Well funded work

The asset management industry is important in Scotland. There are many asset managers who are either based or have substantial offices here. Examples include Scottish Widows Investment Partnership, Baillie Gifford, Resolution, Standard Life, Artemis, Martin Currie, Edinburgh Partners and First State Investments. Most of these offices have their own legal departments, which may also combine as compliance departments.

In private practice law firms, the business of the firm is (or certainly should be!) built around giving the lawyers in the business the tools and support to enable them better to give legal support to their clients. The same principle applies in the asset management industry, but the support is provided to the fund managers, through whom the value of the business is created.

Legal departments in asset managers will most likely have the “normal” role of in-house legal advisers, for instance advising the business on compliance with UK law and regulation (sometimes overseas too) and acting as company secretaries, which is outside the scope of this article. However, they will also have a crucial position in the business to make sure the fund managers have what they need to do their jobs – making profitable investments on behalf of clients. It is this, more technical, aspect to the asset management industry lawyer’s role that we will look at.

Pooled and segregated clients

Typically, most asset managers’ clients can be split into two differing types – those who are pooled and those who are segregated.

Pooled clients – typically open ended investment schemes such as investment companies with variable capital (ICVCs or, more commonly, OEICs) or authorised unit trusts (AUTs) – are vehicles in which investors can buy units or shares and which then make investments on their own account.

The size of an ICVC or AUT increases or decreases depending on whether investors have in aggregate bought or sold more shares/units – in other words, the laws relating to maintenance of capital which apply to UK companies under the Companies Acts do not apply. ICVCs in particular have the ability to set themselves up in an “umbrella” structure, under which sub-funds can be incorporated, each sub-fund having its own investment strategy (e.g. UK equities, European equities, infrastructure etc). Investments are bought and sold in an OEIC on the back of a prospectus in similar terms to that of a normal UK plc, but the prospectus acts (together with an instrument of incorporation) as the constitution of the vehicle and creates the contract between the OEIC and its shareholders.

By way of contrast, segregated clients will appoint a fund manager under their own investment management agreement (IMA), and such clients’ investments will be made in the name of the individual client (or its custodian or nominee), rather than the name of the OEIC as is the case with pooled vehicles. Such clients can withdraw or “top up” their accounts with the relevant manager under the terms of their IMA.

The role of the legal department in each case is typically as follows:

• Product development – where the business wishes to open or close new sub-funds or even a new OEIC, the legal department will be instructed to help draw up the relevant document and (along with the business’s compliance department) make and maintain the appropriate registrations of that document with the regulators in the countries in which the shares of the OEIC will be sold.
• Acting as company secretary to the pooled vehicle – the OEIC will usually itself have to hold board meetings and shareholder meetings, depending on the business it carries out under the rules applicable to it. The role of the legal department in asset management companies typically involves advising on when such meetings are required, convening them appropriately and keeping the appropriate minutes.
• Negotiating IMAs for new segregated clients – these tend to be very highly negotiated documents involving detailed review of terms and liaising with the different business departments to make sure that the terms are acceptable to the business. Primarily, this means making sure that the investment guidelines and restrictions are correct, but there are also “back and middle office” functions which will be affected, such as client reporting, investment operations (for instance relating to whether the client wishes the manager to vote the shares in which the account is invested, or wishes to retain this function itself), and compliance (making sure that the terms of the IMA are monitored and complied with).
• Dealing with regulators – restrictions apply in most jurisdictions on the provision of investment advice/management or the sale or distribution of shares in pooled vehicles in that jurisdiction. The role of the legal department will probably include giving or sourcing legal advice as to what exactly is required and making sure that appropriate registrations are made and maintained.

Regulation change

The rules and regulations applicable to the asset management industry have been in a state of constant flux for many years. Legal departments will have a role in planning for regulatory change and advising on any changes to client agreements or other business contracts arising out of the new rules. Recent projects have included the following:

COLL and UCITS III. UCITS stands for “undertakings in collective investments and transferable securities”, and is broadly a European standard for pooled investment vehicles. Most OEICs will comply with UCITS so that their shares can be marketed in other EU countries more easily. UCITS III was a change to the way in which UCITS vehicles are managed and permitted: for instance, the introduction of performance fees and greater investment freedom, the ability to use derivatives being an example. COLL was the introduction of new rules applicable to UK based OEICs and AUTs, largely to implement UCITS III. Legal departments in the asset management industry will have been involved in planning for COLL and UCITS III, and making the necessary amendments to the constitutional documents of the relevant vehicles to make them compliant.

MiFID. Many solicitors will be aware of MiFID, the Markets in Financial Instruments Directive. This has largely impacted asset managers’ segregated clients, as each IMA has required amendment to make sure it is MiFID compliant. This had to be completed by 1 November.

There is no sign that the rate of change will slow down in the future, so lawyers in the asset management industry can expect to be kept busy.

Dealing in derivatives

Derivatives are a class of investment where the price is derived from an underlying asset. Options, futures and contracts for differences are all types of derivative. Fund managers utilise derivatives, as with all types of investment, to try to maximise returns, but they are also useful to hedge against risk in an investment portfolio.

Derivatives can be either standard exchange-traded contracts or bespoke over-the-counter (OTC) swaps. OTC is the prevalent type by volume. In order to utilise OTC swaps, asset managers will need to enter into a contract with a counterparty (usually a bank or other large financial institution) through whom the derivative will be traded. This contract may take the form of the “ISDA agreement” – an industry precedent allowing trading of most derivatives to be carried out – or a bespoke agreement depending on the type and nature of derivatives concerned. These contracts are highly technical and require input from the investment operations departments and trading desks to make sure that the terms are correct and the risks inherent in the use of such securities is identified and mitigated.

In addition to the negotiation of the relevant counterparty agreement, the legal department will usually be called on to help put in place systems and procedures to make sure that the use of derivatives by asset managers can be supervised so that the risks can be controlled. As the Barings Bank debacle testifies, these systems and procedures are crucial to the proper use of this type of investment!

Join our Forum

As can be seen from the brief summary above, legal advisers in the asset management industry have a varied workload requiring some fairly detailed technical knowledge and the ability to negotiate through often conflicting priorities between internal and external clients. It is an interesting industry and one which is subject to constant change, as the markets in which investments are made also change. However, the industry in Scotland is well positioned and will hopefully be active in Scotland for many years to come.

We have established a Fund Managers Legal Forum to deliberate matters of common concern. Lawyers from most of the Scottish managers participate. If you would like to be included in future communications, please drop me a line.

Adrian Smith is head of legal at First State Investments e: AcnSmith@firststate.co.uk

HOOD’S ADCICE: BE MORE “IN YOUR FACE”

Junior in-house lawyers who feel marginalised should “get in the faces of your clients”, In-house Lawyers Group Chairman Janet Hood told the Group’s annual meeting in Edinburgh this month.

In her Chairman’s address, Hood said the Group had had feedback from lawyers complaining they were kept in back rooms and didn’t know who they were working for. “The only way to get on is to know who your clients are”, she said. “Go and see the services you work for. Fight your way onto management committees. You have to prove that you have a brain that can help with the business.”