Trustees are generally given wide powers of investment in the scheme rules, often expressed to afford trustees the same powers to invest scheme assets as though such assets were owned by the trustees themselves (with certain restrictions, either in the scheme rules or in legislation).
Though they are responsible for the overall investment strategy of the scheme (as set out in the SIP), trustees are able to delegate their investment powers to investment managers who are authorised under the Financial Services and Markets Act 2000.
The terms on which an investment manager (IM) is appointed are governed by an investment management agreement (IMA), which is often based on the IM's own standard terms.
Where derivatives form part of the investment strategy, trustees may find it helpful to consider and / or seek advice on the following general questions before negotiating the IMA:
- what is the scope of the IM's powers of investment – does this dovetail with the investment guidelines in the SIP?
- what level of discretion is afforded to the IM?
- what is the scope of the IM's contractual liability and its duty of care to the trustee? Is the trustee's liability to the IM limited to the assets of the scheme (or the assets of the scheme under the IM's management) from time to time?
- what representations and warranties are included – does this offer enough protection for the trustee?
- are there any exclusions (from warranties in respect of duty of care, liability etc.) in the IMA?
- in what circumstances the IMA can be terminated by each party?
With reference to derivatives, trustees should also consider:
- whether the proposed use of derivatives in the IMA aligns with the scheme's investment strategy? Is the use of derivatives set out in sufficient detail?
- what action the IM will take if a default event occurs under a derivatives contract, e.g. an ISDA?
- whether the IM will facilitate regulatory compliance e.g. with UK EMIR, EMIR and/or its US-equivalent, Dodd-Frank, where applicable?
- how often and to what extent the IM will report to the trustee?
The above questions can provide a useful framework for a trustee's discussions with an IM, but there are a number of issues to consider in terms of the range of services an IM can provide, not just in relation to derivatives. These can include:
- the IM's best execution policy (is the trustee satisfied that the IM will achieve the best possible result for the scheme when executing trades? This is particularly relevant for Agency ISDAs),
- whether trading is done under agency or bilateral documents (see earlier article),
- allocation and procedure in relation to transactions,
- the delivery and performance of the IM's obligations,
and other matters depending on the characteristics of the investment assets and the IMA's investment style e.g. active management or passive tracking.
We have negotiated IMAs on behalf of scheme trustees and IMs, and would be happy to discuss any of the above points in further detail.