Luxembourg’s leading position in the fund industry worldwide demands that the country also be a reference in fund governance. The more oversight is robust and investors are protected, the more its influence in the industry will grow.
Governance is more important than ever because the pace of change seen in the last two decades is anything but decelerating, technological turbulence is growing and financial instability seems to become endemic, as Hyman Minsky once stated. But the reality is even more complex. In the fund industry, continued intensification of regulatory oversight, the current impact of the COVID-19 pandemic, and the still unclear post-Brexit environment call for tighter governance so trust and reputation are maintained, and good performance and regulatory compliance are achieved.
What’s the current state of fund governance in Luxembourg? By way of spoiler, we can already mention ESG, Cybersecurity and Board Diversity as neuralgic topics for boards to address as of now! We discuss these and other fund governance trends in this article.
Reflecting on Governance
We venture to conjecture but when the Greeks—to whom we owe so many modern concepts— coined the word “kybernan”, which gave rise to the word governance as we know it today, they didn’t imagine the variety of fields in which it would be used and needed.
A quick search on Google Trends tells us that data, risk, compliance and corporate responsibility are terms associated with governance worldwide. It doesn’t come as a surprise, as governance has to do with all of them in one way or another. In fact, they are part of the set of matters of the Luxembourg Fund Governance Survey 2020, whose main takeaways we discuss in this article.
Last quarter, in tandem with the ILA, we reached out to investment funds and management companies in Luxembourg – including Super ManCos, UCITS ManCos, AIF ManCos, UCITS and AIFs – to bring about the 10th edition of the survey. With an increased number of matters addressed, this edition provides insights into the current good governance and strengthens the overall governance framework of the Luxembourg fund industry.
Let’s get into its most remarkable takeaways.
Luxembourg Fund Governance 2020: Key Takeaways
- Boards are called to oversee ESG
From a trend, a decade ago, to almost a revolution, ESG has the potential to be the growth trigger the European fund industry has been waiting for. The regulatory momentum couldn’t be more timely to favour the growth of ESG investments. EU policymakers’ sentiment on the matter has shifted, embedding ESG as a central principle of the investment landscape.
The Sustainable Finance Disclosure Regulation (SFDR)’s enforcement is right around the corner, on 10 March 2021, introducing various disclosure-related requirements. Boards are key to overseeing ESG investments and ensuring that funds comply with the SFDR regulation.
There is, undeniably, a growing need for ESG expertise to have the right composition, structure and processes in place to supervise ESG investments and reduce the risk of stakeholder green-washing.
The increasing attention that regulators are giving to the stakeholders in the fund industry will continue, and boards have to live up to current demands.
- COVID-19 triggered new governance practices
The survey results are clear: a large majority of funds and ManCos reacted promptly and properly in response to the COVID-19 crisis. Timely regulation had a lot to do with that. Quite reactive, the CSSF’s guidance was quickly followed by management companies and Luxembourg-based funds.
Like in many other industries, new practices heavily dependent on the internet appeared such as working from home, using VPN network access, videoconferencing or e-signature. On the financial side, we can cite adjusting swing pricing policies.
Will they remain, though?
- Boards and cybersecurity must work in tandem
The internet of (almost) everything calls for the cybersecurity of everything too, including the one of boards. In general, COVID-19 has accentuated the need for members to embrace the digital wave without further delay.
To the ones who participated in the survey, cybersecurity remains the main area of risk. Current times require them to be more and more aware of security issues and reflect on, for instance, the risk of reading emails in public areas or sending confidential data in an unprotected format.
Furthermore, the call for board members to set up the cybersecurity tone and empower the CISO—Chief Information Security Officer, is getting louder.
Cloud computing is timidly moving into the boards’ sky as well. Although we expect it to be more broadly adopted in the long term, for now only 8% of entities reported using it in the wake of the pandemic. But, on the other hand, the likelihood of reverting to their previous practices is little. Pushed by the COVID crisis, 8% of entities started using VPN access to their network.
