Governance
The International Forum of Sovereign Wealth Funds, the de facto organisation of SWFs, has issued the Generally Accepted Principles and Practices for Sovereign Wealth Funds, known as the Santiago Principles.
The Center for Fiduciary Excellence provides excellent guidance for establishing governance frameworks of relevance to sovereign investors. This guidance is applicable to both setting up in-house operations and overseeing the operations of external parties. The guides are supplemented with self-assessment questions. Certification is available.
Investment Steward: A person or organization which has the legal responsibility for managing investment decisions (trustees and investment committee members).
Governments have a responsibility to oversee the mission, strategic direction, finances and operations of their respective organizations. They have an especially high commitment to fulfill these responsibilities honestly and with integrity. With respect to the treasury function, they must establish clear and understandable policies and ensure that they are followed.
Managers of governmental or public funds administer, direct, control, account for, report on, and monitor hundreds of billions of public dollars through governmental investment programs. This institutional environment is markedly different than for-profit sectors in that they must invest as well as borrow; maintaining long-term funds for social purposes such as housing programs, or maintaining short-term funds for governmental daily expenditures. An understanding of the dynamics of cash flow is vital for successful investments, as well as recognition of their fiduciary duties and responsibilities to the public.
Fiduciary duties and responsibilities such as setting investment objectives, developing and implementing an investment policy and investment committee, developing cash flows, performing broker/dealer and custodian due diligence, implementing internal controls, selecting, diversifying, and purchasing investment securities, recording and properly accounting for investments, monitoring the portfolio and evaluating and reporting the results are just a few of the fiduciary duties and responsibilities public investment managers have. A CEFEX-certified public fund demonstrates to the public that fiduciary procedures are in place and that investments are prudently managed.
Fiduciary Advisor: An organization which is responsible for providing comprehensive and continuous investment advice (including wealth managers, financial advisors, trust officers, financial consultants, investment consultants, and financial planners). The link is included here for completeness, as it may provide useful pointers for managing those who advise the fund.
Investment Manager: An organization which makes investment decisions: selects the securities (eg. stocks and bonds) to implement a specific investment mandate (eg. large cap growth).
Each fiduciary practice has criteria to determine conformity to the practice. Since asset managers will have varying implementations of fiduciary practices, the criteria span a broad range. Each criterion is assessed using quantitative measures of adherence to a practice. For example, Practices 3.5 and 4.2, best execution in trading and trade monitoring, contain criteria from the broker selection and trading process, to the monitoring and allocation policies. The assessment of these criteria will include a query on failed trades over a set time period. Another example is in Practice 1.5 where business continuity through reliable IT systems and risk management is addressed. The assessment will query whether back-up facilities and recovery programs are coordinated with the firm's reporting obligations.
Scrutinizing the fiduciary practices of an Investment Managers is challenging. Even today, post Madoff, few investors investigate or monitor their Investment Managers. Even when faced with dramatic losses, most investors choose to accept the reassurances of their advisers that their losses were caused by unforeseeable market forces, not actionable wrongdoing. CEFEX certification allows for a deeper verification of the Investment Manager, thereby increasing trust for both the advisor and investor.
The Prudent Practices for Investment Managers cover 4 major areas:
1. Organizational: succession planning, operational coherence, capacity to serve clients, independent administration, information technology, human resources and compliance.
2. Structural: financial sustainability, business strategy, management of resources, external oversight, cash management, remuneration, marketing & sales and risk management.
3. Implementation: team management, value-added investment systems, research, portfolio management processes and trade execution.
4. Monitoring: attribution analysis, mandate management, controls for ‘soft-dollars’, best execution and proxy-voting and fiduciary review.
Investment Support Services: An organization which is responsible for providing comprehensive and continuous investment advice (including wealth managers, financial advisors, trust officers, financial consultants, investment consultants, and financial planners).The Australian Financial Services Council has a set of mandatory standards for FSC members. The standards include:
- Code of Ethics and Code of Conduct
- Equity Trusts
- Operational Capability Standard
- Product Performance: Calculation of Returns
- Valuation of scheme assets and liabilities
- Presentation of Returns information
- Presentation of past performance information
- Proxy Voting
- Authorisation, regulation and passporting
- Firms covered by MiFID will be authorised and regulated in their "home state" (broadly, the country in which they have their registered office). Once a firm has been authorised, it will be able to use the MiFID passport to provide services to customers in other EU member states. These services will be regulated by the member state in their "home state" (whereas currently under ISD, a service is regulated by the member state in which the service takes place).
