I started watching “Dirty Money” on Netflix last week (for a reason). I am sure most of you have been watching or following the Mark Zuckerberg hearings. It is only at these times that we may think of the underestimated value of Governance. Most media have been tagging this incident as a hack and are more interested in the #DeleteFacebook rise and which celebrity closed its FB account.
On the positive side, over here in Europe, the FCA officially announced new remedies for the UK fund management industry. As always with a focus on improving the competitiveness of the industry and after its usual market study process, there were several rules announced that are centered around protecting investors who are active or passive in their participation. Details are here.
I was very interested in their rulings regarding the duties of fund managers as the agents of investors in their funds and specifically, on the new requirement for fund managers to appoint a minimum of two independent directors to their boards. At first, this seemed to mean an improvement in mitigating potential conflicts that arise at thdisservicece of the investor. However, I realized quickly that this glance is very myopic for more than one reasons.
I reached out to one of the experts in investment governance, Dr. Eelco Fiole, co-founder of Alpha Governance partners which specializes globally in complex governance setups in the investment world. We did agree that “Independence” means “no conflict of interest”, but that term itself opened up a can of worms. First of all, the asset management industry and specifically in the UK, may actually have more hidden agency problems than a traditional integrated corporate structure. A typical case, is an investment manager in the UK, with a fund structure domiciled in Dublin, or Luxembourg, or the Cayman Islands. In most of these domiciles, the part-time or full-time directors are more or less a kind of club with a gentlemen’s referral modus operando. Lawyers involved in setting the fund vehicles may also be members of these clubs or frequent guests. Independence is not black and white. It is a palette of grey colors which leads most board functionaries to be less focused on risk guidance and more on growing their portfolio of directorship positions. The directorship “market” has been fairly commoditized (low prices, standard quality which could only be suitable in less complex setups which is not the case with asset management). Add to that the custodian bank, transfer agent, and the broker or brokers involved.
While I know from experience in the hedge fund industry that there is a unique complexity demanding governance expertise, I don’t know of many actual blowups (a la Enron) which seems to point to an unwarranted concern? The Angolan-Swiss businessman and the Quantum Global scandal about the Angolan sovereign wealth fund, is really an exception (albeit, huge).
Paradise Papers expose:
The Paradise Papers reveal Bastos’ company group, Quantum Global, set up seven investment funds between 2014 and 2015 in the tax haven Mauritius. So far, they contain a total of $3 billion in capital from the Angolan sovereign wealth fund. Those funds, in turn, are managed by another Quantum Global company owned by Bastos, a service for which the firm receives a significant chunk of money. The Bastos company receives 2 to 2.5 percent of the $3 billion each year, making for a guaranteed annual income of $60 million to $70 million from 2015 onward.
On top of these fees, which are extremely high by international comparison, other payments were made as well in 2014. According to the sovereign wealth fund’s annual report, various Bastos companies received around $120 million that year for advisory services.
The revenues Bastos’ company earned from the Angolan wealth fund were so high that he was able to pay himself enormous dividends: $13 million in 2014 and $28 million in 2015.
Eelco, pointed out to me that 99% of governance accidents in the investment realm are negotiated and settled out of court. So, unless you are in the business, you don’t have the actual sense of the existing governance challenges. Given the current macro-economic environment (mounting government debt, illiquidity scenarios, interest rate spikes etc) and the new risks and new uncertainties building up (cyber, fraud, regulatory, etc), there is clearly more degrees of complexity to consider. Unless this is recognized, independence on its own (even if realistically attainable) won’t even scratch the surface. High quality governance is needed in several asset management areas.
We closed our inquiry into the substandard state of the traditional asset management governance (especially that of “alternative investment vehicles”) with the open questions about the crypto asset management emerging area, the true alternative asset class.
I recalled last year in early March, my post Wedding announcements pending between Old & New Finance Tribes: Bitcoin in an ETF gown! while awaiting the SEC decision on the issuance Winklevoss Bitcoin ETF. What a governance nightmare setup: Gemini, the New York State-chartered trust company, which is owned by the twins was chosen to act both as a custodian and as the bitcoin exchange. So, who is taking care of the investor interests in this structure that owns the entire chain of operation? Add, on top of that the challenging issues of any forks! In the case of the Winklevoss Bitcoin ETF governance, the custodian was to decide what the ETF will adopt and when.
We touched upon the few new structures that are being designed right now to facilitate institutional investors to gain exposure to crypto assets in a compliant way. They are all focused on fitting existing fund structures to the old framework: a fund manager, a custodian, a broker. But what about the governance complexities arising, if all these stakeholders have eye-boggling conflicts of interest?
Complexity is mounting. Technology has been applied towards improving governance. Automating regulatory documentation requirements is not governance.