Managing the directors, or directing the manager? Ian Kirk and Paul Wilkes look at where the buck stops when it comes to discretionary delegation of powers relating to offshore funds
The extent to which fund managers are given the reins to run offshore funds vary from structure to structure. The guiding principle is that the director of a corporate fund (or the trustee of a unit trust or the general partner of a limited partnership) should not be shackled by discretions or powers given directly to the manager. Rather, the manager, as their delegate, may be given certain discretions or powers that always remain subject to the overall supervision and veto of the directors/ trustee/general partner.
The balance of power
The increased level of scrutiny from regulators has focused attention on this balance of power, with regulators criticising directors for not being more involved in funds’ management and seeking to limit the scope of the powers and discretions given to managers to the exclusion of the directors. At the same time, the experiences of certain managers during the global financial crisis, where corporate governance procedures have hindered their ability to act quickly, has motivated them to seek broader discretions and powers.
One area in which directors (or trustees or general partners) must delegate a discretion is in the processing of redemptions. For a typical openended fund, the directors would grant the administrator and manager the power to process both subscriptions and redemptions on the relevant dealing day. However, many offshore jurisdictions would require the fund to satisfy a solvency test prior to the payment of any redemption proceeds. The directors are responsible for ensuring this occurs.
Who has control?
More contentious, perhaps, is to whom the discretion or right is granted in respect of a suspension of dealing and/or valuations of a fund or placing assets of a fund into side pockets. Ordinarily such fundamental matters would fall to the directors rather than being delegated or granted to the manager. However, it is often the case, particularly with bespoke asset classes, that the specialised manager has a greater ability to value the assets of the fund and has a keener awareness and understanding of their liquidity. This can lead to potential differences of opinion between the manager and directors as to what steps, if any, should be taken in the best interests of the fund and its investors. The experience of dealing with such conflicts has led some managers to support placing such rights into the hands of the manager to the exclusion of the directors.
A related issue for an openended Guernsey scheme is the extent to which the fund’s custodian must be consulted and/or their consent obtained when considering these issues. It is the custodian’s responsibility to ensure that the fund is conducted in accordance with relevant rules as well as the terms of the disclosure documents and constitutional documents. However, despite instances of a clear discretion being granted to certain parties under the relevant documents, the local regulator has, on occasion, criticised custodians for not recognising, and taking steps to minimise, conflicts in order to protect investors. Consequently custodians are taking a more active role in ensuring that a fund is supervised appropriately by its directors, despite what rights or discretions are granted to the manager.
These examples illustrate ways in which regulators have been addressing this conflict. By making ’the buck stop’ with the directors in respect of compliance with a certain provision (and applying increasingly harsh consequences onto directors for non-compliance) a regulator can motivate directors to involve themselves increasingly in areas where investment managers and other service providers have previously been left to their own devices. It is not sufficient to delegate powers ’subject to overall supervision by the board’ where such supervision is not demonstrable.
Such scenarios are equally frustrating for managers. Opportunities to profit, or mitigate damage arising, from a situation may be fleeting and an added layer of detailed oversight may cause unavoidable delays. To a certain extent this can be managed by providing detailed guidelines as to the manager’s powers in their service agreement and allowing them to act within these guidelines. On the other hand, by detailing the fund’s requirements in this way the ability to react quickly is, to some extent, inevitably lost.
These issues arise when structuring new funds, but are also relevant when reviewing the rights and obligations of directors, managers and custodians of existing structures. Inconsistency in the drafting of a fund’s documents has led to disputes as to whom discretion is granted, and it is preferable to correct these inconsistencies before an issue arises. A pre-emptive health check by the fund’s advisers may be appropriate.
Gone are the days of a fund’s board delegating all its powers and discretions to various service providers and meeting once a year to approve the accounts. That is not to say that managers should not be given the flexibility required to do what they do best, but directors must involve themselves in the day-to-day running of the fund.
Ian Kirk is a partner and head of commercial and Paul Wilkes is a senior associate at Collas Day