Luxembourg Fund Governance Survey 2018

January 2019 2 | PwC Table of contents

Foreword 4

Introduction 6

Board composition 10

Board organisation 20

Roles and responsibilities of the board 26

Conflicts of interest and legal liabilities 32

Code of conduct 34

Looking forward 36

Conclusion 38

Luxembourg Fund Governance Survey 2018 | 3 4 | PwC Foreword

On behalf of PwC and the Institut In addition to early adoption of Luxembourgeois des Administrateurs regulation, the Luxembourg asset (ILA) it gives me great pleasure to management industry is very active in introduce our latest edition of the providing practical guidance to board Luxembourg Fund Governance Survey. members as evidenced by the numerous publications, events and courses This is our 9th edition of the survey developed by both ILA and ALFI several where we were fortunate enough of which are referenced in the results to to gather insights from close to 100 the survey. investment fund and management company boards covering both retail Our aim in preparing this survey is to and alternative products. The level of provide boards with insights into current participation to this year’s survey clearly good governance practices and to shows that the industry remains focused further strengthen the overall governance on governance. framework of the Luxembourg fund industry. The asset management industry has Michael Delano continued to be faced with regulatory In conclusion, I would like to sincerely ILA Fund Committee change since the global financial crisis thank all of the respondents for the time Chairman in 2008. The number of regulations at they took to participate in the survey, the PwC Luxembourg Partner both national and international levels members of the ILA Fund Committee have increased significantly, many of who designed the survey and analysed which have a direct impact on fund and the results and last but not least, my management company boards. You will colleagues from the PwC Luxembourg’s see in the following pages that boards Market Research Center who were have risen to the challenge to keep on instrumental in putting this together. top of the ever-changing regulatory environment while also maintaining a I trust you will find the contents useful. keen focus on their main objective of investor protection. Mike Delano ILA Fund Committee Chairman PwC Luxembourg Partner

Luxembourg Fund Governance Survey 2018 | 5 Introduction

About the 2018 survey Highlights and key trends At a time when governance models This year’s survey reveals that have never been under more governance practices continue to evolve scrutiny, this ninth edition of our across the Luxembourg fund industry. Luxembourg Fund Governance Furthermore, practices within alternative investment entities has greatly matured Survey continues to delve into the since the introduction of the AIFM various approaches to governance Directive four years ago and the resultant taken by the Luxembourg fund creation of the AIFM and AIF status. industry. Since 2010, regulators and industry associations – at both New and revised regulations, such as national and international levels – GDPR, the 4th AML Directive, MiFID have considerably increased the II and PRIPS, have been implemented since the last survey. These regulations number of rules and guidelines have influenced not only fund applying directly and indirectly to management but also governance. boards of funds and management companies. As the new CSSF Circular 18/698 was only released in August 2018, its effects Conducted every two years, the survey will only be seen in the next edition of our aims to gather insights from boards of survey. The main goal of the circular is to Luxembourg-based investment funds create convergence of practices across and management companies in order investment fund management entities to obtain a comprehensive assessment by setting out the same requirements of governance practices within the for both UCITS ManCos and AIFMs. Luxembourg fund industry. Among other topics, it puts a special focus on delegates and the oversight The current edition of the survey of these delegates, defines thresholds was completed over a period of five on the number and time capacity of months, between June and November mandates directors can accept, aligns 2018. It combines answers from risk management requirements between 96 respondents who serve in the UCITS and AIFs, and defines scenarios capacity of board chairpersons and and rules with regards to AML/CTF. directors, or as conducting officers or company secretaries supporting the Reflecting market response to both boards, all with first-hand knowledge growing regulatory pressures, as well of the governance practices at their as increased calls for transparency management companies and funds. from investors, responses show improvements across most areas. Trends noted included increased appointment of independent directors and chairs, as well as improved gender diversity, disclosure of information regarding the board (including on remuneration), and increased use of sub-committees, board performance reviews, and uptake of the ILA Certified Director Program.

6 | PwC General market information Our sample The number of management companies operating on a cross-border basis has Luxembourg is the world’s second This year’s survey draws from a sample of increased since our 2016 survey, with largest fund centre and Europe’s largest 96 participants who answered on behalf of the number of funds having appointed with more than EUR 4.2 trillion in assets either the board of a Manco or the board of cross-border ManCos/AIFMs also having under management (AuM). Luxembourg a fund. Their answers fall into the following increased. Cross-border passporting – has been at the forefront of the UCITS five categories: created by the European legal framework fund industry for many years and is the – is clearly valued by the market. • Super ManCos1 leading cross-border investment fund centre in the world, with Luxembourg- • UCITS ManCos2 Luxembourg funds most often appoint based funds offered in more than 80 • AIF ManCos3 (collectively “ManCos”) a management company located in Luxembourg (63%), with the UK the countries. • UCITS4 second location of choice (16%). With the Since the introduction of AIFMD, • AIFs5 (collectively “funds”). Brexit date fast approaching however, Luxembourg has also become a As in previous years, our survey brings a majority of UCITS funds intend to leading centre for alternative asset together the viewpoints of a substantial appoint a Manco in an EU country other 6 classes, including hedge funds, private section of Luxembourg’s UCITS industry. than the UK in the coming 12 months, equity, real estate, private debt and Although the actual respondents are while many AIFs do not yet appear to infrastructure. Alternative fund managers not always the same, this year our have announced their contingency plans. currently manage more than EUR 710 respondents account for approximately Alternative funds and AIFMs captured billion in alternative assets. 50% of Luxembourg-based UCITS AuM in this year’s survey span a diverse mix and 26% of AIF AuM. of assets - including funds of funds, In this year’s survey, we drew information fixed income, equity, real estate, private from fund promoters originating from equity, hedge fund, private debt/ across the globe, from 20 different loans and infrastructure – with none nations and three continents (North dominating the sample. America, Europe, and Asia). Promoters from the UK, the US and Switzerland were well represented. It is important to point out, however, that the respondents differ significantly from our 2016 survey with roughly only a third being similar. You will also note when reading this that we refer, at various points, to the 2012 and 2014 as well as the 2016 editions of 1. Large management companies overseeing both UCITS and alternative funds; regulated under the survey. We included references to both regimes described below. the previous surveys to better identify 2. Management companies overseeing UCITS trends. funds only; regulated under Chapter 15 of the Law of 17 December 2010. 3. Management companies overseeing alternative funds only; regulated under Chapter 16 of the Law of 17 December 2010 or under Chapter 2 of the Law of 12 July 2013 transposing the AIF Directive into Luxembourg law. 4. UCITS funds; regulated under the Law of 17 December 2010 transposing Directive 2009/65/ EC relating to Undertakings for Collective Investment in Transferable Securities (“UCITS Directive”). 5. Alternative Investment Funds; those funds that are not covered by the UCITS Directives. 6. At the time of print, the UK was an EU Member country.

Luxembourg Fund Governance Survey 2018 | 7 Greece 1% Figure 1: Sample composition FigureFinland 2 1%: Where is the promoter located? Andorra 1% Mauritius 1% Sweden 2% Saudi Arabia 1% Singapore 2% AIF Finland 1% Greece 1% Bermuda 2% 20% Andorra 1% Mauritius 1% Spain 3% UK 27% Sweden 2% Saudi Arabia 1% Netherlands 3% Super ManCo Singapore 2% 33% France 3% Bermuda 2% Denmark 3% Spain 3% UK 27% NetherlandsBelgium 3% 3% 2018 France 3% Japan 4% Denmark 3% Germany 4% Belgium 3% 2018 US 13% Italy 5% Japan 4% UCITS UCITS Luxembourg 7% Switzerland 10% 28% ManCo Germany 4% 7% US 13% AIFM Italy 5% 11% Luxembourg 7% Switzerland 10% Source: PwC AWM Research Centre

Portugal 1% Jersey 1% Bermuda 1% Hong Kong 1% Australia 1% Vietnam 1% Figure 3: Are you a cross-border ManCo? or have you Sweden 2% appointed a cross-border ManCo? PortugalSingapore 1% 2% Jersey 1% BermudaNetherlands 1% 2% Hong Kong 1% Japan 2% Australia 1% Vietnam 1% UK 26% SwedenDenmark 2% 2% SingaporeSpain 2% 3% Netherlands 2% Belgium 4% Japan 2% UK 26% Denmark 2% Germany 5% 2016 80 71% 73% Spain 3% 68% Belgium 4% 70 Italy 6% 58% 56% 60 Germany 5% 2016 Luxembourg 20% France 6% 50 44% 42% Italy 6% US 6% 40 32% 29% Switzerland 13% 27% Luxembourg 20% 30 France 6%

20 US 6% 10 Percentages may not add up to 100%Switzerland due to rounding. 13%

0 Source: PwC AWM Research Centre Super ManCo UCITS ManCo AIFM UCITS AIF

n Yes n No Source: PwC AWM Research Centre

8 | PwC Breakdown of survey areas

The survey was divided into the following key areas of interest:

1 2 3

Board composition Board organisation Roles & deals with matters such as presents the practical aspects responsibilities the profile of board members of board sessions like location, of the board (independence, expertise, attendance, duration of board addresses key issues age, gender, tenure) as well as meetings and agendas for such as management style appointment procedures and those meetings. of the board, oversight remuneration practices. responsibilities, performance evaluation, continuing education and the ILA certified director program.

