26 January 2012 7th ILA and PwC Annual Fund Conference

7th ILA and PwC Annual Fund
Conference
26 January 2012

John Parkhouse,
Chair of the ILA fund committee and Partner, PwC Luxembourg

Agenda
8.45 - 9.00 Introduction
9.00 - 9.35 Regulation and what Boards should be focused on
9. 35 - 10.05 International Developments in Regulation and Practice
10.05 - 10.30 Audit green paper
10.30 - 11.00 Coffee break
11.00 - 11.45 Board evolution - the ILA FAQ and its practical application in the
face of current topical issues
11.45 - 12.15 Board Oversight of Risk Management
12.15 - 13.30 Lunch
13.30 - 13.45 ILA Update
13.45 - 14.15 Fund Governance Survey Results
14.15 - 15.30 Panel : The future of fund governance in Luxemburg and the EU
15.30 - 16.00 Coffee break
16.00 - 17.15 Open Forum on current developments & hot issues
17.15 - 17.30 Conclusions
As from 17.30
Cocktail

ILA introduction
John Parkhouse,
Chair of the ILA fund committee and Partner, PwC Luxembourg

Objectives of the group
• Lead development of the governance framework at board level for all
regulated Luxembourg funds;
• Provide technical and market support for directors of Luxembourg
funds;
• Liaise with respective stakeholders as needed (ALFI, CSSF etc) on
behalf of the Luxembourg fund directors community;
• Implement ILA level initiatives within the fund environment as
relevant;
• Ensure close interactions with ALFI initiatives.

Looking back… and looking forward
FAQ
ALFI
Events
Survey
CO Forums
• Events
• Liability letters and risk for
directors
• Board Evaluation
• AIFMD and its impact on
Boards/Governance
• Open Forum
• FAQ
• CSSF regime for
Dirigeants and Directors
• Survey

ILA Investment Fund Committee
• Formed Q1 2008
• Members:
- John Parkhouse Chair, PwC
- Alan Crutchett Independent Director
- Richard Goddard Independent Director
- Graham Goodhew Dirigeant JPMorgan Asset Management Europe
- Henry Kelly Independent Director, KellyConsult, Chair of ALFI Fund Governance WG
- Bill Lockwood Conducting Officer Franklin Templeton Investments
- Jan Jaap Hazenberg Head of Product Strategy & Market Intelligence, ING Investment
Management Europe
- Jérôme Wigny Elvinger, Hoss & Prussen
- Paul Guillaume Independent Director
- Martin Vogel CEO
- Monique Bachner Bachner Legal

www.ila.lu

Regulation
and what Boards should be focused on
Michèle Eisenhuth,
Arendt & Medernach

Regulation and what Boards
should be focused on
Michèle Eisenhuth, Partner, Arendt & Medernach
26 January 2012

Table of contents
I. Focus on the Key Investor Information Document (KIID)
II. UCITS IV conflicts of interest and best execution requirements: the
role of the board of the fund
III. Outline on specific AML issues under the amended 2004 Law
11

I. Focus on the Key Investor Information Document (KIID)
• Focus on the responsibility related to the content of the KIID
• Focus on the delivery of the KIID to investors:
‣ assessment of the entity responsible for delivering the KIID
‣ delivering the KIID in good time to investors
12

Focus on the responsibility related to the content of the
KIID
Rule:
The self-managed UCITS or the management company is responsible to
ensure that the KIID is not misleading, that it is accurate, consistent with the
prospectus and up-to-date.
Consequence:
As the KIID contains financial information (SRRI, ongoing charges and
performances), the UCITS or the management company must put in place
internal or outsourced appropriate mechanisms and systems to be able to
issue the KIID in due time and assess on an ongoing basis the content of the
KIID so as to keep it accurate and up-to-date.
13

Focus on the responsibility related to the content of the
KIID (ctd.)
Questions:
1) May a benchmark be inserted in the KIID without being
mentioned in the UCITS prospectus?
2) Does the disclosure on the “ongoing charges” need to be
reviewed continually or only on the occurrence of a material
event?
14

Focus on the delivery of the KIID to investors
• Assessment of the entity responsible for delivering the KIID:
Rule:
A self-managed UCITS or the management company is responsible for:
‣ providing investors with the KIID when selling units directly or through
intermediaries acting under the UCITS and/or its management company’s
behalf and under its full and unconditional responsibility; or
‣ providing product manufacturers and intermediaries with the KIID upon
request (the latter being responsible for delivering the KIID to investors),
when not selling units directly or through intermediaries acting under the
UCITS and/or its management company’s behalf and under its full and
unconditional responsibility.
15

Focus on the delivery of the KIID to investors (ctd.)
• Assessment of the entity responsible for delivering the KIID (ctd.):
Consequence:
The self-managed UCITS or the management company should assess which
entity is responsible for delivering the KIID to investors and review the
agreements with its distributors as the case may be.
16

Focus on the delivery of the KIID to investors (ctd.)
• Assessment of the entity responsible for delivering the KIID (ctd.):
Questions:
1) Is the UCITS’ registrar and transfer agent responsible for delivering the
KIID when directly contacted by an investor?
2) Is a website platform responsible for delivering the KIID when an investor
is subscribing through it?
17

Focus on the delivery of the KIID to investors (ctd.)
• Responsibility for delivering the KIID in good time to investors :
Rule:
The KIID constitutes pre-contractual information that shall be delivered to
investors free of charge in good time before subscription of units in the
UCITS is proposed.
Consequence:
Distributors should be educated to deliver the KIID prior to any investment
and to evidence the delivery of the KIID to investors.
18

Focus on the delivery of the KIID to investors (ctd.)
• Responsibility for delivering the KIID in good time to investors (ctd.) :
Questions:
1) Do existing investors need to receive the KIID?
2) Do existing investors need to receive the KIID for subsequent
subscriptions?
19

