The End of the SMIC?

Will the Central Bank’s implementation of CP86 and its subsequent review mean the end of the Self-Managed fund in Ireland?

The Self-Managed Investment Company (“SMIC”) has long been a popular form of structure employed when establishing a UCITS, and to a lesser extent, regulated AIFs in Ireland. The alternative is for a fund to appoint a UCITS management company, or in the case of an AIF, an alternative investment fund manager (“AIFM”). Management companies are regulated by the Central Bank of Ireland (“Central Bank”) to provide management company services to UCITS and/or AIFs. Recent regulatory developments and increased substance requirements from the Central Bank are prompting industry participants to question whether the SMIC will soon disappear, since virtually all regulated funds now appoint a management company.

In December 2016 the Central Bank published its final guidance on Consultation Paper 86 (“CP86”) addressing the effectiveness of Fund Management Companies, which includes SMICs and management companies. CP86 provides guidance in seven key areas:

• The rational for board composition

• Directors’ time commitments

• Organisational effectiveness

• Managerial functions

• Delegate oversight

• Operational issues

• Procedural matters

The implementation of CP86 occurred over a number of months and was completed in July 2018 when all in-scope Fund Management Companies were required to fully comply.

The implementation of CP86 brought increased substance requirements to Fund Management Companies. Substance requirements are measured by time commitments of Designated Persons, who are responsible for the six managerial functions set out under CP86:

• Investment management

• Distribution

• Fund risk management

• Operational risk management

• Regulatory compliance

• Capital and financial management

In the months following the implementation of CP86, applications to the Central Bank for authorisation of SMICs were met with greater time commitments for Designated Persons than had been required prior to the implementation of CP86. In many instances, the new time commitments were five to ten times those previously required for similar structures, resulting in inconsistencies between SMICs established prior to CP86 and those established more recently.

In 2019, the Central Bank began a thematic review of the implementation of CP86 (“CP86 Review”). The CP86 Review was carried out in three steps:

• In Q 2 2019, the Central Bank wrote to over 300 management companies and SMICs requesting the completion of a questionnaire. The stated aim of the questionnaire was “to identify standards of industry compliance in order to inform our supervisory approach and ensure that the required effectiveness and systems of governance are in place to protect investors’ best interests.”

• In Q3 2019, the Central Bank completed in-depth desktop reviews of a selected sample of management companies and SMICs. The desktop reviews focussed on the performance of the managerial functions and the performance of the organisational effectiveness role, which was a new role introduced under CP86. The role is carried out by a director of the management company/SMIC.

• In Q1 2020, the Central Bank conducted on-site inspections of a selected sample of management companies. During the on-site visits, the Central Bank carried out face-to-face interviews with designated persons responsible for risk management and investment management and the director responsible for the organisational effectiveness role.

The Central Bank has provided an indicative timeline of Q3/Q4 2020 for when it will communicate its findings from the CP86 Review to the industry. The expectation is that the Central Bank will de facto increase the required time commitments of Designated Persons supporting SMICs established prior to the implementation of CP86 to bring them in line with those established after the implementation of CP86. This will likely result in significant increases to the time commitments of Designated Persons for a large majority of the existing SMICs.

As many SMICs rely on external consultants in Ireland to provide Designated Persons to meet these substance requirements, increased time commitments will result in increased costs. However, under CP86, where a fund has appointed a management company, the time commitments for Designated Persons apply to the management company rather than to the fund. As such, it is expected that many SMICs will appoint management companies with real substance in Ireland to meet the Central Bank’s new substance requirements rather than absorb the cost of increasing the time commitments of their existing Designated Persons.

Another option is to satisfy the new time commitments by splitting the six managerial functions between Designated Persons located in Ireland or the European Economic Area (“EEA”) (often external consultants) and Designated Persons located outside of Ireland/EEA (generally existing staff of the fund promoter or investment manager). Under CP86, it is required that at least half of the managerial functions be carried out by at least two individuals who are resident in the EEA. This means that two or three of the managerial functions can be carried out by staff of the fund promoter or investment manager, even if they reside outside of the EEA. In practice, most funds appoint Designated Persons in Ireland to carry out at least half of the managerial functions.

The question currently being pondered throughout the industry is whether the Central Bank’s increased time commitments will mean the end of the SMIC. While it is currently still possible to have a SMIC approved by the Central Bank with increased time commitments, there have been very few new SMICs established since the implementation of CP86. The general view in the industry is that while the establishment of SMICs may not be explicitly prohibited going forward, the structure simply will not be suitable for meeting the Central Bank’s expectations as to substance.

Andrew Kehoe, Head of Legal, KB Associates