A Better Grasp of Non-financial Risks

The European Fund Management Industry Needs a Better Grasp of Non-financial Risks — December 2010

3. Risks and Responsibilities in the Fund Industry

funds calls for convergence towards “better regulation”.

from corporate law, so its prescriptions are not as detailed as other countries with civil-law origins. Its legal code is closer to the original Napoleonic code, whereas in France subsequent prescriptions have been added. Luxembourg has detailed the duties of the valuator (the valuator/fund administrator is not regulated in France). The corporate model, with emphasis on the responsibilities of the board of directors, has the theoretical advantage of making possible controls over such common triggers of conflicts of interests as fees, expenses, and turnover. In the US model, where the board technically hires the custodian and the investment manager, it is easy to entrust the board with the responsibility for following best practices in risk management and sub-custodian arrangements, but guidelines are sometimes necessary to perform tasks made more difficult by conflicts of interest. The European model relies on the depositary to assess the compliance of the fund (with regulations and with its prospectus); the relative advantage of reliance on the depositary is that the board of directors cannot assume large financial responsibilities with respect to the end-investor and that, as large firms, they have professional and independent staff; depositaries, unlike the board, have capital requirements, so they may have further incentives to monitor the compliance of funds. In the same line of thought, Morley, Curtis, and Olin (2010) argue that the board of directors is not well equipped to monitor the compliance of funds. Finally, some European models can be thought of as hybrids with both a depositary and a board, where compliance is entrusted to the depositary and the board has more general oversight functions. Boards of directors and depositaries could complement each

3.1.2 The Influence of the Model of the Firm Countries such as Luxembourg, Ireland, and the United States have regulation that resembles that of corporations, as they place large responsibilities on the board of directors and give the board a role that resembles that of the board in a corporation (technically, the board is elected at general meetings; it hires the investment manager; it usually has direct fiduciary duties towards the end-investor and is responsible for ensuring that the fund complies with regulations, even in countries where there is a depositary). France and the United Kingdom, by contrast, have financial laws very distinct from the corporate laws that inspired the regulations of many other countries; in the United Kingdom, there need only be a sole director (in which case this must be an authorised corporate director [ACD], who will serve as the authorised fund manager). The ACD, even if he or she has fiduciary duties, has naturally limited power to oversee his or her own activities. In France, for corporate investment funds (SICAVs), the board is generally made up of the manager, a secretary, and a president, but directors are not required to be independent, and the role of directors is limited to the regulatory minimum: approving the accounts and monitoring legal changes. Last, countries with large domestic markets, such as France, Germany, and the United Kingdom, have historically focused on consumer protection, whereas such countries as Luxembourg have created a market for funds. Luxembourg regulation borrows

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An EDHEC-Risk Institute Publication