II.
UCITS IV conflicts of interest and best execution
requirements: the role of the board of the fund
• The UCITS IV Directive imposes a number of
requirements in terms of conflicts of interest
and best execution on UCITS management
companies or directly on self-managed UCITS
Fund Board
of Directors
• The duty to comply with such obligations
remains unaffected by the delegation of certain
fonctions to third party service providers (e.g.
investment manager)
Management
Company
• It is the duty of the board of the fund, in light of
its ultimate responsibility for the management of
the fund, to verify that all necessary steps are
taken at each level to comply with these UCITS
IV requirements
Service
Provider
20

Conflicts of interest: UCITS IV requirements
• A written conflicts of interest policy must be established to (i) identify
potential/existing conflicts of interest entailing a material risk of damage to
the fund and (ii) set up procedures and measures to manage these in an
independent manner
• Conflicting situations and corresponding procedures/measures must be
recorded in a regularly updated register
• Unresolved conflicts must be escalated to senior management which
must take action in the best interest of the fund (to be reported to
investors, e.g. in the annual report)
21

Conflicts of interest: other legal provisions applicable to
individual board members
• Luxembourg Company Law (Article 57)
Applicable to all Luxembourg funds established in corporate form;
Any director having a conflict of interest is obliged to advise the board and may
not take part in the deliberation;
Proposed amendment pending (Proposal 5703). In particular, any decision
taken by the Board without respecting Article 57 could become null and void.
• ALFI Code of Conduct (Section 8)
Luxembourg funds are strongly advised to adopt a code of conduct. Listed
funds must indicate in their annual report which code of conduct they have
adopted or explain why no code has been adopted;
Under the ALFI code the board should: (i) identify conflicts of interest of its
members, (ii) define the means to avoid, manage or disclose such conflicts, (iii)
maintain sufficient autonomy to resolve conflicts of interests impartially.
• EFAMA Code of Conduct: High level principles and best practice recommendations
22

Best execution principle
• The management company or the self-managed UCITS must establish
procedures, arrangements and policies ensuring that the best possible
result is achieved when executing orders for the fund
• The management company or the self-managed UCITS must be able to
demonstrate that orders have been executed/placed on behalf of the fund
in accordance with the best execution policy (adequate reporting of
transactions)
• The board of the fund must give its prior consent on the best execution
policy, which must be reviewed on an annual basis or when a relevant
material change occurs
• Appropriate information on the policy and any material change thereto
must be made available to investors (e.g. published on the fund’s website
or provided on request)
23

Situations requiring the attention of the board in terms of
conflicts of interest and best execution (examples)
Situations
• Board members may be directors,
officers or employees of the promoter
of the fund or the investment manager
• The investment manager may advise
or manage assets for other clients or
engage in proprietary trading
Potential Conflicts
• In such capacity, the interests of board
members may diverge from their fiduciary
duties towards the fund
• Conflicts may arise with respect to the time
and resources that such board members may
devote to the fund
• The investment manager may face conflicts
when allocating investment opportunities
between the fund, other clients and its own
trading activity
• The other activities of the investment
manager may adversely impact the markets
in which the fund is invested and vice versa
24

Situations requiring the attention of the board in terms of
conflicts of interest and best execution (examples/ctd.)
Situations
•Certain assets of the fund may be
valued by the investment manager
Potential conflicts
•The investment manager may face a
conflict when valuing assets of the fund as
the fund’s NAV generally affects the
investment manager’s fees
•The promoter, the investment manager
or an entity of the same group may deal
commercially with the fund, including as
counterparty to OTC derivatives
• The fund may not deal at the best
available terms and conditions, especially
for very specific trades with no or limited
reference market (e.g. swaps on
homemade strategy indices)
25

Situations requiring the attention of the board in terms of
conflicts of interest and best execution (examples/ctd.)
Situations
• The investment manager may be the
sponsor and/or calculation agent of an
index replicated by the fund (and by
other funds or products promoted by the
investment manager or an affiliated
entity) and/or swap counterparty
• The investment manager may also
trade in the assets underlying the index
for other clients or for its own account
Potential conflicts
• The investment manager may face
conflicts between these different roles and
its own interest, especially to the extent the
index sponsor and/or calculation agent have
the ability to make certain decisions to
administer the index
• Trading in the underlying assets may
adversely impact the performance of the
index and therefore of the fund
26

III.
Outline on specific AML issues under the amended
2004 Law
History
• 2004 Law: automatic exemption in certain circumstances
• ALFI/ABBL/ALCO Practices and Recommandations on AML dated
December 2006
‣ Guidance on best practices for the Luxembourg fund industry
‣ to be updated
• 2008: amendment of the 2004 Law
• GDR dated 29 July 2008: list of “equivalent” third countries
• CSSF Circular 08/387: expands on certain provisions of the 2004 Law
27

Outline on specific AML issues under the amended 2004
Law (ctd.)
History (ctd.)
• GDR dated 1 December 2009: list of “equivalent” third countries abolished
• GDR dated 1 February 2010
• CSSF Circular 10/476: abrogation of the “group” concept
• Law dated 27 October 2010: repeal of automatic exemption from CDD,
concept of “other similar relationships”
• CSSF Circular 10/495
28

Outline on specific AML issues under the amended 2004
Law (ctd.)
Rationae personae of the amended 2004 Law
• Out of scope: funds not marketing their units or shares themselves
• In scope: funds marketing their units or shares themselves
• Simplified CDD (Article 3-1)
• Enhanced CDD (Article 3-3(1) to (4))
• Delegation to a third party (Article 3-3(1)-(4))
• Outsourcing to “trusted persons” (Article 3-3(5))
29

