Article by Valerie Rouse

Originally published in HFM Week, Guernsey Special Report, May 2012

Valerie Rouse and Anthony Williams of Mourant Ozannes discuss the introduction of the new corporate governance code and what lessons, if any, the Guernsey investment funds industry can take from the recent Cayman case of Weavering.

In the world of offshore funds, corporate governance is dominating the headlines as the investment funds industry continues to learn from the hard lessons of the 2008/2009 global financial crisis. With onshore regulators scrutinising their island neighbours ever more closely, offshore regulators are under pressure to ensure that internationally acceptable standards of corporate governance are enshrined in local law, while at the same time balancing the competing market demand for flexibility.

Guernsey has already heeded these warning signs and demonstrated once again its ability to adapt to changing market conditions to the benefit of all its key stakeholders. This article discusses the new Code of Corporate Governance which came into effect on 1 January 2012, queries whether the ripples of the recent Cayman decision of Weavering will be felt in Guernsey, and finally submits that Guernsey's existing regulatory framework already provides a robust system of checks and balances for the benefit of investors and funds alike.

The Guernsey code

Guernsey authorised or registered funds together with their Guernsey licensed service providers, if established as corporate entities, are now subject to the Finance Sector Code of Corporate Governance (the "Code") issued by the Guernsey Financial Services Commission (the "Commission").

The Code came into effect on 1 January 2012 and applies to all companies licensed under Guernsey's main regulatory laws, including The Protection of Investors (Bailiwick of Guernsey) Law, 1987 as amended (the "POI Law"). Underlying special purpose vehicles or investment holding companies are not included. Although it does not apply directly to investment funds established as limited partnerships, it will apply to a corporate general partner licensed under the POI Law. Companies which report against the UK Corporate Governance Code or the Association of Investment Companies Code of Corporate Governance are deemed to meet the Code.

The Code is intended to supplement other corporate governance requirements and applicable law. It consists of eight principles ("Principles") along with second level guidance on meeting those Principles and the approach is one of "comply or explain". It is non-prescriptive, allowing the company concerned to adopt a corporate governance strategy that is proportionate and appropriate to the nature, scale and complexities of the particular business.

Non-compliance with the Code does not automatically render a company liable to any sanction or proceedings but the approach taken for adoption of the Principles and the explanation for any non-compliance will be matters for consideration by the Commission as part of its ongoing supervision.

The eight principles

  1. Companies should be headed by an effective board of directors which is responsible for governance.
  2. Directors should take collective responsibility for directing and supervising the affairs of their company's business.
  3. All directors should maintain good standards of business conduct, integrity and ethical behaviour and should operate with due care and diligence and at all times act honestly and openly.
  4. The board should have formal and transparent arrangements in place for presenting a balanced and understandable assessment of the company's position and prospects and for considering how they apply financial reporting and internal control principles.
  5. The board should provide suitable oversight of risk management and maintain a sound system of risk measurement and control.
  6. The board should ensure the timely and balanced disclosure to shareholders and/or regulators of all material matters concerning the company.
  7. The board should ensure remuneration arrangements are structured fairly and responsibly and that remuneration policies are consistent with effective risk management; and
  8. The board should ensure that satisfactory communication takes place with shareholders and is based on a mutual understanding of needs, objectives and concerns.

Directors of companies subject to the Code must consider and minute discussions relating to it periodically at board meetings. They are also required to confirm to the Commission on an annual basis by means of a written assurance statement that they have considered the effectiveness of their corporate governance practices and, in the context of the nature, scale and complexity of the relevant company, are satisfied with the degree of compliance with the Principles for the relevant period.

Weavering – what does it mean for Guernsey?

In August 2011, the Grand Court of the Cayman Islands handed down its judgment in the case of Weavering Macro Fixed Income Fund Limited (in liquidation) (the "Weavering Fund") v Stefan Peterson and Hans Ekstrom (the "Weavering Judgment"). It triggered a wave of interest in the industry for the extent to which the Court has sought to establish how directors of open-ended funds should approach the discharge of their fiduciary and other duties to the funds of which they are directors.

