Edition: February/April 2018
27FOUR INVESTMENT MANAGERS
TAKEOUTS FROM THE SCANDALS
Service providers must be constantly checked, both in the selection process and in monitoring them afterwards, insists 27four Investment Managers managing director Fatima Vawda.
Undertaking a rigorous due diligence of critical retirementfund service providers – such as asset consultants, asset managers, administrators and auditors prior to appointment – is a crucial component of traditional risk management.
Take recent media coverage of several deleterious scandals.
They arose from questionable intelligence, recommendations and advice proffered by leading service providers. Throwing the issue of service-provider selection into the spotlight, questions are being asked about the efficacy of the checklist format on which funds rely to obtain wider disclosure before they hire service providers.
Outsourcing expertise is applauded because it is associated with several benefits. Amongst these benefits are that the provider comes with expertise as well as an aura of independence and, in the long run, that the whole exercise would turn out to be cost effective and value adding. On their own, these are not at issue.
But sadly, given the increased dependence by retirement funds on external providers, it is imperative that funds strengthen the criteria being used to determine the suitability of, and indeed the selection of, service providers. The costs of not doing so could impact disastrously on the ability of funds to manage their risks and monitor their compliance in line with regulatory requirements.
Besides lacking vigorous activism, many investors are mostly concerned with returns on their investments. It is only when their investments are at risk that risk management and compliance becomes an issue.
A laissez faire attitude exposes funds to unscrupulous and self-interested boards of trustees who also find it convenient to outsource the render of services to cronies, thereby weakening and compromising internal controls. It follows that the decision to appoint a service provider must be subjected to appropriate due diligence and be robustly defensible.
Arising from the fallout from recent governance debacles is the view that such scandals are symptomatic of structural flaws characterising the current procurement system. The common thread is a concentration of certain favoured service providers in particular fields; for example, auditing. It can be argued that, even if the funds did not tick all the boxes of the due diligence process, these service providers would still be preferred on the basis of their names.
However, the scandals have revealed that names do not matter. Simply because the service is offered by a big name does not mean that the procurer of services is in good hands. Unfortunately, and until recently, entities have been inextricably loyal to big firms. That loyalty has arguably engendered some complacency on the part of favoured service providers.
The prevailing scenes demonstrate that reputation is a fallible asset. It takes ages to build a strong, sustainable corporate reputation but the same can be lost in no time. The repercussions of a poorly managed procurement regime can be devastating for both the service provider and the hiring entity.
Ultimately it all comes down to the procurement model. It’s inadequate when it is not based on credible considerations, such as ethical values and normative rules, with which stakeholders want to be identified. An inadequate model is clearly susceptible to failure.
In directing the way forward, trustee boards must move beyond box ticking. The due diligence process needs to be augmented by an investigatory team to assess the capacity of the service provider to meet the objectives of the fund. Consent for approval must be obtained and contractual agreements entered. There must be continuous monitoring and scrutiny of the provider against its contractual obligations.
Since corporates suffer more from reputational damages than from fines, a new penalty framework that impacts on reputation need to be carved. In the UK, for instance, the ‘credible deterrence’ model works hand-in-hand with reputational damage. This seems to have helped restore professionalism amongst service providers. More than this, a proactive investor community is indispensable.
A successful relationship does not arise from shuffling papers between the potential service provider and the procuring entity. There is no foolproof due diligence mechanism because, as it’s often found, “systems” can be beaten.
Important lessons should be drawn from the recent scandals. Auspiciously, the acerbic press headlines have galvanized the private sector and government to start exploring alternative pre-award models that would better serve investor and public interest. What these efforts will avail remains to be seen.