Outline on specific AML issues under the amended 2004
Law (ctd.)
Practical aspects of fund boards’ role under the amended 2004
Law
Revised simplified CDD (Article 3-1)
• Repeal of automatic exemption
• If clients = institutions subject to equivalent CDD rules
‣ Equivalence : risk self-assessment
‣ Ongoing monitoring
• Identification and verification of the client
‣ “reasonable amount of information”
‣ BO ?
30

Outline on specific AML issues under the amended 2004
Law (ctd.)
Practical aspects of fund boards’ role under the amended 2004
Law (ctd.)
Enhanced CDD: correspondent banking relationships with
credit/financial institutions in third countries and other similar
relationships as an alternative to simplified CDD (Article 3-2(3))
• Enhanced CDD on the respondent institution only ?
• Fund board’s enhanced obligations
• « other similar relationships »
‣ Relationship between a fund and a nominee ?
31

Outline on specific AML issues under the amended 2004
Law (ctd.)
Practical aspects of fund boards’ role under the amended 2004
Law (ctd.)
Performance of the CDD by third parties (Article 3-3(1) to (4))
• For institutions subject to equivalent CDD rules
• Liability remains with the fund
• Transfer of data without objecting any confidentiality or professional secrecy
rules
32

Outline on specific AML issues under the amended 2004
Law (ctd.)
Practical aspects of fund boards’ role under the amended 2004
Law (ctd.)
Outsourcing to “trusted persons” not subject to the 2004 Law or
equivalent regulations (Article 3-3(5))
• Application of Luxembourg AML regulations
• Liability: CDD performed by the service provider/agent deemed performed
by the fund
33

Contact us
• Michèle Eisenhuth
• Partner at Arendt & Medernach
• Tel : +352 40 78 78 638
• Email : michele.eisenhuth@arendt.com

International Developments in Regulation and
Practice
Alain Guérard,
ManagementPlus Luxembourg
Henry Kelly,
KellyConsult S.à r.l.

Henry Kelly, Independent Director, KellyConsult Sàrl
Alain Guérard, Managing Director, ManagementPlus (Luxembourg) S.A.
ILA and PwC Annual Fund Conference: 26 January 2012

ILA and PwC Annual Fund Conference: 26 January 2012
Increased focus on the role and responsibilities of fund directors (industry
codes, EU Green Paper, etc.)
Fund governance vs. corporate governance
Inter-action with other actors within fund governance arena
(depositary, investment manager, auditor, etc.)
Self regulation (e.g. Codes) vs. imposed regulation
Irish, UK and European developments
37

Issued in December 2011, effective 1 January 2012
ILA and PwC Annual Fund Conference: 26 January 2012
“Voluntary” with full application from January 2013
Applicable to CIS and Management Companies
Reasons for non-compliance with any provisions of the Code to be
disclosed in a “publicly available medium” (e.g. Directors’ Report,
annual report on website)
38

Minimum of 3 directors
ILA and PwC Annual Fund Conference: 26 January 2012
Majority of non-executive directors
At least one independent director
(independence: neither employee/partner of CIS/ManCo nor of service
provider nor significant shareholder)
Minimum of 2 directors must be Irish resident
39

ILA and PwC Annual Fund Conference: 26 January 2012
Minimum of two directors available to meet the Central Bank at short
notice (one must be an independent non-executive director)
Letter of appointment specifying time commitment
Directors to disclose time commitments (incl. foreign CIS)
Maximum of 8 non-fund directorships
Disclosure of conflicts of interest
40

Board membership to be formally reviewed every 3 years
ILA and PwC Annual Fund Conference: 26 January 2012
Annual Board evaluation with formal review every 3 years
Role of Board (strategy, appointment and oversight of service providers,
compliance, risk management, etc.)
Meetings (at least quarterly, full documentation)
Definition of reserved powers and use of committees
41

Financial Reporting Council (FRC): UK CG regulator
ILA and PwC Annual Fund Conference: 26 January 2012
First UK Code on Corporate Governance produced in 1992 by the
Cadbury Committee
The UK Corporate Governance Code (June 2010)
o
o
o
“Comply or explain”
Applies to listed companies
Five main principles: leadership, effectiveness, accountability,
remuneration, shareholder relations
42

The UK Stewardship Code (July 2010)
ILA and PwC Annual Fund Conference: 26 January 2012
o
o
o
o
o
Complements UK Corporate Governance Code
“Comply or explain”
Applicable to UK-authorised asset managers
Objective: enhance quality of engagement between institutional investors and
investee companies
Seven principles covering proxy voting, conflict of interests policy, monitoring investee
companies
FRC Guidance on Board Effectiveness (March 2011)
Association of Investment Companies Code (May 2007)
43

EFAMA Code for External Governance (April 2011)
ILA and PwC Annual Fund Conference: 26 January 2012
o
o
Voting policy and disclosure
Monitoring of investee companies
EU Green Paper on Corporate Governance in financial institutions and
remuneration policies (June 2010)
o
o
o
o
Risk management; conflict of interests
Board: number of mandates, remuneration
External governance
External auditors; Supervisory authorities
44

ILA and PwC Annual Fund Conference: 26 January 2012
Board Composition
o
o
o
o
o
Role of independent directors
Importance of the role of the chairman
Board membership review and evaluations
Directors’ competence, experience and training
Stricter screening of directors by regulators
Board Focus
o
o
o
Conflicts of interest
Risk management and internal controls
Regulatory and compliance issues
45

Independent Directors Council (IDC) & Investment Company Institute (ICI)
Fund Governance Practices Report 1994-2010 – Released Oct 2011
ILA and PwC Annual Fund Conference: 26 January 2012
Universe: $12 Trillion AUM for 7,756 funds in 2010
Fund Governance Development:
46