4 5 6

Conflicts of interest Code of conduct Looking forward and legal liabilities examines board considers the implications of features information regarding implementation of their the latest regulations as well the management of conflicts adopted code, and takes a as areas that will require extra of interest as well and closer look at the ALFI7 code of attention from the board over management and mitigation of conduct. the next two years. directors’ liabilities.

7. Association of the Luxembourg Fund Industry; the official representative body for the Luxembourg investment fund industry.

Luxembourg Fund Governance Survey 2018 | 9 | 9 Board 1 composition

Board size Chairperson appointment - it is an on-going process over the entire year. In addition to matters related to Our findings align with those of In line with good governance practice, meetings, such as steering discussions, our 2014 survey, revealing that the most boards appoint a board setting the tone of the board and average board of both ManCos and chairperson as a formal on-going ensuring that conclusions are reached funds consists of 4 to 5 members, position, which reflects to the continuous in a timely and transparent manner, the leadership role of a chairperson. chairperson should also be involved in including the chairperson. In Nonetheless, more than a third of liaising with the Company Secretary practice, however, this can differ UCITS ManCos, AIFMs and AIFs only and CEO. This is critical when setting vastly. The number of board appoint a chair of each meeting and no meeting agendas, ensuring follow up of members frequently increases actual board chair, surprisingly with this action points between meetings, being in conjunction with increasing seeming more common among Anglo- the first point of contact for board issues AuM or the number of sub-funds Saxon boards. and escalation, and generally ensuring overseen. Among our sample, continued governance on an on-going Appointing a strong board chairperson the largest board consisted of basis. (in the corporate governance sense) 12 members belonging to a large is consistent with global corporate UCITS fund. governance trends as leadership is much more than chairing an individual meeting

Figure 4: Is the chairman position appointed for a fixed period or at each meeting?

100 3% 22% 80 39% 43% 45% 60 97% 78% 40 57% 55% 61% 20

0 Super UCITS AIFMs UCITS AIFs ManCos ManCos

Appointed for a fixed period Appointed at each meeting (by rotation) Source: PwC AWM Research Centre

10 | PwC Independent and Non-Executive Figure 5: Proportion of boards with at least one independent directors director

Over the last decade independent and non- executive directors have come to play an 100 93% 95% increasingly important role in improving corporate 89% governance and in ensuring companies follow ethical practices. As part of this trend, many 65% companies ensure a certain percentage of their 51% 50% board are not affiliated with the company, i.e. 50 individuals who are external to the company (“Non- 100 Executive Director” or “NED”). Where the non- executive satisfies certain additional criteria, such as no current other business relationship with the company and not being a recent ex-employee, they may also be considered as an independent non- 500 executive director (“Independent Non-Executive ManCos UCITS AIFs Director” or “iNED”).8 2012 2018 This year we placed a special focus on the Source: PwC AWM Research Centre proportion of boards with at least one independent 100 non-executive director and found a clear upwards 0 Figure 6: Proportion of boards with an independent trend since previous surveys. We noted, however, that fund boards, be it UCITS or AIFs, are still more chairperson likely to have at least one independent director than 50 the boards of ManCos. Whilst this could be due 100 to the fact ManCo boards are, in some cases, still seen as an extension of the promoter, we welcome the trend towards also appointing non-executive directors on ManCo boards. 58% 0 The appointment of an independent chairperson, 50 43% also considered good governance practice, has seen an upwards trend. It is encouraging to note 29% 23% that the majority of AIFs who responded to our 18% survey now have an independent chairperson. In 10% its 2017 Annual Corporate Directors Survey9, based 0 on the opinions of 886 directors on the boards of public companies in the U.S., PwC found that ManCos UCITS AIFs independent chairpersons are more likely to be 2012 2018 challenging and prepared to have those difficult conversations which are necessary from time to Source: PwC AWM Research Centre time. The same survey found that directors on boards with non-executive chairs are more than twice as likely to say that their board decided not to 8. For a fuller discussion on independence criteria, please refer to the “Board re-nominate a director, or provided training or other Member Independence” paper on the ILA and ALFI websites - http://www. support to a director (because of a more robust alfi.lu/node/3168 board assessment process). 9. PwC’s Annual Corporate Directors Survey has gauged the views of public company directors from across the United States on a variety of corporate governance matters for more than a decade. In the summer of 2017, 886 directors participated in the survey. The respondents represent a cross- section of companies from over a dozen industries, a majority of which have annual revenues of more than USD 1 billion.

Luxembourg Fund Governance Survey 2018 | 11 Figure 7: What are the main areas of expertise of the chairperson and Board expertise the board members? A boards' collective skills and expertise are critical for successfully fulfilling their Chairperson Investment management mandate. In order to make informed decisions, board members should have Fund administrationInvestment management / Operations 49% expertise covering key aspects of the Fund administration / Operations 32% CEO / Managing director business. Survey participants indicated CEO / ManagingDistribution director 32% that most board members had two to Fund governance / ProfessionalDistribution director 24% three from our list of suggested areas of Fund governance /Finance Professional / Accounting director 20% expertise. FinanceRisk management/ Accounting 18% Collectively, boards display a Risk managementLegal 15% comprehensive knowledge in the ComplianceLegal 15% key areas - investment management, ComplianceCustodian 14% fund administration, distribution, fund CustodianIT 11% governance, risk management, finance IT 3% and accounting, and compliance. Since our last survey, distribution has become more represented in line with the Board members Commission de Surveillance du Secteur Financier (CSSF) having emphasised Investment management 33% the requirements on distribution Fund administrationInvestment management / Operations 33% oversight which are further clarified in Fund administration / DistributionOperations 25% Circular 18/698. Fund governance / ProfessionalDistribution director 25% Fund governance / ProfessionalRisk management director 22% On the other hand, IT expertise remains FinanceRisk management/ Accounting 21% low on the list of board skills. With the Finance / ComplianceAccounting 20% CSSF focusing evermore on outsourcing/ delegation, as well as ICT dependency CEO / ManagingCompliance director 18% and data security risks increasing across CEO / Managing directorLegal 16% all aspects of business, we expect CustodianLegal 10% boards will increasingly seek expertise in CustodianIT 2% these areas in the coming years. OtherIT 2% Other

Source: PwC AWM Research Centre

12 | PwC Appointment procedures The ALFI Code of Conduct recommends going training offered to directors. Some board composition be balanced and letters also reference the company’s An increasing number of Luxembourg diverse in order to help the board to policies and procedures. boards have formal procedures in have better discussions and hence place to appoint new members when make better-informed decisions. A majority of boards have now put in compared to our previous surveys. That Board members should ideally have place written terms of appointment for being said, it remains a non-systematic complementary knowledge and skills, their non-executive and independent practice, as formal procedures often with consideration given to including directors. We’ve seen an upwards trend exist at head office or promoter level. one or more board members who since our 2010 survey when only 32% are deemed independent. Recent of UCITS boards had written terms of The existence of formal appointment CSSF Circular 18/698 also sets out appointment for independent directors. procedures is good practice to ensure expectations, for example regarding However, we remain surprised that there board member diversity. This includes personal skills to enable integrity and is this distinction being made on this having created a board skills matrix, a independence of mind, and regarding topic between executive directors (those document offering a snapshot of desired professional skills where the board as that are employed by the promoter) skills across a particular board, along a whole should understand the various and non-executive and independent with those covered by the current board activities, with each individual also directors. and providing an overview of missing expected to understand the internal skills. In Luxembourg, only a minority governance arrangements and their A large majority of boards (84% overall) of boards maintain such document, responsibilities within the entity. have procedures in place that allow however it can be invaluable in terms directors to gain an understanding of the of professionalising board renewal ALFI and ILA provide guidelines10 on promoter group, management company processes in a manner to ensure board member letters of appointment, and the funds managed. This due boards are, and remain, appropriately pointing out that these are useful to diligence takes place at various stages composed (whether in terms of board clarify various issues such as time (prior to appointment, upon appointment training or in terms of board renewals commitment, remuneration, VAT and throughout the director’s term). and recruitment). application, D&O insurance11 and on-

Figure 8: Does the board have formal procedures to appoint new members?