- Client categorisation
- MiFID requires firms to categorise clients as "eligible counterparties", professional clients or retail clients (these have increasing levels of protection). Clear procedures must be in place to categorise clients and assess their suitability for each type of investment product. That said, the appropriateness of any investment advice or suggested financial transaction must still be verified before being given.
- Client order handling
- MiFID has requirements relating to the information that needs to be captured when accepting client orders, ensuring that a firm is acting in a client's best interests and as to how orders from different clients may be aggregated.
- Pre-trade transparency
- MiFID will require that operators of continuous order-matching systems must make aggregated order information on "liquid shares" available at the five best price levels on the buy and sell side; for quote-driven markets, the best bids and offers of market makers must be made available. (Note consideration is being given to extending these requirements to other financial instruments. Under Article 65(1) of Directive 2004/39/EC, the European Commission is due to submit a report to the European Parliament and to the Council on extending pre- and post-trade transparency requirements to transactions in financial instruments other than shares by October 2007.)
- Post-trade transparency
- MiFID will require firms to publish the price, volume and time of all trades in listed shares, even if executed outside of a regulated market, unless certain requirements are met to allow for deferred publication. (Note see comment above regarding extension of these requirements to other financial instruments).
- Best execution
- MiFID will require that firms take all reasonable steps to obtain the best possible result in the execution of an order for a client. The best possible result is not limited to execution price but also includes cost, speed, likelihood of execution and likelihood of settlement and any other factors deemed relevant.
- Systematic Internaliser
- a Systematic Internaliser is a firm that executes orders from its clients against its own book or against orders from other clients. MiFID will treat Systematic Internalisers as mini-exchanges, hence, for example, they will be subject to pre-trade and post-trade transparency requirements (see above).
Financial Reporting
The global standards are the International Financial Reporting Standards (IFRS), published by the International Accounting Standards Board. United States Generally Accepted Accounting Practices (GAAP) issued by the Financial Accounting Standards Board are on a convergence path with IFRS.
The major accounting firms have produced valuable guidance, in the form of model reports, compliance checklists and so on. Some also provide training modules.
Deloitte's IAS Plus reference site has a wide range of useful resources.
Ernst & Young provide illustrative financial statements for:
- Investment Fund (liabilities) 2010
- Investment Fund (equities) 2010
- Real Estate 2010
PricewaterhouseCoopers provide illustrative financial statements for:
KPMG provide illustrative financial statements for:
Performance Measurement
The major standards are the Global Investment Performance Standards (GIPS) issued by the CFA Institute, sponsored and promoted by organisations in 32 countries.
The GIPS standards are a set of standardized, industry-wide ethical principles that provide investment firms with guidance on how to calculate and report their investment results to prospective clients.
The GIPS standards provide:
- Firms with an ability to compete across the globe
- Investors with the ability to make comparisons
Click to access Guidance Statements.
Norges Bank (manager of Norwegian Global Pension Fund - Global) provides examples of a compliance manual, performance results, methodology, and a verification report.
Best Execution
The Investment Industry Regulatory Organization of Canada (IIROC) has issued revised guidance on best execution and management or orders, as well as with respect to the use of certain order types. IIROC originally published the guidance for comment in November 2010.
The CFA Institute has issued Trade Management Guidelines to help firms, investment professionals, and clients better understand the complexities of best execution, the way firms maximize the value of a client's portfolio.
What Do the Trade Management Guidelines Cover?Also see MiFID above re best execution.
Use of the Trade Management Guidelines will:
- Processes firms use to execute and oversee trades
- Disclosure of those practices and conflicts of interest
- Record keeping.
- Ensure clients receive the highest degree of care through comprehensive controls
- Enhance the oversight of trading
Operational Capability
Guidance for operational capability is primarily derived from auditing standards.
The international standard is International Standards for Assurance Engagements (ISAE) No. 3402, published by the International Auditing and Assurance Standards Board (IAASB), a standard-setting board of the International Federation of Accountants (IFAC).
ISAE 3402: The International Standard on Assurance Engagements, Assurance Reports on Controls at a Service Organization is to be the new globally recognized standard for assurance reporting on service organizations. While many past and present standards still exist for reporting on service organizations (SAS 70, CICA 5970, and AAF 01/06), practitioners now have the ability to use a globally accepted framework, thus creating a more unified and transparent reporting tool when reporting on controls at service organizations. As of this writing, it is not yet known what the long-term effect of ISAE 3402 will have in replacing other standards as mentioned.