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
47

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
48

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
49

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
50

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
51

ILA and PwC Annual Fund Conference: 26 January 2012
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Proportion of boards with at least one
independent director
85%
81%
75%
67%
UCITS NON-UCITS Anglo-Saxon Continental
Source: PwC-ILA Fund Governance Survey 2010/2011
52

ILA and PwC Annual Fund Conference: 26 January 2012
80%
70%
60%
50%
40%
30%
20%
10%
0%
Proportion of UCITS boards with at least one
independent director
55%
62%
75%
2006 2008 2010
Source: PwC-ILA Fund Governance Survey 2010/2011
53

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
54

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
55

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
56

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
57

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
58

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
59

ILA and PwC Annual Fund Conference: 26 January 2012
Source: ICI & IDC Fund Governance Fund Practices 1994-2010
60

ILA and PwC Annual Fund Conference: 26 January 2012
Fund Boards, as a group, follow strong governance practices to best serve the interest of the
shareholders - Study of board practices indicate that over the past 16 years, fund boards have adopted
such practices in advance or in absence of any regulatory mandate to do so.
91% of fund surveyed have more than 75% independent directors on their boards
63% of surveyed funds have an independent board chair
39% of surveyed funds have more than 4 board meetings per year
29% of surveyed funds requires independent directors to own shares in the fund
Average Independent Director Age is 65 years old
Average Independent Direct Length of Service is 11 years
91% of Funds surveyed report to have a dedicated legal counsel for its independent directors
97% of Surveyed funds report having a financial expert on the audit committee (disclosure is required
by SEC)
http://www.ici.org/pressroom/news/11_news_fund_gov_pract
61

ILA and PwC Annual Fund Conference: 26 January 2012
Thank you
62

Audit Green Paper
Pierre Krier,
Chair of IRE, PwC Luxembourg

ILA and PwC Annual Conference
26 January 2012
EC Legislative Proposals on Audit Policy
Pierre Krier
President
Institut des Réviseurs d’Entreprises

Why EC Proposals on Audit Policy?
• Financial and economic crisis (Eurozone debt crisis, liquidity/solvency constraints for
banks, credit crunch, low GDP growth);
• EC Internal Markets Reform Agenda:
- European Supervisory Authorities (ESMA, EBA, EIOPA);
- Banking Regulations;
- Financial Instruments;
- Rating Agencies.
• Time to further regulate Audit Profession;
• Michel Barnier, EC Commissionner Internal Markets: “Status quo is not an option”.
26 January 2012

Evolution of Audit Profession Regulations
since 2000
• 2001 Collapse Enron, Demise Arthur Andersen;
• 2002 Sarbanes Oxley Act and creation of PCAOB;
• 2002 EC Recommendation on statutory auditors independence;
• 2006 EU Audit Directive (8 th Directive):
- End of Self Regulation;
- Start of Public Supervision;
- Public adoption of Auditing Standards.
• 2009 Public adoption of “clarified” ISA.
Objective: Strengthening of Audit Quality
26 January 2012

Next steps: Proposal for a Directive and a
Regulation published by the EC on
30 November 2011
• Objective: Further strengthening of Audit Quality;
• 4 focus areas:
- Narrow audit expectation gap;
- Reinforcement of auditor independence;
- Opening-up of audit market to new entrants;
- Creation of an integrated European audit market.
• Shortfalls:
- Disregard of 2010 Green Paper consultation results;
- No impact assessment done of 2006 EU Audit Directive;
- Disregard of September 2011 EP “Own initiative report” concerning Green Paper
propositions.
26 January 2012

Who will be impacted by the EC Proposals
on Audit Policy?
• Audit Profession: in particular statutory auditors of Public Interest Entities (PIE)
• Auditees: in particular PIE being:
- Listed companies;
- Credit institutions;
- Insurance undertakings;
- Payments institutions;
- E-money institutions;
- Investment firms.
- Central securities depositories;
- EU Alternative investment funds;
- UCITS.
• Public Supervisory Authorities of Audit Profession:
- EU: ESMA;
- Lux: CSSF.
26 January 2012

Positive Proposals
Strengthening of corporate governance relating to
statutory audit
• Audit Committee requirement for each PIE (art. 31): composed of
non-executive directors with industry specific competence. 2 members knowledgeable
in accounting and audit. Majority of members and chairman to be independent
AC exemption for UCITS or AIF: explain to the public the reasons for not having an AC
• Appointment of statutory auditors (art. 32): formal selection process to be
organised by AC. Comprehensive tender documents to be prepared. Invitation to at
least 2 audit firms of which at least one which has less than 15% total audit fees from
large PIE. AC to submit a recommendation regarding the audit firm to be selected to
Board of Directors. Final appointment to be approved by the shareholders
For banks and insurance companies: veto right by supervisory authorities of audit
profession regarding proposed audit appointment
26 January 2012

Positive Proposals
Strengthening of corporate governance relating to
statutory audit (cont.)
• Communication of statutory audit results (art. 21-25):
- To the public: extended audit report (4 pages max.) presenting the results of the
statutory audit. In addition to true and fair view audit opinion, information on
audit methodology, materiality levels, key risk areas including fraud;
- To the AC: additional report explaining in detail results of the audit (process, work
done, findings, control issues, compliance issues, going concern issues);
AC can disclose report to Management, Board of Directors and shareholders:
- To the Supervisors of the audited PIE: duty of statutory auditors to report
promptly to the Supervisors any material breach of laws/regulations, going concern
issues, refusal to issue audit opinion or qualified opinion.
• Harmonisation of Auditing Standards across the EU:
- After the harmonisation of the accounting standards (IFRS) to be applied by
corporates, now harmonisation of auditing standards (ISA) to be applied by
auditors.
26 January 2012