30 56% 47% 47% 20 34% 29% 24% 10 17% 18% 11% 9% 0 Super ManCos AIFMs UCITS AIFs UCITS ManCos 10. Available on the ILA and ALFI websites – for example in the ALFI Code section of the ALFI 2016 Yes Source: PwC AWM Research Centre website (www.alfi.lu) 2018 Yes 11. Directors and officers liability insurance; it offers indemnification for losses or advancement of defense costs in the event an insured suffers such a loss as a result of a legal action brought for alleged wrongful acts in their capacity as directors and officers.

Luxembourg Fund Governance Survey 2018 | 13 Directors serving at both Board diversity

management company and The average age of board members, for fund level both ManCos and funds, in Luxembourg is approximately 50 years old. This figure A majority of respondents indicated has remained stable since our 2014 that directors are frequently appointed survey, indicating boards in Luxembourg on both the board of the ManCo and appear to have an acceptable turnover the board of a fund managed by the rate, albeit more frequently of the ManCo. On average, between one and executive directors. three directors of the ManCo board are appointed to the boards of the Terms vary across boards and functions. various managed funds. At fund level, At chair level the average tenure varies this typically translates into at least one between five and seven years, while director sitting also on the management at director level this is slightly lower company board. at four to six. The majority of boards in Luxembourg do not limit how long This type of dual appointment opens up a director can remain on a board communication channels between the and those who do (less than 10% of ManCo and managed funds, however respondents) largely use length of one must remain vigilent to potential service (rather than say a retirement age) conflicts of interest. In light of this, to determine when a director should step the CSSF requires that a majority of down. Various EU texts consider that directors be different. after 12 years a director will no longer be considered independent, which should feed into periodic renewal of the independent non-executive directors.

Figure 9: Are there written terms of appointment, which outline roles and responsibilities, for the following board members? (% yes)

Super UCITS AIFMs UCITS AIFs ManCos ManCos Chairperson of the board 40% 17% 36% 41% 47%

Directors employed by the promoter or fund 37% 43% 30% 26% 53% sponsor

Directors employed by a service provider or 37% 20% 33% 38% 50% advisor

Independent directors 58% 67% 67% 88% 78%

Source: PwC AWM Research Centre

14 | PwC Across the Asset and Wealth Figure 10: What is the approximate numbers of years the chairperson and the Management industry gender diversity board members have served? has become an important topic. Under- representation of women on boards remains an issue in Luxembourg with 10 women making up less than a fifth of board members. While this has increased minimally since our 2012 7.2 survey, should gender equality become 6.7 6.2 mandatory at board level, the investment 6.0 5.5 fund industry would have a long way to 5.0 4.8 4.8 go. 05 4.4 4.2 Beyond gender equality, diversity has, in recent years, been under regulators and investors’ spotlight. Encompassing a range of factors such as age, skills, education, ethnicity, nationality, disability, beliefs, and social networks, 00 among others, institutional investors Super UCITS AIFMs UCITS AIFs are increasingly requiring more action ManCos ManCos to be taken on board diversity. This Chairman Board members Source: PwC AWM Research Centre is not necessarily about equality – it is because they consider it good 40 business. Increasingly research relating to behavioural economics topics such as group think, bias, and how both Figure 11: Average percentage of female board members individuals and groups make decisions show the benefits of diverse thinking in all areas of business. 20 18% 17% 15% 11% 11%

0 ManCos UCITS AIFs

2012 2018 Source: PwC AWM Research Centre

Luxembourg Fund Governance Survey 2018 | 15 In its 2018 Annual Corporate Directors Survey12, PwC notes that many Investor developments on board diversity institutional shareholders have been discussing the need for, and benefits • Sent letters in February 2018 to all Russell 1000 companies that of, diverse boards for years, and are have fewer than two female directors on their board, asking them backing up their words with actions. BlackRock to explain their board diversity efforts and long term strategy. They have been updating proxy voting • Voted against directors at five companies in 2017 for failing to address investor concerns related to board diversity. policies, talking about their concerns, and even voting against directors whose • Stated in August 2017 that gender diversity on boards would be a boards fail to consider and promote Vanguard focus in the next few years. Cited research indicating boards with diversity. Some examples of this include: “a critical mass” of women perform better than those without. • Voted against directors at 581 companies around the world in 2018 that had no female board members. State Street Global • Stated that they will expect portfolio companies to detail and Advisors (SSGA) disclose gender diversity not only at the board level, but also across all levels of management for transparency into the development pipeline. • Sent letters to 151 companies in fall of 2017 asking them to New York City Pension publicly disclose the skills, race and gender of board members in a Funds matrix format, as well as their process for refreshing the board. • Sent letters to 504 companies in August 2017 that they believed California Public 12. PwC’s Annual Corporate Directors Survey has lacked sufficient gender diversity. gauged the views of public company directors Employees’ Retirement • Withheld votes from 271 directors at 85 companies in 2018 that from across the United States on a variety of System (CalPERS) corporate governance matters for more than a had not improved diversity on their boards. decade. In the summer of 2018, 714 directors participated in the survey. The respondents California State • Announced that it will now hold the entire board accountable—not represent a cross-section of companies from Teachers’ Retirement just the nominating and governance committee—if board diversity over a dozen industries, a majority of which have System (CalSTRS) is found to be lacking. annual revenues of more than USD 1 billion.

Source: PwC, 2018 Annual Corporate Directors Survey

16 | PwC Publicly available Figure 12: Is the following information regarding directors Investor developments on board diversity information on directors provided in publicly available fund documentation? (% yes)

• Sent letters in February 2018 to all Russell 1000 companies that Transparency is often an important have fewer than two female directors on their board, asking them aspect of good governance, and the BlackRock to explain their board diversity efforts and long term strategy. UCITS AIFs • Voted against directors at five companies in 2017 for failing to first step for investors to be able to address investor concerns related to board diversity. assess whether a board has the required diversity of skills and other factors to Name 96% 100% • Stated in August 2017 that gender diversity on boards would be a Vanguard focus in the next few years. Cited research indicating boards with optimise the exercise of its mandate. “a critical mass” of women perform better than those without. We’ve seen an encouraging trend in Job title 85% 83% the increasing amount of information • Voted against directors at 581 companies around the world in 2018 made publicly available regarding board that had no female board members. Short biography / Background 63% 78% State Street Global • Stated that they will expect portfolio companies to detail and composition. In particular, funds are Advisors (SSGA) disclose gender diversity not only at the board level, but also increasing their disclosure of director Address 48% 61% across all levels of management for transparency into the titles, short biographies and skills development pipeline. brought to the board. In light of GDPR13, Date of appointment / 33% 56% Number of years of service • Sent letters to 151 companies in fall of 2017 asking them to we expect age and address to remain at New York City Pension publicly disclose the skills, race and gender of board members in a a low disclosure rate, if not decreasing, Funds Skills brought to the board 15% 28% matrix format, as well as their process for refreshing the board. in the coming years. • Sent letters to 504 companies in August 2017 that they believed California Public Guidance on board composition Age 7% 17% lacked sufficient gender diversity. Employees’ Retirement information disclosure can be found • Withheld votes from 271 directors at 85 companies in 2018 that System (CalPERS) had not improved diversity on their boards. in the ILA/ALFI Guidance notes to the Note: the question was asked only to respondents representing boards of ALFI Code of Conduct: “Guidance on UCITS or AIFs. California State • Announced that it will now hold the entire board accountable—not Directors’ Reports”.14 In particular, it Source: PwC, 2018 Annual Corporate Directors Survey Teachers’ Retirement just the nominating and governance committee—if board diversity suggests disclosing board members’ System (CalSTRS) is found to be lacking. length of service – which according to respondents only a third of UCITS funds currently do. Alongside this, the guideline encourages boards to publish a short bio of directors, as well as including a description of the board’s policy on diversity.

