The issue – the owner of an investment management firm is the dominant equity owner, and probably the dominant personality and wants control, but promises to be nice to employees, clients and the market. The FCA (and probably clients) want to ensure there are systems and process to ensure proper accountability, openness and probity.
How can both be accommodated?
There has been much (too much?) written about the various erstwhile bodies who have worked on the area of governance in financial services firms since the laissez-faire days of 2006-7 came to an abrupt end. Much of this has focused on the banking area for obvious reasons, and regulation there has gone so far as to cause some directors to resign rather than take the risk of personal liability and even criminal sanction for simply attempting to manage a bank. The world of investment management has not been impacted so directly, but if a firm is to be authorized, and succeed, the question of governance needs to be taken very seriously.
The pressure is coming from several different directions – Government, the regulator, institutional and professionally advised clients – and there is no sign that this is going to reduce any time soon. Firms need to embrace the FCA guidance in this area, and embed it into the culture of the firm if they are to prosper in the post-Lehmans World.
So what is required? Let’s start with how the firm should look when it is up and running successfully and work backwards. There needs to be an effective management board. While it is obvious that the executive members need to be good at the day job for which they are appointed, there needs to be effective oversight. The FCA does not prescribe how this is to be achieved and there are a number of alternatives:
NEDs – the most common route is through the appointment of Non-Executive Directors. This process works if the right director(s) can be found and a process implemented to ensure that they are kept properly informed with sufficient information in order to be able to challenge management. NEDs will need to go through the approval process as Significant Influence Functions and will be an integral part of the firm. Care needs to be taken to ensure that there are proper records of all information supplied, and any interaction with the NEDs. This will extend beyond board minutes, which historically were almost the sole point of focus for the FCA, to all communications. Informal meetings, to update NEDs are now also seen as a good way to keep in touch, along with monthly management reports etc., which the NEDs can come back on by phone or email exchange.
Oversight boards – these can be used for specific areas of the business such as investment or distribution, or as the process for challenge of the management board itself. In smaller firms, the ability to call on independent outside help to scrutinise investment strategy, or the marketing process for example, can be extremely useful, as well as demonstrating the sort of review which appeals to the regulator. They can also be used as a strategy sounding board, giving the main owner the chance to run ideas past an independent panel who have the firm’s best interests at heart but are likely to have a greater eye for the concerns of other stakeholders in the business.
Risk (and Other) Committees – this is an area of specific concern, and the presence of an independent person here can be of great benefit both in terms of ensuring that the firm is aware of current market practice but also to ensure compliance with the letter and spirit of regulation. An expert can be drawn from an appropriate consulting firm or a known individual with wider expertise may be the best route.
Whichever route, or combination of routes is used, it is key to ensure that there is a culture of challenge in the firm. Provided that the firm is using the correct individuals or firms to provide the necessary degree of expertise and independence, this should be a healthy state for the firm and give the key individual(s) comfort that they are on the right track. Given the immense amount of knowledge that employees in the firm will have, a process whereby they can feed into the process can also be of enormous benefit.
How do we balance challenge with the key individual’s desire for control?
This is a commonly raised issue when looking to structure or re-engineer a firm which has a dominant individual or two. Quite rightly, they see this as their idea and success comes significantly from their expertise and industry reputation. They may well have left a major institution due to frustration with interference from other parts of the organisation and are loathe to surrender power or control. They also frequently point to the fact that for the people they recruited (frequently from their former employers) have joined because it is going to be run by the main guy. There are a couple of points here:
Employees are likely to have given up secure well-paid roles to join and the idea that there is a robust independent element or point of contact can be a great comfort, and influence the decision to join.
Clients will be coming to the firm because of the key individual, but they will want to see that the business is safe and that there are some wise heads helping to keep an eye on things. Clients of a new business frequently have concerns that the key people may be stretched too thinly.
The concerns of the main people will be that they are giving up control, or are even giving themselves a new boss. In practice, these need not be concerns;
The executives, and hence in practice the key individual will be deciding on the whole strategy for the firm. In forming this strategy, outside input in terms of risk analysis, and a sounding board with industry expertise, can be of great benefit.
There will be areas of the business which are either not of great interest to the key person, or are outside their area of expertise. These can sensibly be passed to someone else to play a key role in deciding.
Some areas of regulation require an independent input, and this is likely to increase. If there are some individuals, whether they be NEDs or experts appointed to an oversight panel or committee, who know the business thoroughly, the process is likely to work well.
The key point for the owner(s) is that they can be in control of the process. Constitutional documents such as shareholder agreements and partnership agreements can be drafted to separate out economic and control provisions.
There is no problem with the owner ensuring that they keep the right to appoint NEDs for example. While care needs to be taken to ensure that they do not use this provision to simply appoint Yes People, it does mean that if they do not have a good working relationship with an individual, or their ideas are inconsistent with the way the owner wants to see the business go, they can be replaced.
The structure can be set up so that, while the independent element has detailed knowledge and are in a position to advise and challenge, they cannot make any decisions. Anything of import would require the assent of the owner.
Provided that it is set up correctly, and that record-keeping is up-to-scratch, the owner can have their cake and eat it – control of the business and key decisions, but an independent informed element to advise and constructively challenge, and in compliance with the requirements of the regulator and increasingly well-informed clients.