Negative Proposals
Audit Profession in Europe believes the following
proposals will weaken audit quality
• Mandatory Firm Rotation (art. 33): every 6 years. Every 9 years in case of Joint
Audit. 4 year cooling-off period;
- Investment for auditee and auditor because of familiarisation process after each
new appointment;
- Italy: only EU country with mandatory firm rotation. No new entrants to PIE audit
market. Even higher concentration among large audit firms;
- EC to do first impact assessment regarding internal rotation principle required by
8th Directive.
26 January 2012

Negative Proposals
Audit Profession in Europe believes the following
proposals will weaken audit quality (cont.)
• Prohibition of the provision of non-audit services (art. 10):
- PIE auditor restricted to statutory audit services and related financial
audit services (limited to 10% of the statutory audit fees):
◦ Scope of related financial audit services: review of interim accounts, corporate
governance/CSR statements, regulatory reporting, compliance with tax
requirements;
◦ Issue in certain EU countries including Luxembourg, where additional work
assigned to auditors by law: Long Form Report, NAV error or compliance
breaches, periodic review of interim accounts, German tax certificates.
- Total ban of non-audit services to PIE by their statutory auditors
(including tax consultancy and advisory services).
26 January 2012

Negative Proposals
Audit Profession in Europe believes the following
proposals will weaken audit quality (cont.)
• Prohibition of the provision of non-audit services (art. 10) (cont.):
- Creation of pure audit firms: audit firms generating more than 33% of their
annual audit revenues from large PIE and belonging to a network having annual
audit revenues exceeding €1,5 bio:
◦ Shall not provide non-audit services to any PIE;
◦ Shall not belong to a network that provides non-audit services within the EU;
◦ Increasing complexity of the corporates requires non-audit experts to be
involved in the audit process to ensure quality work (example tax consultants, IT
experts, actuaries, risk management experts);
◦ Loss of attractiveness of pure audit firms for experts, decrease of competencies
in audit firms, lower audit quality;
◦ Demand of corporate world to have multi-disciplinary audit firms knowing their
business and culture who can help them in areas other than audit;
◦ AC to ensure avoidance of independence issues through approval of non-audit
services.
26 January 2012

Negative Proposals
Audit Profession in Europe believes the following
proposals will weaken audit quality (cont.)
• Prohibition of the provision of non-audit services (art. 10) (cont.):
- Creation of pure audit firms: audit firms generating more than 33% of their
annual audit revenues from large PIE and belonging to a network having annual
audit revenues exceeding €1,5 bio:
◦ Shall not provide non-audit services to any PIE;
◦ Shall not belong to a network that provides non-audit services within the EU;
◦ Increasing complexity of the corporates requires non-audit experts to be
involved in the audit process to ensure quality work (example tax consultants, IT
experts, actuaries, risk management experts);
◦ Loss of attractiveness of pure audit firms for experts, decrease of competencies
in audit firms, lower audit quality;
◦ Demand of corporate world to have multi-disciplinary audit firms knowing their
business and culture who can help them in areas other than audit;
◦ AC to ensure avoidance of independence issues through approval of non-audit
services.
26 January 2012

Conclusion
• Audit Reform driven by EC political agenda rather than pressing need to further
strengthen audit quality;
• Disregard of Green Paper consultation results, EP and EU Member States
recommendations;
• Certain proposals will neither help large, medium and small audit firms nor the
corporate world and other stakeholders;
• Voice your concern during the next 18 months of the legislative adoption process
26 January 2012

Questions?
26 January 2012

Coffee Break

Board evolution - the ILA FAQ and its practical
application in the face of current topical issues
Monique Bachner,
Bachner Legal
Richard Goddard,
Independent Director

“Board evolution - the ILA FAQ and its
practical application in the face of
current topical issues”
ILA Annual Funds Conference 2011, Luxembourg
Monique Bachner
Richard Goddard
26 January 2012

Agenda
Introduction
1. The nature and structure of the FAQ
2. The “Weavering case” and the FAQ
2.1 The start-up phase
2.2 Business as usual
2.3 Directors in a crisis situation
Conclusion

1. The nature of the ILA Frequently Asked Questions (“FAQ”)
It is based on real-life questions asked by directors of Luxembourg funds,
especially from overseas
Its subject is Corporate Governance NOT Compliance
It describes current Luxembourg and some “best” international practices
It does not represent a list of recommendations, let alone rules and regulations
It is for the practical guidance of fund directors in day-to-day situations
It is aimed at being usable rather than complete

1.2 The structure of the ILA FAQ
1. Board Composition and Organisation
2. The Role of a Director
3. Functioning of the Board
4. Liabilities
5. Insurance and Indemnities
6. Listed Funds
7. Bibliography
Appendix 1
Appendix 2
Appendix 3
Appendix 4
Appendix 5
Appendix 6
Appendix 7
Example Quarterly Board Meeting Agenda – UCITS Fund
Checklist of other potential items to consider
Sample Action Points Table
Sample Errors and Breaches Log
Sample template: Status of agreements
Board Policies and Procedures
List of potential clauses for a Director’s
appointment letter

2. The “Weavering case” and the FAQ
The “Weavering case” can also be viewed as a “how to” or “how not to” guide
for investment fund directors
The judge distinguished between behaviours expected of directors in three
distinct phases:
1. The start-up phase
2. The “business as usual” phase
3. A crisis situation
This does not correspond to the structure of the FAQ,
but is nevertheless a useful way of proceeding....