13. The General Data Protection Regulation 2016/679 is a regulation in EU law on data protection and privacy for all individuals within the European Union and the European Economic Area. It also addresses the export of personal data outside the EU and EEA areas. 14. Available on the ILA and ALFI websites – for example in the ALFI Code section of the ALFI website (www.alfi.lu)

Luxembourg Fund Governance Survey 2018 | 17 Director remuneration Unrealistically low remuneration (less overseeing a flagship fund will earn than EUR 10,000 per year) remains on higher remuneration than for other funds Similar to our previous surveys, board the fringe and trends seem to indicate with the same promoter. This is largely member remuneration varies depending this is decreasing, although may be because flagship funds will have a higher on role – executive, non-executive or indicative of holding other better paid AuM and a larger number of sub-funds independent non-executive director. mandates for the same promoter. than others – implying more complexity Executive directors, those employed With the increasingly high levels of and increased responsibility. directly by the promotor, tend not to responsibility and expertise required receive remuneration specific to their from directors along with the new caps An increasing number of funds and position on a ManCo or fund level. On on numbers of mandates, we expect ManCos have begun to disclose the other hand, non-executive and to see fees increasing over the next directors’ remuneration in annual independent non-executive directors are periods. reports, which also makes sense given specifically compensated for their role. that the shareholders vote on director Median remuneration for independent Meaningful comparisons of fees remain remuneration. It should be noted that the non-executive directors has increased difficult due to many directors holding ALFI Code of Conduct recommends that slightly since 2012 to the EUR 20,000 mandates on multiple vehicles for the board remuneration be disclosed either to EUR 30,000 per year bracket. same fund promoter. Typically, directors on an individual or collective basis.

Figure 13: What is the remuneration received by individual board members?

12 35 23 30 Independent directors 9 27 30 33

68 8 9 11 4 Directors employed by a service provider or advisor 64 7 7 7 15

90 4 5 1 Directors employed by the promoter or fund sponsor 93 2 211 20 40 60 80 100 0

2012 Remuneration included in salary Less than €10K a year €10K-20K a year €20K-30K a year More than €30K a year 2018

Source: PwC AWM Research Centre

18 | PwC Figure 14: Is director's remuneration disclosed in the annual report?

100 91% 83% 80

60 57% 48% 47% 47% 40 37% 30% 22% 20 17% n Yes, disclosure on an individual basis 9% 7% 5% n Yes, disclosure on an aggregate basis 0% 0% 0 n No disclosure Super UCITS AIFMs UCITS AIFs ManCos ManCos

Source: PwC AWM Research Centre Yes, disclosure on an individual basis Yes, disclosure on an aggregate basis No disclosure

Luxembourg Fund Governance Survey 2018 | 19 Board 2 organisation

Board meetings For ManCo boards it is usually The ILA/ALFI Guidance notes to the considered they should meet at minimum ALFI Code of Conduct: “Guidance on Meeting frequency and on a quarterly basis for their scheduled Directors’ Reports”15 suggests publishing attendance reporting meetings, with a quarterly director attendance in the annual board minimum now set out also in CSSF report. Institutional investors tend to Our survey shows that boards met Circular 18/698. For funds, however, the consider board meeting attendance a on average 5.5 times a year, with frequency varies depending on asset serious matter, with the fact that – even this number increasing for AIFMs class and factors such as whether if not published – Luxembourg’s strong who met on average eight times the fund is open or closed-ended. director attendance records should a year. For boards to meet their Scheduled reporting meetings are often certainly be brought to their attention. less frequent for funds with illiquid duties to investors, shareholders assets and who are closed-ended, such Circular resolutions and other stakeholders, it is as funds with private equity or venture critical that meetings be organised capital assets. Over 80% of Luxembourg-based boards regularly throughout the year. use circular resolutions on an ad-hoc Regarding location, board meetings basis to pass decisions outside of board primarily take place in Luxembourg, with meetings, although use has begun meetings outside the Grand Duchy being to wane since our last survey. Super an exception. The majority of members ManCos and AIFMs used, on average, physically attend meetings (77%), with 11.3 circular resolutions a year. only a minority attending by phone (13%), Boards use circular resolutions for a videoconference (8%) or by proxy (2%). mix of both urgent and routine matters. Meetings held exclusively by phone Some matters may need to be urgently appear significantly more common decided between scheduled meetings, among AIFMs – likely as in addition to while others, such as changing an the periodic full meetings with the regular authorised signature list at the request agendas and board packs, AIFMs and of a service provider, are routine. While AIFs need to meet also at shorter notice there is no legal requirement to ratify and more often for certain other items circular resolutions at the following board such as approving new investments. A meeting, a majority of respondents minority of Luxembourg-based funds stated they do so or otherwise list the publish attendance records, which is circular resolutions taken in the period in line with previous surveys. This is at the time of the next scheduled board surprising since the attendance record meeting. is very good for the great majority of boards that participated in the survey. We have, however, noted an increase in the number of AIFs that publish attendance records, up from 5% in 2016 to 11% in 2018.

15. Available on the ILA and ALFI websites – for example in the ALFI Code section of the ALFI website (www.alfi.lu)

20 | PwC Figure 15: How many circular resolutions does the board use on average per year?

20 18

11.3 10.9 11.3 10 7.8 6.8 7.1 5.7 Meeting duration and 5.4 agenda 4.5 Directors should commit a significant amount of time to both prepare and 0 attend board meetings. On average, Super UCITS AIFMs UCITS AIFs directors spend between 4 and 8 hours ManCos ManCos reviewing papers prior to meetings. The amount of time spent preparing for a n 2016 n 2018 Source: PwC AWM Research Centre meeting has increased since 2016, which is in line with an observed enlargement of board packs and responsibilities. Figure 16: What is the average estimated time directors spend reviewing the board papers prior to board meetings? (in hours) Board papers are typically disseminated five to six working days prior to board 10 meetings, mostly via digital channels – largely email, but in some cases through 8.1 a web-based application. Password 7.7 protection of these documents has 6.6 largely become industry standard among 5.3 5.1 5.2 UCITS and AIFs since our last survey. 5 4.4 4.3 4.0 3.6 Board meetings typically lasted between 2 ½ hours and 4 ½ hours. An increase in time spent was especially noticeable among UCITS respondents 0 – reflecting increasing complexity Super UCITS AIFMs UCITS AIFs and responsibilities. The majority of ManCos ManCos respondents are pleased with the duration of board meetings, however we n 2016 n 2018 Source: PwC AWM Research Centre note that 27% of AIFM respondents and 11% of UCITS respondents feel that the meetings were too short. We encourage Figure 17: What is the average duration of board meetings? (in hours) those who feel that board duration is not adequate to raise their concerns with 10 their board chairperson and also during their board evaluation process.