- Board’s performance is increasingly evaluated
When evaluating one can demonstrate impact. Ideally, evaluation exercises should be both systematic and documented to track changes over time and act accordingly. Because institutional investors and regulators pay more attention to boards, the importance of evaluating their performance is also growing.
The survey unveiled that the number of Luxembourg boards undergoing performance evaluations has increased since the previous edition of the survey, in 2018. And commonly, these evaluations are run yearly.
Among the categories of fund institutions surveyed, ManCos declared documenting the evaluation process, which led to the implementation of a remedial action plan.
- Gender parity is improving but it isn’t quite there yet
Diversity matters. Ideally, organisations’ workforce should mirror the society they operate in or, at least, the diversity of their clients. Boards aren’t the exception to that rule.
Diversity can stimulate board’s creativity and address long-term risks affecting, for instance, reputation, trust, client affinity and, ultimately, performance. Empathy and sense of belonging are new golds for relationship building with stakeholders.
We observe a positive trend in the number of female board members—14% in 2016, 16% in 2018, 22% in 2020 —however, under-representation is still an issue. Only one out of five board members is a woman.
On the other hand, transparency is the first step to evaluating a board’s level of diversity. it’s encouraging to see that the trend of making information on the board’s composition publicly available has continued.
Diversity factors are richer than gender, nevertheless. That’s why we plan diving into ethnicity/race diversity in next editions of the survey.
- Attention to AML regulation should increase
The 6h Anti-Money Laundering (AML) Directive complements and reinforces the 4th AML Directive. It develops the definition of abetting in financial crimes, adds cybercrime to the list of offences prosecuted, and establishes a set of minimum rules on criminal liability in relation to money laundering.
Our survey revealed that, albeit various levels of reviews regarding the strategic and operational implications of the 6th AML Directive are being carried out, the majority of boards, especially those of management companies, have yet to give it more attention.
- Leaderships is reinforced with a growing number of chairpersons appointed
The practice of appointing a permanent chairperson has grown among UCITS and AIFs since the 2018 survey. Boards are increasingly stepping away from the previous approach of only appointing meeting chairs to designating a permanent chairperson that ensures consistency, organisation and efficiency.
Leadership, therefore, is ensured during and outside board meetings. The appointed chairperson plays an important role in liaising with the corporate secretary and CEO.
- Board members like to keep knowledgeable
The fact that more than half of directors surveyed are pursuing training on SRI/ESG investments doesn’t come as a surprise. The matter is in the spotlight! Overall, they show proactivity when it comes to remaining knowledgeable and capable to live up to their responsibilities.
Interestingly, training on a personal level happens twice as frequent as the one provided by the board (three to four days compared to one or two, respectively).
Common training areas are AML/KYC and developments of legal and regulatory matters. We expect the former to grow due to the CSSF circular 18/698’s new reporting requirements in the AML/CTF realm.
- Codes of conduct are increasingly adopted
The use of a code of conduct is becoming more ubiquitous. Indeed, 75% of UCITS ManCo and SuperManco boards have already adopted a code of conduct. In the case of AIF, only 50% of the surveyed directors have done so. Overall, more than 50% of the boards in the sample regularly check that their governance practices are in line with the adopted code of conduct, with those in the UCITS world being more vigilant.
Institutional investors and regulators encourage the adoption of a code of conduct because it ensures that board members hold to their fiduciary responsibilities and follow the same set of principles—honesty, fairness, transparency, to name a few.
The ALFI code is always the preferred choice for Luxembourg-based boards.
- Governance practices are converging
The UCITS and Alternatives governance practices are converging. The CSSF 18/698 is the key factor for this convergence, especially for risk management and due diligence of delegates. We expect this trend to grow in the future.
The full version of the survey is available here.
The more participants in the survey, the more accurately it will mirror the state of fund governance in Luxembourg. We count on you for the next edition!
What we think
It is encouraging to see the continued focus on good governance practices by boards in Luxembourg. The 120+ responses we received to the survey further demonstrates that governance is taken seriously which is critical to maintaining the reputation of Luxembourg and our standing as the 2nd largest fund domicile in the world.