2. 1.1 The judge’s thoughts on the start-up phase
The directors should ensure that:
• contracts were “appropriate and consistent with industry standards”
• there was ”a proper division of responsibilities among service providers”
• “the auditors’ contractual terms and conditions were reasonable”
• the “offering document complied with the requirements of...the Mutual
Funds Law”
• they “make enquiry of the lawyers who have coordinated the work”
...despite recognising that “they may well be the last of
the players to enter the scene”

2. 1.2 The start-up phase and the FAQ
The FAQ covers the appointment of directors and summarizes the role of the
board and it duties to:
• sign audit letters of engagement (2.1)
• appoint service providers (2.1)
• ensure that there are detailed legal agreements, including potentially also
service level agreements and/or board delegation guidelines (2.2)
• Review and comment on the articles, prospectus, engagement letter and
other contracts (3.4)
But does it sufficiently cover these in the start-up phase?
And, are the judge’s expectations realistic?

2. 2.1 The judge’s thoughts on the business as usual phase
In relation to the conduct of board meetings, the directors should ensure that:
• “an agenda...be prepared and circulated in advance of each meeting”
• it should “reflect input from the investment manager, the administrator....”
• there are “reports from the administrator, the investment manager, and the
auditor
• “these should be invited to attend board meetings”
• they review “the most recent management accounts”
• minutes are not prepared on a “pro forma” basis
...but directors’ jobs are not confined to board meetings....

2. 2.2 More thoughts on the business as usual phase
The judge would also expect directors to:
• be parties to “occasional e-mails identifying matters for discussion”
• “initiate conversations with the administrator and audit engagement partner”
• “enquire about any issues which may have arisen during ...the audit”
• evidence time spent on meaningful review of documents
• “be alive to the issues which are likely to arise” from side letters
This is an ongoing, not an occasional role.

2. 2.3 The business as usual phase and the FAQ
The FAQ focuses more on business as usual phase, for example on:
• Sample agenda items and board papers, including reports from service
providers (Appendices 1-6)
• Review of accounts (3.2)
• Document review (3.4)
• Ongoing supervision between meetings (3.4)
• Further enquiries from delegates (3.5)
• The preparation of minutes (3.14)
It does not cover some very specific issues, such as
side letters

2. 3.1 Directors in a crisis situation
The judge is particularly critical of the directors continued inactivity during the
2008 financial crisis, as significant redemptions or even counterparty failure
might have been expected.
In fact, he dates the calculation of USD 111 million damages from this time.
The FAQ briefly covers crisis situations in section 4.6.
When planning their capacity, directors should take into account the fact that
time involvement can increase exponentially in the case of crisis at a fund or
macroeconomic level.

Conclusion
The ILA FAQ for Directors is deliberately in the form of “frequently
asked questions” and not recommendations
Its responses do aspire to combine current with international “best
practice”
However, the circumstances of every fund, asset class and jurisdiction
will differ over time, and directors need to continually adapt
We will continue to adapt and improve the FAQ

Board oversight of Risk Management
Antonio Thomas,
MD, RBS

Board Oversight of Risk
Management
Practical considerations
Antonio Thomas, Managing Director
RBS (Luxembourg) S.A.
ILA and PwC Annual Fund Conference
26 January 2012
"To be the leading independent 3rd party Management Company and provider of Risk Management Services for our clients"
RBS57409
92

Biography of Antonio Thomas
Antonio Thomas
Managing Director and Conducting Officer of RBS (Luxembourg) S.A. since March 2009. He has over 22 years
experience in the financial services industry across a wide spectrum of areas, including operational and product
development and has built an extensive knowledge of the products and regulations in various jurisdictions. He is
recognised as a leading figure in the funds space in respect of corporate governance and technical operational
matters where funds are concerned. He has built and run various fund platforms including UCIT’s vehicles in
multiple jurisdictions including the UK, Ireland and Luxembourg (for the F&C Asset Management Group ) and
Management Company businesses more recently for RBS in Ireland and Luxembourg. He is also a director of a
number of investment vehicles and represents RBS on industry bodies including ALFI and EFAMA.
RBS57409

Topics for discussion
‣ Pre vs Post UCITS IV
‣ Operating model versus the regulatory requirements
‣ Board reporting increasing in volume & complexity – how to use
the data to make informed decisions?
‣ Harmonisation of fund documentation
‣ Continuously changing environment – what’s coming next? are
we equipped? how much will it cost?
RBS57409
94

Pre vs Post UCITS IV
Pre
‣ Portfolio Risk – VaR,
Soph v Non-Soph
‣ Overdraft Policy
‣ Links between
performance return &
costs of marketing/ x-
border registrations
UCITS IV
‣ Risk Management Process
‣ CSSF Circular 11/512
‣ Counterparty Risk
‣ Liquidity Risk
‣ Market Risk
‣ Operational Risk
‣ Governance Policies – e.g. enhanced
ALFI Code of C, CSSF Circ 11/508
‣ LFR Analysis
‣ Swing Pricing/ Dilution
Levy/ Fair Valuation of
stale prices
‣ Monitoring of delegates, e.g.
depository
‣ Documentation – KIID (SRRI),
Prospectus & Annual Report disclosures
RBS57409
95

Operating model versus the regulatory requirements
‣ Proportionality
‣ Due Diligence visits
‣ Conducting Officers/Non Executive Directors - trends
‣ Conflicts and Inducements Reporting
‣ Liquidity Risk – link distribution strategy with investment
strategy
‣ Increased transparency – shareholder & regulatory driven
‣ Independence – at arm’s length
RBS57409
96

Board reporting increasing in volume and complexity - How to use
the data to make informed decisions?
‣ Board Composition – achieve the right mix; Promoter vs NED;
skillsets
‣ More frequent engagement – quarterly BoD meeting vs daily risk
monitoring - role of Conducting Officers
‣ Use of sub-committees – e.g. Pricing, Audit
‣ Escalation Process to the BoD
‣ Evidence of decision making: comprehensive Board meeting
Minutes – Action Points escalated to the BoD intra board
meetings
‣ New regulatory requirements – CSSF onsite visits – use of board
packs as part of inspection.
RBS57409
97