5 4.1 4.6 3.8 2.9 2.9 2.8 2.6 2.5 2.2 2.4

0 Super UCITS AIFMs UCITS AIFs ManCos ManCos

n 2016 n 2018 Source: PwC AWM Research Centre

Luxembourg Fund Governance Survey 2018 | 21 Standard agendas have become of time. Agendas tend to include a vast commonplace for the majority of boards array of reports that require attention, in particular with respect to the scheduled although the frequency of review varies reporting meetings. While this ensures that by item. The table below summaries the regular matters are consistently attended review periodicity of items by board type: to, ad hoc issues might suffer due to a lack

Figure 18: Review periodicity of the different items constituting the board agenda

Super ManCos UCITS ManCos AIFMs UCITS AIFs AML/KYC report At each meeting At each meeting Periodically At each meeting At each meeting Audit External audit findings report Annually Annually Annually Annually Annually Internal audit report Periodically Periodically Periodically Ad-hoc Ad-hoc Budget and other fund costs (TER) Periodically Periodically Periodically Periodically Periodically

Central administration report At each meeting At each meeting Periodically At each meeting At each meeting (includes fund administration and transfer agent report) Compliance report At each meeting At each meeting At each meeting At each meeting Periodically Conducting officer report At each meeting At each meeting At each meeting At each meeting Periodically Conflicts of interest At each meeting At each meeting At each meeting At each meeting At each meeting Custody report At each meeting At each meeting Periodically At each meeting Periodically Cybersecurity report Ad-hoc Periodically Ad-hoc Ad-hoc Never Distribution report At each meeting At each meeting Periodically At each meeting Periodically Fair valuation report Periodically At each meeting Periodically At each meeting Periodically Investment manager report At each meeting At each meeting At each meeting At each meeting At each meeting Investment restriction breaches report At each meeting At each meeting At each meeting At each meeting Periodically Investor complaint report At each meeting At each meeting At each meeting At each meeting Periodically Annual Annually Annually Annually Never Never Financial statements of Semi-annual Ad-hoc Ad-hoc Annually Never Never the ManCo Monthly or quarterly At each meeting At each meeting Periodically Never Ad-hoc Financial Annual Annually Annually Annually Annually Annually statements of the fund Semi-annual Ad-hoc Ad-hoc Annually Annually Ad-hoc New product approval At each meeting At each meeting Ad-hoc Periodically Ad-hoc Prospectus update At each meeting Ad-hoc Ad-hoc Ad-hoc Ad-hoc Regulatory and legal updates At each meeting At each meeting At each meeting At each meeting Periodically Regulatory correspondence At each meeting Periodically At each meeting At each meeting Periodically Risk management report At each meeting At each meeting At each meeting At each meeting Periodically Tax update Ad-hoc Ad-hoc Ad-hoc Ad-hoc Ad-hoc

22 | PwC On average, boards of Super ManCos ILA has issued guidance16 Invitation of non-board reviewed 16 reports at each meeting, recommending that the board, prior while boards of AIFMs reviewed 9 at to meetings, should receive a formal members each meeting and 8 periodically. A agenda of all matters to be reviewed, Inviting a select group of external noteworthy development has been discussed and approved, along with representatives to attend board meetings the increased review of reports in the sufficient supporting documentation. in person and to report on important alternatives section since our 2014 Key reports and updates to be supplied topics is generally considered in line with survey, when little periodic review took good governance. The most frequently place. It is also worth explaining that periodically to the board according to ILA’s guidance may include the following: invited non-board members are the while AIFMs reviewed fewer reports compliance officer, conducting officers, at each meeting, they met more often • Risk management report investment managers, risk manager and than ManCos and Super ManCos. This • Investment manager report internal legal advisor. is likely largely due to the nature of the underlying investments - for example, • Investment restriction breaches report ILA’s guidance documents17 suggest that closed ended funds having less work in • Compliance report boards consider inviting different non- terms of monitoring changes in investors • Investment manager report members to board meetings from time (who should rarely change), whilst to time: certain alternative assets tend to require • Conducting officer report, or ManCo/ more frequent approval of investment AIFM Report • external counsel and external auditor, decisions by the board (real estate and • Investor complaint report at least once per year, to discuss any major legal, regulatory or fiscal private equity for instance). • Central administration report changes, and the results of the audit; • Summary of regulatory CSSF Circular 18/698 reinforces the • investment manager, on a periodic correspondence importance of those reports mentioned basis; in the table. For example: • AML/KYC report • head of risk management and head of • Chapter four stipulates that the • Distribution report valuation, on a periodic basis; meeting agenda must be documented • Conflicts of interest • representatives of service providers in writing; • Custody report (such as the depositary), on an ad-hoc • Chapter five specifies that the • Regulatory and legal updates basis. board should receive the necessary • Tax update information from the delegates in 16. See document titled "Directors FAQ – order to carry out an effective control • New product approvals Luxembourg investment funds", available to ILA over each delegate. • External audit findings report members on the ILA website (www.ila.lu) 17. See documents titled "Directors FAQ – • Annual financial statements (and Luxembourg investment funds" and "AIF and AIFM semi-annual, where applicable) – A practical guide for directors" available to ILA members on the ILA website (www.ila.lu)

Figure 19: Invitation periodicity of non-board members to attend board meetings

Super ManCos UCITS ManCos AIFMs UCITS AIFs Compliance officer At each meeting At each meeting At each meeting At each meeting Periodically Conducting officer At each meeting At each meeting At each meeting At each meeting Periodically Depositary Ad-hoc Ad-hoc Never At each meeting Periodically External auditor Annually Annually Annually Annually Annually External legal advisor Never Ad-hoc Ad-hoc Ad-hoc Ad-hoc Fund administrator Ad-hoc Periodically Periodically At each meeting Periodically Global distributor Ad-hoc Ad-hoc Never/Not applicable At each meeting Never/Not applicable Internal auditor Periodically Periodically Periodically Ad-hoc Never Internal legal advisor At each meeting At each meeting Ad-hoc At each meeting Ad-hoc Investment manager Periodically At each meeting At each meeting At each meeting At each meeting Risk manager At each meeting At each meeting At each meeting At each meeting Periodically Transfer agent Ad-hoc Ad-hoc Never At each meeting Periodically Product development team Periodically Periodically Ad-hoc Periodically Ad-hoc

Note: Average of respondent answers. The scale used was the following: "At each meeting", Source: PwC AWM Research Centre "Periodically", "Ad-hoc" and "Never" and for some items “Annually”, "Ad-hoc" and "Never". Luxembourg Fund Governance Survey 2018 | 23 Formal committees Sub-committees are also frequently established in the alternative world, an Specific sub-committees have indicator of alternative management become increasingly common among companies and funds being well- Luxembourg boards. These committees organised following the introduction of tackle specific issues, such as risk, audit, the AIFMD. In line with our 2016 findings, valuation or remuneration, and consist the committees that tend to be the of members specifically responsible for most established are valuation, risk, oversight of those areas. Of course, the remuneration and audit. existence of sub-committees depends to some extent on the size of the board.

Approximately 78% of Super ManCo boards have established one or more sub-committees.

Figure 20: Proportion of boards that have established one or more sub-committees

Super ManCos UCITS ManCos AIFMs UCITS AIFs

78% 67% 55% 28% 61%

Source: PwC AWM Research Centre

24 | PwC As a result of the EU Audit Reform ILA has issued various guidance papers Directive, audit committees have which include discussions regarding become slightly more common. the establishment of various board level If an entity is qualified as a Public committees within the Luxembourg fund Interest Entity (PIE) this leads to extra industry.19 requirements, such as the need to have an audit committee and to ensure periodic auditor rotation. ILA has issued a guidance paper18 in this area, which 18. See document titled "ILA Audit Committee Guide includes considerations for whether or for Boards of Luxembourg Investment Funds and not to create an audit committee, and Management Companies", available to ILA advice on how to create an effective members on the ILA website (www.ila.lu) audit committee (including sample 19. See documents titled "Directors FAQ – Luxembourg investment funds" and "AIF and AIFM terms of reference, composition, chair, – A practical guide for directors", available to ILA committee meetings and remuneration). members on the ILA website (www.ila.lu)

Figure 21: Formal committees established by the board

Super ManCos UCITS ManCos AIFMs UCITS AIFs Valuation / Price committee 56% 17% 45% 8% 39% Risk committee 44% - 18% 4% 6% Remuneration committee 34% - 18% 4% - Audit committee 25% 17% 18% 12% 17% Investment management committee 22% - 27% 4% 28% Compliance committee 22% - 27% - 6% Product committee 22% - - - 6% Other committees 19% - - 8% -

Note: Other committees include Risk and control, Client acceptance, Distribution oversight, AML, Source: PwC AWM Research Centre Portfolio disclosure, Excessive trading, Fair valuation, Investment risk oversight

Luxembourg Fund Governance Survey 2018 | 25 Roles and responsibilities of 3 the board

