Date Published 26/11/2021
Recent Disciplinary Action by the Central Bank of Ireland – Sarasin Funds
On 27 September 2021, the Central Bank of Ireland (the “CBI”) fined Sarasin Funds Management (Ireland) Limited (“SFMIL”) €385,000 in respect of four breaches of investment funds regulations during the period between 25 March 2017 and 2 March 2018.
SFMIL Business Plan and UCITS Regulation
SFMIL is authorised by the CBI as a UCITS fund management company. SFMIL set out, through its Business Plan dated 20 September 2016, the procedure for compliance with its regulatory obligations, which included the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011 (the “UCITS Regulations”) and the Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1)) (Undertakings for Collective Investment in Transferable Securities) Regulations 2015 (as amended) (the “CBI UCITS Regulations”).
The Business Plan stated that a number of fund management functions were to be delegated to external service providers and monitored on a continuous basis by designated directors. Among these delegated functions are investment management services, which are delegated to an investment manager (the “Investment Manager”). Such delegations are in line with the UCITS Regulations, and are standard practice in the context of Irish funds. However they do not reduce the management company’s responsibility to comply with its regulatory obligations.
In April 2017, the Investment Manager proposed that a sub-fund it managed (the “Merging Fund”) be closed and merged into another fund (the “Receiving Fund”). This transaction (the “Merger”) was approved by the Board of Directors on 16 May 2017.
The proposed Merger was on the basis that assets would transfer by way of a process known as ‘in-specie’, which involves the ownership of the underlying assets of one fund can be transferred to another without the need to convert the assets into cash.
However, in or around June 2017, the Investment Manager decided to convert the vast majority of assets in the Merging Fund to cash so that only cash would be transferred to the Receiving Fund, to be subsequently re-invested by the Receiving Fund in the relevant assets. The result of this would be that investors would not benefit from any positive market movements while their investments were held in cash.
Having converted the majority of the assets to cash in the days leading up to the Merger, the Investment Manager then decided to invest 94.49% of the assets of the Merging Fund into a UCITS exchange traded fund (the “ETF”). The purpose of this was to recreate market exposure for the Merging Fund.
Contraventions of UCITS Regulations
1. Breach of Investment Restrictions in the UCITS Regulations
Regulation 73(1) of the UCITS Regulations allows a UCITS to acquire the units of another UCITS, provided not more than 20% of its assets may be invested in such units. The purpose of this is to mitigate risk to investors by reducing financial exposure to a single investment. The investment by the Investment Manager of 94.49% of the assets of the Merging Fund into the ETF constituted a breach of Regulation 73(1).
2. Breach of Investment Restrictions in the Merging Fund’s Prospectus
The Merging Fund’s Prospectus restricted the Merging Fund from investing more than 10% of its net asset value in other UCITS. Again, the Investment Manager’s investment of 94.49% of the assets of the Merging Funds into the ETF breached this requirement.
3. Reporting and Communications Procedures
Under Regulation 22 of the UCITS Regulations, a management company must establish and maintain effective internal reporting and communication of information. The CBI found that SFMIL failed to ensure compliance in a number of areas, including failure to provide timely delegates’ reports; failure in exception reporting and escalation reporting concerning the various breaches of UCITS Regulations; and failure to keep a designated director to monitor compliance with UCITS Regulations in place.
4. Ineffective Supervision of Delegates
Regulation 98(1) of the UCITS Regulations permits a management company to delegate activities to third parties provided that the delegation does not prevent the UCITS from being managed in the best interests of its investors and provided also that measures are put in place to enable to management company to monitor the activity of its delegates.
Regulation 98(1) of the CBI UCITS Regulations requires a management company to designate a specific director in respect of each delegated activity to monitor that activity.
The CBI found that, due to the communications failings described in the third contravention above, SFMIL breached each of these Regulations as it did not have adequate information to effectively monitor the activities of its delegates.
Significance of CBI Enforcement Action
The investigation and subsequent penalty demonstrates the CBI’s close monitoring of management companies’ activity and its willingness to impose strict penalties in the event of contraventions. The CBI placed particular emphasis on the Investment Manager’s knowledge of the contraventions at the time and what it found to be SFMIL’s serious deficiencies in the supervision and monitoring of its delegates. However, SFMIL’s cooperation with the CBI in its investigation was seen as an important mitigating factor in determining the penalty.
The CBI’s enforcement action also illustrates the increasing importance of compliance by firms with their regulatory and supervisory obligations and highlights reporting, communication and monitoring activities as key steps in ensuring an adequate compliance framework.