Harmonisation of Fund Documentation
‣Luxembourg ahead of the game via ALFI and CSSF guidance
‣ Regulatory:
‣RMP
‣Prospectus
‣KIID
‣Long Form Report
‣ Commonly used business tools in Luxembourg today:
‣Service Level Agreement/Operating Memorandum
‣Quarterly Management Company/Conducting Officer
Report
‣Monthly MIS Report
RBS57409
98

Continuously changing environment – what’s coming next? Are we
equipped? How much will it cost?
‣ Continuous assessment of the Board
‣ Is the Board make up / Skill set still fit for purpose?
‣ Evolving Regulations – UCITs V, FATCA, AIFMD, MIFID II,
Dodd Frank….
‣ Market events - Euro Debt Crisis, Madoff…..
RBS57409
99

Summary
Regulators
Custodian
Sub-Custodian Network
Depository Oversight
Board of Directors
Auditors
LFR, AR – Regulatory
Filing Deadlines
Management
Company
Conducting
Officers
Legal & Tax Advisers
FATCA, AIFMD, MIFID
II, Dodd Frank….
Corporate Secretary
Administrator &
Transfer Agent
AML/KYC
Operational
Oversight
Investment Manager
Portfolio Liquidity
Performance
Compliance & Risk
Distributor
Investor Liquidity
KIID, Cross Border
Registration
Sub-Distribution Oversight
Board Meeting Minutes
RBS57409
100

QUESTIONS?
RBS57409
101

Disclaimer
This material is issued by RBS (Luxembourg) S.A. (“RBSLux”). It is intended to provide the recipient (the “Recipient”) with a summary of the services
provided by RBSLux. Unless and until both RBSLux and the Recipient agree to, and sign formal written contracts for the provision of services, it is
not intended that either RBSLux or the Recipient are, or will be, bound by anything contained within this material.
This material is confidential. It is intended for use only by the Recipient and its professional advisers and remains the property of RBSLux. It should
not be reproduced or disclosed to any other person without the consent of RBSLux and must be returned on request to RBSLux and any copies
thereof destroyed. Nothing in this document should be construed as legal, tax, accounting or investment advice or as an offer by RBSLux to provide
services to the Recipient. RBSLux makes no representations or warranties with respect to the material, and disclaims all liability for any use the
Recipient or its advisers make of the contents of the material.
Any views or opinions expressed in the material (including statements or forecasts) constitute the judgement of RBSLux as of the date indicated and
are subject to change without notice. RBSLux does not undertake to update this document. The Recipient should not rely on any representations or
undertakings inconsistent with the above paragraphs.
RBSLux is a member of The Royal Bank of Scotland Group (“RBS Group”). RBSLux and its affiliates, connected companies, employees or clients
may have an interest in financial instruments of the type described in the material or in related financial instruments. Such interest may include
dealing, trading, holding, acting as market-makers in such instruments and may include providing general banking, investment banking, credit and
other financial services to any company or issuer of securities or financial instruments referred to herein.
RBSLux is authorised by the Commission de Surveillance du Secteur Financier in Luxembourg to conduct collective portfolio management.
• Contact Antonio Thomas – Managing Director
• Phone +352 27 111 300
• Email Antonio.Thomas@rbs.com
• Website http://www.rbs.co.uk/corporate/deposits/g4/international.ashx
RBS57409
102

Lunch

ILA Update
Marie-Jeanne Chèvremont,
Chair of ILA, Banque Privée Edmond de Rothschild Europe

Fund Governance Survey Results
Jan Jaap Hazenberg,
Head of Product Strategy & Market Intelligence, ING Investment
Management Europe

Investment Fund Governance
PhD Research of Luxembourg UCITS
Jan Jaap Hazenberg
ILA Conference, 26 January 2012

Overview
I. Background & Theory
II. Empirical research
III. Key findings
IV. Recommendations

I.1 Background

I.2 Theory: Principal-Agent problem
• Ambachtsheer (2005) calls the conflict of interest
between profit-seeking fund management companies
and fund investors the premier agency issue in the
financial services industry:
“The combined forces of acute informational
asymmetry and pronounced principal-agent
problems logically lead to many clients paying
too much for too little.”

I.3 Theory: Principal-Agent problem
• Fund management company revenues are
investor costs
High costs
• Management fees
• Other costs
Conflicts of
interest
Suboptimal
performance
Suboptimal
behaviour
• Market timing & late trading
• Fund tournament
• Leaning for the tape
• Favouritism

I.4 Theory: Mitigating factors
• Monitoring forces protecting investors
Regulators
• Including monitoring
by fund boards
High costs
Conflicts of
interest
Suboptimal
performance
Suboptimal
behaviour
Market
forces
Fund
governance

II.1 Research question
• Independent directors is the category least
burdened by this conflict of interest.
• Are (more) independent boards more effective
for investors, leading to lower costs and/or better
investment performance?
• Relevance:
– Fund selection
– Fund regulation

II.2 Independence of fund boards
• Many have
independent board
members voluntarily
U.S. Europe Luxembourg
Regulation
1940 Act
UCITS IV
2010 Law, part 1
• Independence
• ≥40%*
• Not required
• Not required
• Role
• Negotiate fees
• Transparent
• Transparent
• Other oversight
• N.A.
• Depositary
• Depositary
• Promoter**
Industry
association
codes
ICI (1999):
≥ 66.7%
Stricter definition
EFAMA (2006):
… act in sufficient
autonomy and
independence
ALFI (2009):
… to provide
independent
review and
oversight
* >50% in case fund relies on excemption rules
** Extra-legal concept

