This INDOS Financial article was first published by Global Investor and can also be read here (subscription required).

A decade ago, fund governance was seen by some managers as little more than a clerical duty　albeit one which did not intrude on their activities or strategic decision-making. Equally many investors rarely spoke of or monitored the actions of those directors, despite their essential mandate to look after clients’ fiduciary interests. 2008 was not the proudest moment for some directors, as they signed off on actions instigated by managers that disenfranchised clients and disregarded investor interests.

Since then, investors have become more vigilant about the quality of directors, but so too have financial market regulators. The Cayman Island Monetary Authority (CIMA) required local fund directors to register, and it set up a closed database containing their details. Ireland, a major onshore fund jurisdiction,  has also made enhancements to its corporate governance with its Central Bank imposing, through CP86, a strict location, capacity and competence policy on directors serving on the boards of alternative investment and UCITS fund management companies.

Now it is the time of the UK Financial Conduct Authority (FCA) to outline its expectations on corporate governance at asset managers. In the FCA’s final report on the asset management industry, which was released in June 2017, governance was prominent throughout, and the regulator clearly sees it as an important safeguard in protecting investor interests and ensuring value for money.

The FCA’s report said it expected the appointment of at least two independent directors to sit on the board of UK management companies of UK authorised funds and UK or European UCITS funds. Whilst the scope excludes alternative investment funds such as hedge funds, private equity and real estate funds and investment trusts, there could be potential for the proposal to extend to these types of funds in the future.

With heightened and more robust governance will come greater accountability, not least from service providers such as depositaries, who under the Alternative Investment Fund Managers Directive (AIFMD) and UCITS V,  carry out a critical oversight role over fund operations, existence of assets, cash-flows and compliance. Boards may also start to demand more independent risk oversight takes place in order to effectively discharge their duties.

Following the FCA’s new guidelines on corporate governance, depositaries are likely to be under greater scrutiny from board directors to ensure they are performing their AIFMD and UCITS V obligations to the highest standard. More broadly, service providers overall are going to have to demonstrate that they are doing their jobs properly, and should poise themselves for more frequent engagement and tougher questioning by independent board directors.

AIFMD has been a key feature for the European funds industry for three years now and depositaries have helped bring greater security to investors and this has been achieved at only a modest cost to the fund management industry.

Brexit, admittedly, has introduced uncertainty and there have been calls in the industry for the UK government to replace AIFMD and other funds regulation with looser, less prescriptive rules. The FCA study is a good indicator this will not happen. It states it expects its proposals will strengthen fund governance and lead to the UK asset management industry being a more attractive place for investors and improve the relative competitiveness of the UK market. Watering down regulation　could also undermine the UK’s battle to obtain equivalence with the EU, something which would be highly damaging to financial services at a very sensitive period.

The UK government has also shown no will or inclination to dis-apply existing rules. The FCA has a history of gold plating certain EU rules while also applying proportionality to others. The depositary is viewed, like effective independent directors, as one of the cornerstones of sound fund governance. The likelihood therefore of the UK regulator adopting a U-turn on depositaries is near to nil.

Directors will be enlivened and more rigorous in how they conduct business in the UK under the new FCA regime, and the role of the depositary is going to become critical, as they emerge as an increasingly important reference point for boards scrutinising managers’ activities.