Despite the looming EU deadline on ESG reporting, around a third of boards of UCITS funds and nearly half for alternative funds report had not reviewed the implications of the sustainable finance disclosure regulation (SFDR). This is one take-away from the new Luxembourg Fund Governance Survey 2020* by the Luxembourg Directors’ Institute (ILA) and PwC.
Boards of investment funds and fund management companies (ManCos) are having to acquire a new outlook fast. SFDR requires all funds to take a position on their green investing stance by 10th March this year, but this new report suggests that significant numbers had yet to get moving when the survey was conducted. That said, directors appear to be working to boost their understanding of these challenges, with the survey finding more than half of directors undergoing ESG or socially responsible investing training.
The survey also looked into the Covid effect. It was a key driver for the increase in the average number of board meetings, from 5.5 in 2018 to 7.7 in 2020. Regulatory factors were also at play too, particularly circular 18/698.
The survey showed that for most boards, business continuity was the number one area of added concern due to Covid. The exception was for alternative funds for which dealing with new business opportunities was the main impact, as lockdowns gave a jolt to business models in areas such as private equity, real assets and debt. No fewer than 96% of boards used new regulatory leeway to increase working from home arrangements during the March-May lockdown.
Lack of cyber risk management
Increased working from home carries greater cyber security risk, yet the report suggests directors’ attention may not have kept pace with this change. Over a quarter of boards said they didn’t receive sufficient reporting on cyber security last year. Of boards that map the skills they require of their team of directors, cybersecurity expertise was only required by 16%. This compares to 37% who required ESG expertise and around 70% for a range of regulatory and product-related skills.
The survey also sought to gauge long term trends related to fund governance, which of course is the sometimes-overlooked element of “ESG”. Where there could be a strong suspicion of regulatory box-ticking around the role of fund boards in the past, these bodies are now increasingly expected to add value on strategy, risk management and more.
What is an independent director?
Greater independence and diversity are seen as crucial as organisations seek to challenge group-think, with this being encouraged by hard and soft regulatory pressure. The number of independent board members rose from 30% in 2018 to 35% in 2020 on average. For UCITS funds this reached 42% and for AIFs 49%, but was only close to a quarter for fund ManCos.
Yet these numbers have to be treated with caution as there are different interpretations of the word “independent” in this context. ‘There is no official definition from what we consider an independent director, but we considered that although a service provider is not an executive director they are also not independent,’ said Michael Delano, ILA Fund Committee Chairman and PwC Luxembourg.
The practice of having directors on both the board of the ManCo and the fund managed by the ManCo has declined. CSSF circular 18/698 specifically counselled against this dual role as a way to reduce conflicts of interest. For Super ManCos (which act as both UCITS and AIF ManCos) there was a particularly sharp change: down from 4.7 directors at both levels in 2014 to 1.3 in 2020.
The presence of female board members has gone from 14% in 2016 to 22% last year, with UCITS boards being 31% female but just 16% for AIFs. The report says the authors did not scrutinize diversity in terms of directors’ geographical origin this time, but intend to do so in the next survey.
Independent directors were found to be slightly more experienced than average, and are much more likely to have acquired ILA certification or be in the process of doing so (40%). The average independent fund or management company director was also more likely to be female, with women representing 28% of the total compared to 19% with fund promoters and 9% with service providers.
There has also been change in how funds manage fees: a key point in the current environment of low investment returns. UCITS reported an increase in the practice of fixing total expense ratios (up 8 points to 50%) but there has been a decline for AIFs (down 10 points to 8%). The report suggests that this change points to more predictable UCITS funds being more transparent about how fees will be charged over the year, while alternatives are seeking greater flexibility given the greater volatility they tend to encounter. If these changes are accompanied with transparency by the fund, it should give investors better value said the report.
* This is the 10th edition of this exercise, which surveyed board chairs and members, conducting officers, and corporate secretaries in 122 investment fund and management companies of all types based in Luxembourg. These organisations represented 69% of total UCITS assets under management in Luxembourg and 44% of AIF assets. It covered fund promotors from 22 different countries, but mainly UK, CH, Luxembourg, the US and France.