Management style and Review of fund The practice of reviewing marketing materials and factsheets in Luxembourg relationship with the documentation boards depends to which extent the promoter One of the key undertakings of boards distribution function has been delegated. The newly released CSSF Circular Our 2018 survey confirms that the is a review of fund documents. In Luxembourg, the majority of fund 18/698 formalises that ManCos are prevailing management style within boards examine a variety of documents, responsible for ensuring that fund Luxembourg boards is mainly including prospectus, financial marketing is carried out in compliance "active board discussions on statements, funds-related agreements with legal and regulatory provisions in existing issues, high level oversight and shareholder communications. More place. ManCo boards should therefore and management by exception". than half of UCITS boards surveyed also ensure there are robust processes examined KIIDs (Key Investor Information in place for the review of marketing At fund level, the board should Document). Notably however, timing of materials. pursue its own mandate and, as the boards’ involvement varies greatly; such, should have a relatively fund agreements are generally reviewed high degree of autonomy from the on a systematic basis, while the majority of other documents are reviewed on an promoter or fund sponsor. ad-hoc basis. Our 2018 survey reveals that a strong majority of fund Figure 22: If the board reviews the following documents, what is the timing of boards perceive themselves as board involvement? (all respondents) independent. However, we note that about a quarter of UCITS and Fund agreements KIIDs Shareholder AIF boards saw themselves as communications an integral part of the promoter’s 12% operations (a figure that is in line 33% 28% with prior findings). We note the ALFI Code of Conduct requires boards to conduct themselves in a fair and independent manner, particularly in their relationship with the promoter or fund sponsor. The code also recommends 88% 67% 72% that boards consider appointing Prospectus Marketing materials Shareholder independent non-executive and factsheets application forms directors. 27% 24% 17%

73% 76% 83%

n Systematic review (yearly, quarterly or more often) Source: PwC AWM Research Centre n Review at initial issuance or ad-hoc review

26 | PwC ILA guidance20 on this matter indicates Additionally, a third of respondents Concerning fund performance, that fund directors should approve perform periodical calls for tenders respondents receive regular reports changes to the prospectus, sign material regarding the external auditor. For other from the investment manager in order fund related agreements and ensure service providers, periodical calls for to monitor performance. However, that information on the fund’s financial tender only takes place at a minority of approximately only one in four of situation is disclosed in accordance boards. boards stated they intervene in cases with applicable legal and regulatory of underperformance. This raises the requirements. European regulators have placed question of when it would be the role oversight of outsourced activities front of boards to intervene in response to Oversight of service and centre. The CSSF’s new circular underperformance when the investment also places a strong focus on delegation providers strategy chosen by the investors is and oversight aspects applicable to all nonetheless being adhered to. delegates. ILA’s various fund-related Oversight of service providers is guides21 encourage AIFs and AIFMs another major responsibility of boards. Oversight of fund expenses to perform due diligence and ongoing We asked respondents what was their monitoring of delegates (including the process of choice to ensure the quality Following the global financial crisis, portfolio manager, the asset/property and efficiency of services provided. investor protection, as a topic, has manager, etc.) and service providers. Luxembourg boards are clearly aware dominated fund industry discussions. of the importance and usefulness of A major part of these debates has performing such oversight. A majority of Oversight of investment concerned the transparency of expenses our respondents perform due diligence management charged to shareholders. Some prior to initial appointment as well as regulations such as RDR in the UK and periodical assessments of the following Circular 18/698 sets out that while the MiFID II in Europe have put pressure service providers: investment manager is responsible for on funds to unbundle expenses in the taking investment decisions, the ManCo interest of improving transparency • Risk manager is ultimately responsible for this activity and investor protection. As calls for • Fund administrator as well. In this sense, ManCos are the industry to increase transparency • Custodian / Depositary responsible for ensuring that investments continue, we believe fee pressures will are made in compliance with the increase in the coming years.22 • Global distributor objectives and strategy of the fund, as • External auditor well as for overseeing the performance In light of this, we asked respondents • Internal auditor of those investments. whether or not fund expenses were covered by a fixed TER (Total Expenses • Compliance function The control requirement is relatively Ratio). Results show that the proportion • Transfer agent new for ManCos as historically the of Luxembourg-based entities charging • Investment manager / advisor fund board was primarily responsible shareholders fixed TERs has increased slightly since 2014. The figures below • Legal advisor for monitoring investment compliance under Luxembourg law. Interestingly, our tend to hide the divergence in the survey shows that in practice oversight market. Some entities are moving away of investment management is exercised from fixed TERs in order to be more both at the level of the ManCo board transparent, while others are adopting a fixed TER in order to guarantee a certain 20. See document titled "Directors FAQ – and fund board. In the majority of cases, Luxembourg investment funds", available to ILA respondents indicated that the board level of fixed expenses to shareholders. members on the ILA website (www.ila.lu) exercises oversight by receiving regular 21. See documents titled "Directors FAQ – reports from the investment manager Luxembourg investment funds", and "AIF and AIFM – A practical guide for directors" available to and monitors for investment restriction ILA members on the ILA website (www.ila.lu) breaches and net asset value errors. 22. For more information on fee pressure and margin compression, read for example PwC’s report titled “Asset & Wealth Management Revolution: Pressure on profitability” available on PwC website (www.pwc.com)

Luxembourg Fund Governance Survey 2018 | 27 Figure 23: Are the expenses of the fund (flagship fund) covered by a fixed TER? Oversight of risk management

100 CSSF Circular 18/698 aligns regulatory risk management requirements for UCITS and AIFs, and details 61% 57% the prerequisites for implementing 80% 58% 82% the risk management function. As 50 implementation of each function is ultimately the responsibility of the board of directors, when the risk management 39% 43% 42% function is delegated to a specialised 20% 18% service provider, the CSSF requires 0 boards to implement robust oversight Super ManCos UCITS ManCos AIFMs UCITS AIFs measures. n n Yes No Source: PwC AWM Research Centre A majority of the boards we surveyed reviewed the effectiveness of risk management process, at least on an Nevertheless, the ALFI Code of Conduct annual basis. Moreover, most boards recommends reviewing fund expenses (about 90%) believed that they receive and their impact on fund returns in adequate reporting on the different order to ensure that the expenses risks outlined in the regulations, e.g. charged by the fund are reasonable, market risk, counterparty risk, liquidity fair and appropriate. This year’s survey risk, valuation risk, operational risk and reveals that the majority of boards collateral risk. are either involved in monitoring fund expenses or reviewing budgets vs. actual However, fraud risk has been on the expenses. Interestingly less than a third mind of some respondents, with a third of our respondents compare the fund’s of respondents feeling they do not expenses to their competitors, this is receive adequate reporting on this topic. notwithstanding that such an exercise Fraud risk reports vary greatly depending is considered to be in the shareholders on the underlying asset class of the fund. best interest. To be effective, fraud risk reports should include items such as: • an estimate of the likelihood of occurrence of various fraudulent activities; and • a description of preventative measures and controls currently in place to prevent fraud.

28 | PwC As noted earlier, cybersecurity is a hot Figure 24: How does the fund (flagship fund) handle global distribution? topic at the moment. More than 80% of respondents believed that they do not receive adequate reporting on 100 cybersecurity risk. In fact, the World 11% 20% Economic Forum’s Global Risks Report 43% 44% 2018 ranks cyberattacks as the third- 48% 33% likeliest risk for companies, behind data 30% fraud and theft. Therefore, we expect 50 technology risk to be of paramount importance for the industry and for 57% 56% 56% regulators in the coming years. ILA has 52% 50% also recently launched cybersecurity courses specifically tailored to boards. 0 Super ManCos UCITS ManCos AIFMs UCITS AIFs Overall however, boards appear well versed in risk management issues. All n The ManCo is appointed as global distributor Source: PwC AWM Research Centre respondents indicated that collectively n A seperate global distributor is appointed the board has sufficient knowledge, n The fund signs its own agreements and a fifth of respondents indicated that each individual director at their board is knowledgeable in risk management.

