Thousands of professionals are diligently monitoring compliance with Investment Management Agreements (IMAs) and Fund Prospectuses. But despite their best efforts, most firms suffer from weak governance.

How does you firm’s IMA/Prospectus governance measure up?

1. What is the Problem?

If you work in the investment restrictions field, you will know why it is important and should skip to “Best Practice” below. If you don’t, then here is a quick overview…

Investment Managers are given assets to invest, either directly by institutional investors/high net worth individuals or through funds which can be sold to retail or institutional investors.

Before the investment manager can invest their client’s money, they sign a contract (an investment Management Agreement (IMA)) which specifies how they will invest and in what assets.

Compliance doesn’t just happen, it has to be planned

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If an investment manager invests outside the permitted assets or acts beyond the powers specified in the IMA, they have to compensate their client for any loss.

In addition to the investment manager, there are several parties who monitor the portfolio/fund to ensure it is “compliant”, including custodians/depositaries and fund administrators. Each firm who has a responsibility to monitor a client’s investment restrictions has to have the systems, processes, controls and people in place to provide the service.

2. Best Practice

Given the importance of investment restrictions and guidelines (IRGs) you would think that investment managers would operate a strict governance environment – but many do not. In the ideal world, IRG Governance would include the following:

2.1 Senior Management Responsibility

A named senior manager should be responsible for all issues regarding compliance with clients’ investment management agreements and/or prospectus.

The named senior manager will appoint the team monitoring compliance with the IMA/Prospectus, set budgets, be notified of material errors, receive periodic reports and ensure necessary improvements are made.

2.2 Requirements & Risk Assessment

A formal periodic review of the requirements for monitoring the firm’s clients’ IMAs/Prospectuses should be performed.

The Requirements & Risk Assessment review should include an analysis of how each requirement is addressed by current systems and a risk/probability of errors.

The Requirements & Risk Assessment is an important document because it determines how the whole area of IMA/Prospectus governance is approached, including the resourcing and procedures.

2.3 Resource Analysis

After preparing/updating the Requirements and Risks Assessment, the firm would determine the resources necessary. Resources can include:

  • Technical – software, integrations and data (regarding the client, their investments and securities invested in)
  • People – the number of professionals, their qualifications and location

2.4 Policies and Procedures

Detailed procedures are required to explain how firms ensure they manage client accounts in accordance with their IMA/Prospectus. The policies and procedures should be drafted based on the Requirements & Risk Assessment performed above – otherwise, you are just guessing your risks.

If you think IMA/Prospectus compliance is expensive, try non-compliance!

2.5 Implementation

Even the world’s greatest procedures need to be implemented. You cannot implement bad procedures, so putting time and effort into the Policies and Procedures is essential before they are implemented. Post implementation, there needs to be a constant feedback to enhance the Policies and Procedures in the light of operational feedback.

2.6 Monitoring the Monitor

It is necessary to undertake periodic reviews of how IMA/Prospectus management is operating, sometimes called “monitoring the monitor”!

Very few firms have the internal expertise outside the IMA/Prospectus monitoring team who are expert enough to audit the business area (this is a common challenge for all business areas in financial services). External auditors are even less familiar with IMA/Prospectus monitoring which means “monitoring the monitor” is of limited practical value.

2.7 Reporting

There are two types of report that the Senior Manager responsible for IMA/Prospectus management needs to receive:

  • Periodic – the results of IMA/Prospectus monitoring
  • Exceptional – breaches or possible breaches that have to be reported as soon as identified due to materiality (which can be by the size or sensitivity)

2.8 Professional Development and Training

IMA/Prospectus monitoring is constantly changing. Keeping up to date with the latest developments is essential, both for the firm doing the monitoring and for the professionals in the business area.

All employees working in IMA/Prospectus compliance need to have their training requirements assessed and appropriate training delivered (including the senior manager responsible for the area).

A Confession

The outline of “Best Practice” for IMA/Prospectus Governance is directly based on my work on AML Governance – there is no reason that good processes cannot be repurposed!

Good governance principles work across business areas

I am not aware of any firm that has implemented rigorous governance over IMA/Prospectus compliance because there is no specific or detailed regulatory requirement in this area.

The result is that each firm has a stab at IMA/Prospectus compliance but fail to allocate appropriate resources or even know their requirements. Firms could be spending too much, or too little on IMA/Prospectus compliance – but they will never know.

Dynamic-GRC

Dynamic-GRC offers firms a technology solution for firms to assess their IMA/Prospectus compliance governance.

Our clients can use our “Dynamic-Forms” out of the box, edit them for their specific requirements or work with their own consultants to assess their own IMA/Prospectus compliance level.

Our GRC-Maestro system also monitors and manages:

  • Complexity – some investment restrictions cannot be coded in other systems
  • Judgmental – some rules require a professional opinion, e.g. “Don’t invest in companies with poor environmental standards.”
  • Ancillary – clauses beyond the investments which relate to: investment analysis, portfolio management, key personnel, etc.

Conclusion

To ensure your firm is not left behind by these changes it is essential to know your investors’ and regulators’ expectations. If your IMA/Prospectus compliance slips behind your competitors, it is extremely painful to catch-up.

IMA/Prospectus compliance isn’t a “nice to have”, it is essential to win and keep clients

Proactively managing your IMA/Prospectus Governance is not just diligent, it is essential. The commercial risks of errors and oversights are highly material to the firm and the careers of professionals working in IMA/Prospectus compliance.

Adrian was a co-founder of LatentZero (now Fidessa BuySide) and is a Director of Dynamic-GRC, the leading RegTech solution provider: www.dynamic-grc.com

If you have question/comments/suggestions do email Adrian at: apay@dynamic-grc.com

Adrian Pay

Author Adrian Pay

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