II.3 Earlier research:
Costs & Performance of U.S. open-end funds
Study % Ind. /
Costs*
Tufano-Sevick (1997)
–
% Ind. /
Perf.*
Meschke (2007)
Ferris-Yan (2007, 2009)
Kong-Tang (2008)
Cremers et al. (2009)
Adams et al. (2010)**
0
0
+
0
0
–
0
–
0
0
* Relationship percentage independent directors and costs and performance:
+ Significantly positive
– Significantly negative
0 Not significant or inconsistent
** Index funds

II.4 Own research: 2 approaches
Luxembourg UCITS umbrella funds
Flagships of 48 top cross-border promoters (PwC Global Fund Distribution)
Quant
analysis
Survey
- Multiple regression analysis
- Relationship independence with
Costs (TER) and Performance
(Carhart alpha)
- 6 equity sectors (593 sub-funds)
- Retail share class
- 2000-2009 period
- Interviews based on 41
questions
- 1 board member of each
umbrella

II.5 Definitions: Board members
• Dependent:
• Employed by promoter (group)
• Independent:
• Not currently or previously employed by promoter (group)
• Not employed by service provider
• Semi-independent:
• Previously employed by promoter (group)
• Employed by service provider

II.6 Definitions: Boards
• Dependent
• Independent
• Semi-independent

III. Key findings

Finding 1.1: Development board members
100%
90%
80%
70%
60%
50%
Dependent
Semi-independent
Independent
40%
30%
20%
22%
14%
10%
18%
25%
0%
Jan/00
Jul/00
Jan/01
Jul/01
Jan/02
Jul/02
Jan/03
Jul/03
Jan/04
Jul/04
Jan/05
Jul/05
Jan/06
Jul/06
Jan/07
Jul/07
Jan/08
Jul/08
Jan/09
Jul/09

Finding 1.2: Development boards
60.0%
50.0%
40.0%
30.0%
Independent
Semi-independent
Dependent
20.0%
10.0%
0.0%
Jan/00
Jul/00
Jan/01
Jul/01
Jan/02
Jul/02
Jan/03
Jul/03
Jan/04
Jul/04
Jan/05
Jul/05
Jan/06
Jul/06
Jan/07
Jul/07
Jan/08
Jul/08
Jan/09
Jul/09

Finding 1.3: Explanation developments
• Independent board members are more common
among Anglo-Saxon (AS) promoters than
among Continental European (CE) promoters.
• AS promoters increased the percentage of
independent board members.
• CE promoters decreased the percentage of
independence, in several cases to zero.

Finding 2: Main reasons
Against independence
For independence
• Not required on the basis of
regulations
• Not requested by (prospective)
clients
• Higher convenience
• Consistency with other fund
ranges
• Good practice
• Provides proper checks and
balances
• Expertise
• Commercial benefits
• Consistency with other fund
ranges

Finding 3: Governance models
• Integrated model:
– Part of the internal processes of the promoter
– Dependent board members only
• “Different hat” model:
– Board has distinct, separate position versus promoter
– Dependent boards and boards with (semi-)
independent minority
• Independent model:
– Independent position
– (Semi-) independent majority

Finding 4.1: Cost & performance
• No consistent evidence that more
independence leads to:
– Lower costs
or
– Better performance

Finding 4.2: Independence & costs
200
TER (in bp)
TER% (in bp)
195
190
185
180
175
170
2008
Continental
European
promoters
2000
Anglo-
Saxon
promoters
2008
165
160
2000
155
150
0% 5% 10% 15% 20% 25% 30%
Independence I% (I%)

Finding 5: Board priorities
Irrespective of
the board type:
– Risk mgt and
Compliance
prioritised.
Grey: Box plot of board priorities
Green line: Average score for (semi-) independent boards
Red line: Average score for dependent boards
– Performance
and Costs deprioritised.
Both seen as
prerogative of
the promoter.

Finding 6: Promoter distribution model
• Performance independent promoters is better:
– 1.0-1.2% p.a. (risk-adjusted, net of fees)
• Costs of independent promoters are higher:
– Almost 20bp (TER, both components contribute)
• Possible explanations:
– Higher active share
– More attractive place to work

Finding 7: Economies of scale
• Costs:
– Larger funds have lower TERs (Other Costs)
– Funds in larger umbrellas have lower TERs (both
components)
– Funds of larger promoters have higher TERs
(Management and Distribution Fee)
• Performance:
– Larger funds have better performance (evidence is
weaker)

IV.1 Recommendations: Governance
• Results are not supportive of making
independent boards mandatory or giving
governance a significant weight in fund selection
• Boards can put greater focus on fees, e.g. by
applying breakpoints
• Independent oversight at promoter level to be
considered

IV.2 Recommendations: Future research
• Luxembourg funds in general are underresearched
• Board effectiveness:
– In “unusual” situations (e.g. launches, mergers,
liquidations)
– In the case of funds of smaller promoters
• Performance differences between independent
and affiliated promoters

Panel: The future of fund governance in
Luxemburg and the EU
Panel:
Jean Guill,
Commission de Surveillance du Secteur Financier
Marie-Jeanne Chèvremont,
Chair of ILA, Banque Privée Edmond de Rothschild Europe
Freddy Brausch,
Linklaiters LLP, Partner
Denise Voss,
Vice Chair of ALFI, Franklin Templeton International Services S.A.
Moderated by: John Parkhouse

Coffee Break

Open Forum on current developments & hot issues
Moderated by:
Marie-Jeanne Chèvremont,
Chair of ILA, Banque Privée Edmond de Rothschild Europe

Conclusions
John Parkhouse,
Chair of the ILA fund committee and Partner, PwC Luxembourg

Cocktail