Oversight of distribution Similarly to risk management, the distribution. This year’s participants ManCo is ultimately held responsible highlighted AML compliance and The industry overall makes use of various for implementing and ensuring the failure to comply with local jurisdiction distribution models. Global distribution follow-up of the marketing policy and sales and marketing laws as the most is either performed in-house by the distribution of the funds it oversees. important risks. ManCo or by a delegated third-party When distribution is delegated to a third institution. This decision depends, at party, boards remain responsible for the It is hardly surprising that AML least in part, on the funds’ AuM. Benefits oversight of said delegate. Despite the compliance is currently is the spotlight. of scale are apparent here, with ManCos tendency to have a layered distribution, The 4th AML directive entered into effect with more than EUR 50 billion in assets from ManCo to global distributor to local in June 2017 and MiFID II became having indicated that they are more sub-distributor, the ManCo remains applicable as of January 2018. These likely to perform the distribution function ultimately responsible for the function. regulations strengthen the rules in a themselves. ILA’s guidance brochures23 include number of areas, including reporting good practice advice to directors obligations, penalties for non- A majority of ManCo and fund boards of Luxembourg funds in the field of compliance, data privacy and respect of indicated they perform due diligence distribution oversight. country-specific regulations. of their distribution function. This is most often performed internally, with Global distribution, by its very nature, the exception of AIFs. Two third of AIFs is a complex activity due to the variety do not perform due diligence on their of investors (retail and institutional) and distributor. This is likely as the result of the large number of countries where the differences in model where the ManCo funds are being distributed. As such, is doing so or it could be attributed there are a variety of risks that can affect to differences in the lifecycles of AIFs (e.g. a closed ended fund once it is fully committed). 23. See documents titled "Directors FAQ – Luxembourg investment funds" and "AIF and AIFM – A practical guide for directors", available to ILA members on the ILA website (www.ila.lu)

Luxembourg Fund Governance Survey 2018 | 29 Involvement outside of board for board members (maximum 1,920 to assist boards with getting comfortable hours per annum and 20 mandates). ALFI with the practice in Luxembourg. To meetings and ILA have both issued guidance24 on complement the guidance on board The roles and responsibilities of time capacity to help directors assess evaluations, ILA has issued a Board 26 board members do not stop at board their time commitment. evaluation form containing more than meetings. There is an increasing demand 120 quick multiple-choice questions to on director’s time outside of board Board performance reviews answer. meetings. Our respondents this year confirmed that outside of scheduled As institutional investors and regulators Board training board meetings they were largely pay increased attention to board involved in ad-hoc meetings (84%) and effectiveness, the number of boards A majority of board members spent more signing agreements (75%). More than a undergoing performance evaluations has than three days of training on a personal third were also involved in performing increased notably. basis annually, with many spending more than five days per year. While the most due diligence on investment managers Of those who performed a board and other service providers, instructing sought after areas included training evaluation, they tended to do so once in AML/KYC, legal and regulatory payments, meeting with investors and a year. About a fifth of boards perform other various tasks. developments, and risk management, their evaluation every 2 to 3 years or on nearly half of directors surveyed were As institutional investors become more an ad-hoc basis. We expect the practice pursuing training in cybersecurity, which involved with their investments, directors to become more prevalent in the coming has become an increasingly popular have begun to perform or undergo due years as it is also a requirement of most diligence at the request of investors. This codes of conduct, and has also become an important tool in the global corporate trend was unheard of five years ago, with 24. See document titled "Board member time now 27% of respondents performing this governance toolkit. capacity" available on the ILA and ALFI websites task. (www.alfi.lu), and document titled Getting" on The ALFI Code of Conduct recommends Board – A guide for accepting company Directors’ boards ensure that directors are mandates" available to ILA members on the ILA CSSF Circular 18/698 emphasises website (www.ila.lu) collectively competent to fulfil the that board members must devote the 25. See brochure titled “Board evaluations – necessary time and attention to their board’s responsibilities. In line with this, Enhancing Board Effectiveness " available to ILA members on the ILA website (www.ila.lu) and duties, and even defines a threshold on ILA and ALFI have issued guidance notes25 on board evaluations in an effort the note "Board evaluations" available on the ILA the time spent and number of mandates and ALFI websites (www.alfi.lu) 26. Available to ILA members on the ILA website (www.ila.lu) Figure 25: Proportion of boards that are evaluating their performance

Super ManCos UCITS ManCos AIFMs UCITS AIFs

48% 29% 36% 65% 32%

Source: PwC AWM Research Centre

30 | PwC topic. Other areas of interest included Since the program’s inception there has between 1 and 2 independent directors tax, ethics, products, digitalisation and been clear interest from directors. The sitting on a board are in the process crisis management. number of Super ManCo boards with or were ILA certified. Encouragingly, at least one director in the program or we noted a trend in Super ManCos to Disappointingly, continuing education having completed the certification rose have in-house directors also enrolled in provided to the board by the promoter from 18% in 2014 to 44% in 2018. At the the program or certified, which seems remains limited, however, amounting same time, the number of UCITS boards a welcome new trend. Once certified, to no more than two days a year, in line with one director involved in the program directors are required to maintain their with previous years’ findings. We hope or certified rose from 19% to 58%. knowledge by participating in training that boards will in future be offered more to hone their professional skills, and opportunities to train as a group. The majority of directors participating have annual continuing development in such program are independent requirements. In-house training was most often non-executive directors. On average, in the areas of AML/CTF, and legal and regulatory developments. As Circular 18/698 lays out new reporting Figure 26: How many days have directors spent on average on continuing requirements and introduces scenarios professional education in the last twelve months? in the area of AML/CTF, we expect boards to continue receiving extensive Training provided to the board training provided by the promoter in this 4% 100 3% area. 10% 11% 17% 17% 100 Furthermore, certain codes and 50% 33% regulations require formal director induction and training programmes to 50% 50 70% 42% be in place. The AIFM Directive requires induction and training of members of 50 the AIFM body, while the X Principles 50% 38% 56% of Corporate Governance of the 30% 20% Luxembourg Stock Exchange stipulate 0 that the company shall allocate adequate Super ManCos UCITS ManCos AIFMs UCITS AIFs resources to induction and on-going 0 n Less than 1 day n 1 to 2 days n 3 to 4 days n 5 days or more training of its directors. More information Super ManCos UCITS ManCos AIFMs UCITS AIFs 27 100 is available from ILA guides. Training taken personally 100 ILA Certified Director 18% 34% program 39% 50 57% In 2012, ILA introduced a certification 63% 45% program for directors sitting on 50 34% 30% Luxembourg boards. This forms part of its aim to develop members into 29% 27% 26% highly qualified, effective and respected 0 21% 26% directors. Additionally, this ensures Super10% ManCos UCITS14% ManCos AIFMs UCITS 5%AIFs continued promotion of good practices 0 9% 4% 5% in Luxembourg in the corporate Super ManCos UCITS ManCos AIFMs UCITS AIFs governance field. n Less than 1 day n 1 to 2 days n 3 to 4 days n 5 days or more

27. See documents titled "Directors FAQ – Luxembourg investment funds" and "AIF and AIFM Source: PwC AWM Research Centre – A practical guide for directors", available to ILA members on the ILA website (www.ila.lu)

Luxembourg Fund Governance Survey 2018 | 31 Conflicts of interest and legal 4 liabilities

Conflicts of interest The majority of Luxembourg-based boards, 93% of ManCo boards and 91% Over the past few years, conflicts of AIFM boards, indicated that there is of interest have been at the a written policy in place for identifying forefront of regulatory focus, and handling conflicts of interest. especially in the alternative Additionally, as can be seen in figure 27 below, the number of boards having a investment space as a result of conflicts of interest declaration on their several cases pursued by the standard board agenda has increased SEC and the FCA. These put from past surveys. a spotlight on deficiencies in private equity, venture capital and In Luxembourg, there are no legal hedge fund structures due to the requirements preventing directors from large asymmetry of information investing in the funds they oversee. between managers and investors. In fact, our survey reveals that a large More generally, in the overall majority of boards in the UCITS world industry there is a certain level allow directors to invest in the funds they of misalignment between the oversee, albeit often with restrictions manager’s and the investors’ such as pre-trade compliance and 28 disclosure. However, about 50% of AIFM respective interests in a fund. boards prohibit directors from investing CSSF Circular 18/698 also sets in the funds they oversee, to avoid out minimum requirements on potential for conflicts of interest. how conflicts of interest should be dealt with by Luxembourg-based Legal liability ManCos. It outlines requirements such as having a clear conflicts Legal liability is an important issue in an of interest policy in place, along intensely regulated industry. Liability may potentially arise from breaches of a vast with obligations to keep records array of obligations, such as inadequate of conflicts of interest, and in implementation and oversight of risk certain cases obligations to inform management, errors in accounts, investors. incorrect valuations, not filing accounts within legal or regulatory deadlines, or improper uses of corporate assets. That is why it is paramount for directors to be made aware of their liability, including potential sanctions.

