What is an OEIC?
Recent reports suggest that the FCA is planning to review the role played by Authorised Corporate Directors (ACDs), following the problems encountered by Neil Woodford’s Equity Income Fund. ACDs play a vital role in the smooth functioning of the UK’s investment management sector, yet their purpose is not widely recognised by investors. To understand more about ACDs, we first need to look at a particular type of investment fund – the Open-Ended Investment Company or ‘OEIC’.
What is an OEIC?
Open-Ended Investment Companies, also sometimes known as Investment Companies with Variable Capital or ICVCs, are one of the most common types of investment fund used in the UK, rapidly overtaking the traditional unit trust. Most investors will understand the basic concept of a fund as a pooled investment vehicle, but underneath the surface, an OEIC has an intricate series of legal relationships between various parties.
The key principle of an OEIC is that it is established under company law, and therefore has a distinct legal personality. This enables the OEIC to enter into contractual relationships. Rather than the Companies Act 2006, OEICs are constituted under their own set of rules – the OEIC Regulations 2001 – however, just like standard UK companies, the regulations state that at least one director must be appointed.
For an OEIC, one director must be an FCA-approved entity designated as the Authorised Corporate Director. This is a specialised role, responsible for much of the day-to-day running of the fund structure and with a litany of significant functions.
What does the ACD do?
The ACD’s duties include:
- administration of investor subscriptions and redemptions, ensuring that units are created or cancelled in line with demand
- ensuring that the OEIC is operated in the best interests of investors and in accordance with all applicable regulation, such as the FCA’s COLL sourcebook, and reporting any breaches accordingly
- management of the fund’s portfolio of underlying investments
- oversight of any outsourced arrangements used by the OEIC
- preparation of the OEIC’s report and accounts
- production of daily valuations and calculation of prices
- retaining records as required by regulations, for example of investor transactions and balances
Which firms are ACDs?
There are a number of companies that provide ACD services. Each fund operated by an ACD will typically be identified with a prefix in the full fund name. The table below shows a non-exhaustive list with some examples of ACDs, their prefixes and an example fund operated by that ACD.
How does an ACD work in practice?
The operations of an OEIC and the relationship between the different parties involved can seem fairly opaque and difficult to understand for those who are not closely involved. The schematic below shows a simplified version of how the key players interact in a typical structure:
At the centre of the diagram is the OEIC – that is, the body corporate, formed with the aim of investing in securities. The OEIC has beneficial ownership of the underlying portfolio of assets.
Investors are actually shareholders in the OEIC, in much the same way as if they were shareholders in any other UK company. They have a beneficial ownership of the company – but not the underlying portfolio.
As noted, the Authorised Corporate Director is responsible for the operations of the OEIC; one aspect of this role is the management of its investments. This is usually delegated to a dedicated Investment Manager.
Finally, an independent FCA-approved entity needs to be appointed by the ACD who has responsibility for the legal ownership and safekeeping of the OEIC’s scheme property – this is another fundamental part of the framework, known as the depositary. In turn, the depositary may delegate safekeeping to a specialist custodian, but it maintains ultimate responsibility for the protection of the fund’s investments. The depositary also provides oversight of the ACD to make sure it carries out its duties in accordance with regulations.
Why is an ACD so important?
In a purely technical sense, the ACD operates the fund and appoints an investment manager to manage it. In practice, however, to set up an OEIC, an investment manager will appoint the ACD and pay a fee for their services. In turn, the ACD will delegate investment management services back to the investment manager.
This might sound convoluted, but there is a fundamental logic to these arrangements: the presence of an ACD allows investment managers to concentrate their efforts on investment strategy, portfolio construction and trading, rather than having to worry about the day-to-day operations of the fund, which are taken care of by an expert regulated entity. By transferring much of the administrative burden of running a fund to the ACD, the investment manager reduces costs and these savings can ultimately be passed down to investors.
The OEIC framework also contains a number of checks and balances which protect investors. The ACD is tasked with ensuring regulatory compliance of the investment manager and, in turn, the depositary provides independent supervision of the ACD. New FCA rules which come into effect in September 2019 will require ACDs to appoint at least two independent non-executive directors to their boards to further bolster governance.
Nevertheless, recent events have raised questions about this operating model. Are there inherent conflicts of interest, and is there sufficient challenge of investment managers by ACDs? It is likely that the FCA will look at the Woodford fund suspension closely, with a particular eye on the actions of the ACD, and there could well be changes to the mechanics of OEIC governance.
It is likely, however, that ACDs will continue to play a crucial role in the fund management industry for many years to come. The work of ACDs often goes under the radar, but it ensures the efficient running of hundreds of funds and deserves to be much more widely understood by investors.