is comprised of 6 chapters:
- Delegate oversight
- Organisational effectiveness
- Directors time commitments
- Managerial functions
- Operational issues
- Procedural matters
The Central Bank has confirmed that “[d]ivergence from the guidance will not be a regulatory breach. However, the Central Bank’s supervisors will have reference to this guidance when forming a view as to whether a fund management company has complied with its regulatory obligations.”
With regard to transition:
- For existing ManCos, compliance with the new rules relating to managerial functions, organisational effectiveness, retrievability of records and location rule/effective supervision must be 1 July 2018.
- For New ManCos, applications after 1 July 2017 must be in compliance with the new rules.
Now that the rules are in final form, Dechert will be producing a more detailed CP86 OnPoint in January 2017.