28. For example, the carried interest compensation structure typically found in many alternative funds can give the manager an incentive to make riskier or more speculative investments than what would normally be in the best interests of the fund’s investors in order to generate greater compensation.

32 | PwC According to our survey, on 70% of Figure 27: Proportion of boards asking for conflicts of interest to be declared boards directors self-inform on legal liability. In addition, 32% of boards at each board meeting as a standard agenda item were informed of their legal liabilities at induction through the letters of 100 appointment. Furthermore, about 85% 63% received either specific training 80% or a briefing by an internal or external 74% counsel. We believe that these briefings to the board as a whole should become more common given the clear trend 53% 53% towards increased sanctions and fines 50 by regulators. It is important that all members of a board are fully aware of 33% their duties and their responsibilities.

Mitigation of director liability remains an eminently important issue. In the past, promoters have traditionally insured both 0 independent and executive directors. ManCos UCITS AIFs This year’s survey shows that insurance is being provided by the promoter and n 2012 n 2018 Source: PwC AWM Research Centre ManCo, while both the promoter and fund provide indemnities.

Self-insurance was also important for independent directors, with the majority of independent directors having subscribed their own insurance.

Luxembourg Fund Governance Survey 2018 | 33 Codes 5 of conduct

A large majority, more than 80% in Regulators and institutional The ALFI Code of Conduct the case of UCITS respondents, have investors are increasingly placing adopted a code of conduct, with the The purpose of the ALFI Code of importance on the adoption of a ALFI code being the most common for Conduct is to provide boards with a code of conduct that ensures all Luxembourg-based boards. While 91% framework of high-level principles and board members are aligned with of AIFMs have adopted a code, ALFI is best practice recommendations for the stated principles and practices not necessarily the preferred choice; the governance of Luxembourg-based of the board. While a variety AIFs lag behind with only 63% having investment funds and ManCos. The of these codes exist, however adopted a code. code is principles-based rather than they all tend to place emphasis rules-based in that it relies upon good Overall, about 68% of boards that judgement rather than prescription. As on principles such as honesty, have adopted a code of conduct have such, the recommendations recognise fairness, fiduciary duties towards disclosed this adoption. While this that the “right approach” for many issues shareholders, respect for the figure has increased from past surveys, depends on the circumstances. integrity of markets, competence, we would expect such disclosure to transparency, and, finally, respect be higher given the positive message All respondents were positive when for rules and regulation. that adopting a code sends to the asked how they perceive the ALFI market, providing of course that the code, with nearly all believing that the board actually follows its principles and principles-based approach of the code recommendations. is appropriate. However, this year we note that a quarter of AIFM respondents When asked whether the board thought that the code should be more regularly checks how it complies with prescriptive or rules-based. As the AIFM its adopted code of conduct, two thirds status is still relatively new, we gather of respondents said yes. The checks, that AIFM practitioners would like more which are recommended by ALFI, prescriptive guidelines to help them should ideally be done once a year as navigate corporate governance issues. a mapping exercise, and can be linked as a reference for the board’s evaluation Finally, in an effort to keep the code assessment. up-to-date and practical we asked which issues were currently not addressed. Respondents indicated that ESG29, gender diversity, tenure and technology should be introduced or expanded upon to keep the ALFI Code of Conduct up-to- date and relevant.

29. ESG stands for Environmental, Social and Governance factors - those that are central in measuring the sustainability and ethical impact of an investment in a company or business. 34 | PwC Luxembourg Fund Governance Survey 2018 | 35 Looking 6 forward

With the uptick of regulatory directives A majority of participants reviewed In order to prepare boards for in recent years, many are likely to have Brexit at least strategically - of course the coming years and to highlight a strong impact on operations and those having operations or distribution the governance outlook, we have boards in the coming years. While the in the UK are more likely to be impacted. included a looking forward section majority of boards have reviewed the However, the Capital Markets Union in which we explore participants’ implications of these directives (GDPR, (a plan by the European Union to build views for the coming two years. 4th AML directive, MiFID II and PRIPS), a true single market for capital across both strategically and operationally, we all member states) was not on our note that AIFs are somewhat lagging participants’ radars for the moment. behind the pack. Should their AIFMs be However, respondents were likely to responsible for keeping new regulations begin reviewing this once the EU rolls out under review on their behalf, then this a more operational plan for the CMU. makes more sense.

Figure 28: Has the board reviewed the implications of the following regulations?

Super UCITS AIFMs UCITS AIFs ManCos ManCos GDPR (General Data Protection Regulation) Yes, Yes, Yes, Yes, Yes, operationally operationally operationally operationally operationally 4th AML Directive Yes, Yes, Yes, Yes, Yes, operationally operationally operationally operationally strategically MiFID II Yes, Yes, Yes, Yes, No operationally operationally operationally operationally PRIPS (Package Retail Investment Products) Yes, Yes, No Yes, No operationally operationally operationally Brexit Yes, Yes, Yes, Yes, Yes, strategically strategically strategically strategically strategically CMU (Capital Market Union) No No No No No

36 | PwC Secondly, boards indicated that impact Figure 29: Top 5 areas requiring additional attention from the board in the investing topics, such as ESG, SRI, sustainability and climate risk, have coming 12-24 months increasingly come to the fore in recent years. These are becoming evermore Super UCITS AIFMs UCITS AIFs prevalent across the entire Asset & ManCos ManCos Wealth Management industry, and a #1 Law & Law & Law & Law & Law & majority of directors on ManCos, UCITS regulation regulation regulation regulation regulation and AIFM boards have seen such changes changes changes changes changes topics appear on board agendas in the - - past twelve months. We expect such Governance & Investment areas to require more attention from a compliance performance governance standpoint in the coming #2 Governance & Governance & Valuation & Governance & Governance & years. compliance compliance pricing compliance compliance Finally, we examined what the main #3 Investment Risk Risk Distribution Valuation & points of attention will be for boards in performance management management - pricing - Transparency the coming 12-24 months. As one would Transparency expect, the focus of the industry remains & investor & investor needs on law & regulation changes as well as needs governance & compliance. This is due to #4 Risk Distribution Transparency Market Transparency the growing regulatory burden that takes management & investor developments & investor a lot of time and energy from directors needs needs who must be constantly focused on their primary goal of investor protection. #5 Distribution Performance Investment Investment Market - of vendors & performance performance developments Performance service of vendors & providers service providers

Luxembourg Fund Governance Survey 2018 | 37 Conclusion

Governance practices continue to improve as the Luxembourg fund industry grows. Luxembourg, being the world’s second largest fund domicile, has a history of strong governance practices and our respondents this year clearly indicate they plan to continue this tradition. Following the introduction of the AIFM Directive, we have noticed that practices among alternative entities have become significantly more robust.

Many new and revised regulations, such as GDPR, 4th AML directive, MiFID II and PRIPS, have been implemented since the last survey. These regulations naturally influence both fund management and governance. However, updated guidance from industry associations as well as boards’ continued interest to perform their mandates mean that the industry is largely prepared to tackle these. The effect of CSSF Circular 18/698 will be captured in the next edition of the survey, where we expect increased convergence of practices within UCITS and alternative investment entities as a result of the circular.

Growing regulatory pressures, as well as increased calls for transparency from both investors and regulators have been well noted by market players. Responses from participants show improvements regarding the appointment of independent directors and chairs, gender diversity, disclosure of information on directors (including on remuneration), the use of sub-committees, board performance review, uptake of the ILA Certified Director Program, and declarations of conflicts of interest.

We are pleased with the respondents’ continual adoption of new governance policies. We have also highlighted areas that should be addressed more vigorously in the future. The high response rate to the survey underscores the fact that governance is a key focus for participants in the Luxembourg fund industry.

38 | PwC Luxembourg Fund Governance Survey 2018 | 39 www.pwc.lu

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Contact

Michael Delano +352 49 48 48 2109 [email protected] ILA Fund Committee Chairman PwC Luxembourg Partner

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