Saturday, March 10, 2012

Hedge Fund Industry Comments on MiFID Compliance Function as ESMA Readies Proposed Regulations

The hedge fund industry supports a robust regulatory framework for the EU Markets in Financial Instruments Directive (MiFID) that includes an effective internal compliance function. In a letter to the European Securities and Markets Authority, the Managed Funds Association provided comments on a number of matters to assist ESMA in balancing the need for effective regulation with the reality of existing market practices.

The MFA believes that the role of the compliance function should be institutionally important and its success is more likely to be achieved where senior management strongly sponsors this function. A collaborative approach is more likely to lead to effective and sound decision-making by senior management who are ultimately accountable for the firm's failures.

Also, the MFA said that in the case of an investment firm which is part of a corporate group, it may be appropriate to have a centralized compliance function situated within another group entity. The association also noted that compliance officers should not be required to have formal compliance or legal qualifications, provided that they have a good knowledge of the regulatory system combined with a thorough understanding of the business carried out by their investment firm gained through relevant experience. This is particularly important in the context of a corporate group with a centralized compliance function where the chief compliance officer for the group may be based in a jurisdiction outside of the EU.

The association supports the principle that the compliance officer should have unrestricted access to the governing body of the firm and should have the right to attend meetings of senior management when the compliance officer believes that it is necessary for the effective exercise of the compliance function. In this respect, a compliance officer may consider that it is necessary for him or her to attend meetings where organizational changes or modifications to the investment firm's investment services, ancillary services and new products are discussed.

The MFA asked, however, if ESMA could clarify that this requirement does not imply that the compliance officer should be made a member of the senior management or the governing body of the investment firm. In this context, it is important for ESMA to emphasize that the primary role of the compliance function is to advise the senior management of the firm with respect to their decision-making. The compliance function should not be required to have an executive or decision-making role.

Separately, the MFA said it should be clarified that compliance officers should not be required to justify to the management body why they believe their attendance is necessary at a particular meeting. Conversely, if a compliance officer chooses not to attend or is unable to attend a particular meeting, the compliance officer should not be required to justify his or her absence from the meeting to competent authorities.

The MFA agrees that the compliance officer should have sufficient knowledge of legal and regulatory requirements to be able to assess the potential compliance risks and conflicts of interest relevant to the investment firm’s business and activities and should have the support of senior management to develop and deepen this knowledge and understanding on an ongoing basis. However, the MFA does not believe that compliance officers should be required to have formal compliance or legal qualifications.

In many smaller firms, individuals carrying out the compliance function will have background experience in finance, operational, risk management or investment matters.
The MFA believes that so long as such individuals are sufficiently familiar with the regulatory requirements and receive support from external legal and compliance adviers, they should be in the position to carry out the compliance function effectively.

Compliance arrangements should be appropriate in view of the size of the firm, complexity of its operations and its organizational structure. As a general matter, the effectiveness of the compliance function cannot be necessarily ensured by its
independence from the influence of senior management or other business units. Conversely, the independence of the compliance function cannot be guaranteed by the compliance officer holding a particular position in the organizational structure.

In the MFA’s view, a better approach might be to encourage collaboration of the compliance officer with senior management and business units. This collaboration would not necessarily undermine the independence of the compliance officer, provided that the compliance officer has sufficient authority and credibility to access and challenge senior management if required. More important than independence is a strong culture of compliance grounded in the commitment and active involvement of the senior leaders of the firm. The role of the compliance function should be institutionally important and its success is more likely to be achieved where senior management strongly sponsors this function. A collaborative approach is more likely to lead to effective and sound decision-making by senior management who are ultimately accountable for the firm's failures.

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