It should be plausible to assume that the American Institute of Certified Public Accountants SAS 70 standard (which will be superseded by SSAE 16 in 2011 for the effective date), the Canadian Institute of Chartered Accountants CICA 5970 standard, and the Institute of Chartered Accountants in England & Wales (ICAEW) AAF 01/06 (formerly FRAG 21) standard may very well still be used in their own national localities or other regional specific areas. The intent of ISAE 3402 is not to directly replace these standards, but to provide a globally accepted alternative for primary use, if needed.
User entities, user auditors, service auditors, and service organizations should look upon the new ISAE 3402 standard favorably, as it creates a much needed directive for assurance reporting on todays vast and complex global service organizations. The guidelines and subsequent requirements for reporting on controls as put forth by the ISAE 3402 standard will now gain greater clarity and transparency, allowing user entities and all intended parties to have greater confidence in reports received on service organizations.
(Above explanation from The ISAE Resource Guide)Existing standards:
- The United States SAS70 issued by the Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) with its content codified as AU 324.
- The Asset Management Group (AMG) of the Securities Industry and Financial Markets Association (SIFMA) today issued recommended baseline areas of scope and control objectives for asset managers' SAS 70 reports. SAS 70 reports, which are issued in accordance with guidance from the American Institute of Certified Public Accountants to demonstrate that a firm has appropriate internal controls, are typically requested by the customers of asset managers, such as pension funds and mutual funds. The recommended asset manager baseline areas of scope and control objectives include asset management operations and the IT general computer controls and were developed to make the audit reports more understandable and provide a more consistent reporting model for the industry.
- The Australian Auditing and Assurance Board has issued Guidance Statement GS 007: Audit Implications of the Use of Service Organisations for Investment Management Services. Appendix 2 contains illustrative controls covering the areas of custody, asset management, property management, investment administration, registry, and information technology. Note: the listed activities are not comprehensive and tend to be those that give rise to accounting entries, relfecting the nature of this, the SAS70 and the AAF 01/06 as auditors' documents.
- The UK AAF 01/06 issued by the Institute of Chartered Accountants of England and Wales covers very similar material to the Australian standard, though the illustrative controls have a few differences.
- The Australian Financial Services Council has published an Operational Capability Standard that includes the following requirements:
- Compliance with Code of Ethics and Code of Conduct
- Business continuity and disaster recovery planning
- Insurance
- Appropriate control systems
- Effective compliance and audit arrangements
- Sufficient financial and other resources to fulfil obligations
- Sufficient number of capable employees
- Assessment of related party controls
- Dispute resolution
Soft Dollars
The CFA Institute has published Soft Dollar Standards which cover:
- Definition of soft dollars
- Appropriate products and services to purchase with client brokerage
- Establishment of standards for soft dollars use
- Model disclosure guidelines
- The manager's role and responsibility to clients
The Securities and Exchange Commission (SEC) has issued "Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934" which covers the use of soft dollars in the US market. Fiduciary law and ERISA have confirmed that institutional brokerage commissions are an asset of the client / beneficiary / principal.
The Financial Services Authority in the UK has banned the use of soft dollars. FSA Rule 05/09 on bundled brokerage and soft commission arrangements:
- limits investment managers’ use of dealing commission to the purchase of ‘execution’ and ‘research’ services;
- requires investment managers to disclose to their customers details of how commission payments have been spent and what services have been acquired with them;
- embeds in the commercial relationship between investment managers and brokers incentives to secure value for clients for execution and research spend; and
- promotes competition between those who produce investment research by removing the regulatory distinction between research services provided by brokers along with execution (i.e., bundled services) and research services provided by third parties (i.e., softed services).
Transition Management
The Transition Management industry has a Code of Best Practice, known as the T-Charter. The T-Charter introduces 10 key commitments covering disclosure, conflicts of interest, client confidentiality, resources available to transition managers, systems and processes, cost estimation, dealing strategy and practices, evaluation, errors and compliance.
The T-Charter is supported by a reporting standard, known as the T-Standard. The standard was developed by Russell Investment Management in consultation with the transition management industry. The standard was developed to help investors measure the performance of portfolios during a transition. It's an important step toward bringing transition management to the same consistency expected in more traditional forms of performance measurement.
The T-Ratio is designed to complement the T Standard by providing a context to evaluate and compare transitions that differ in complexity, particularly in terms of size and risk. The T Ratio standardizes post-transition implementation shortfall and compares it to the original pre-transition estimate by adjusting the shortfall for the transition event risk.