Notwithstanding the excitement generated by some of the commentary in the industry concerning the

Weavering Judgment, the short point is the case is remarkable in that for the first time, the Court has considered the extent and scope of directors' duties in the context of an open-ended investment fund, and the interplay of those duties with the obligations delegated to and assumed by professional service providers including investment advisers and fund managers.

The Judgment summarises the duties owed by directors to their companies. Although these duties were expressed in the context of a Cayman fund, they are likely to be adopted in Guernsey. Of particular relevance to fund governance will be the series of important statements that the Court made in relation to the duty of directors to perform a high level supervisory role, particularly in respect of the powers they have delegated to others.

It is common ground in the industry that the facts underlying the Weavering Judgment were extreme. In that case, the liquidators of the Weavering Fund alleged that the directors of the fund were in wilful default and neglect of their duties as directors, an allegation which was upheld by the Court. In the Weavering Judgment, the defendant directors were described as "automatons" who signed whatever documents were put in front of them without "making enquiry or applying their minds to the matter in issue, on the assumption that the other service providers have all performed their respective roles (actual or perceived) and therefore do not need to be supervised in any way whatsoever". It was held that they in effect rubber-stamped the advice they received concerning the performance of the Weavering Fund.

While it would be easy to dismiss the Weavering Judgment as an extreme case, the Guernsey investment funds industry would be wise to heed the benchmark set by the Court in relation to the supervisory role to be exercised by directors in relation to the performance of the appointed service providers. It is important to note in this regard that the Court stated that the Weavering Fund's management structure was entirely conventional (except perhaps for the composition of its board of directors), in that it had appointed an administrator, custodian and investment manager, each of whom undertook to perform the roles typically assumed by those types of service providers.

Therefore the comments of the Court may be applied equally to other conventional fund structures. Importantly, while the Court acknowledged that "in the context of open ended investment funds, investment management, administration and accounting functions are invariably delegated to contracted professional service providers...", the directors of the fund must continue to exercise an independent judgment by conducting a review of the performance of those service providers in an inquisitorial manner.

While this may sound obvious to professional fund directors, the Court also raised the bar in relation to the reasonable care, skill and diligence to be exercised by directors in relation to their duties. The Court held that directors of open-ended investment funds must have a proper understanding of the financial results of the fund's investment and its trading activity as part of their overall supervisory role.

While there will always be extreme cases in any forum, lessons can be learned from the Weavering Judgment, particularly in respect of the supervisory role which directors are now expected to undertake. However, in light of the new Corporate Governance Code, it is submitted that Guernsey's corporate governance regime is well placed to tackle these issues and prevent, to the best extent possible, the potential pitfalls expressed in the Weavering Judgment.

Back to the code

The Code is a binding code of practice. While it does not codify or amend any existing laws, it adds another layer of focus on the increasingly important requirement for appropriate corporate governance. By requiring a board to provide an annual written assurance statement confirming its satisfaction with its degree of compliance with the Code, it necessarily requires the board to consider that compliance in the context of the nature, scale and complexity of the business in light of its common law fiduciary and other duties.

Valerie Rouse is a senior associate at Mourant Ozannes. Rouse specialises in offshore collective investment schemes and regulatory issues and has considerable experience in this area through employment for many years in the offshore finance sector. Before joining the firm in 1997, Rouse spent three years with the Guernsey Financial Services Commission.

Anthony Williams is a senior associate at Mourant Ozannes. Williams joined Mourant Ozannes in 2008 from Australia where he specialised in corporate litigation. He specialises in banking and finance litigation and contentious trust disputes. He also has a particular interest in funds litigation and advises a wide range of investment funds, investment companies and fiduciaries.

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