How Fund Directors bring value to the external audit: Best practices and developments – 13 November 2019

As the board is ultimately responsible for producing relevant and reliable financial statements, they must ensure that investment funds undergo high quality external financial audits. To enhance board engagement with this key role, ILA has just published a new guide to the financial statement and audit.

To help launch this publication, a panel of experienced local players discussed “How fund directors bring value to the external audit: best practice and developments” at an ILA conference on 13th November. The discussion was moderated by fund-industry consultant Henry Kelly (independent director and member of ILA’s management committee), with a panel featuring Carine Feipel (ILA chair, lawyer and independent director), Virginie Lagrange (member of ILA’s board and banking committee), John Li (ILA board member and partner of The Directors’ Office), and Justin Griffiths (partner at Deloitte).

Audit sub-committees

Best practice doesn’t mean rigidly following a set of rules. For example, the recommendation that each board should have a dedicated audit sub-committee to analyse the accounts in depth sounds attractive. Yet when the average fund board is about five people, having two of them working alone makes little practical sense, the panel agreed. This is a major reason why only a handful of large Lux funds have such a structure. Carine said she sits on a fund audit committee, but this is with a board of 10 directors. She finds this work to be important, with the sub committee’s work generally taking four hours, and resulting in a 15 minute report to colleagues. This allows the Board to focus more time on other topics such as product development, firm strategy, etc.

Rotation rules and practice

Auditor rotation seeks to prevent excessively cosy relationships from developing thus impairing independence of the audit firm. EU rules require a fresh tender process to be run after the first ten years of a relationship, with it being obligatory to choose a new audit firm after 20 years. However John felt 10-20 years is not a serious timeframe. “Most boards conduct a review every four to five years–, a tender process takes place to test the market to ensure the fund is still paying an appropriate level of fees. It does not always result in change but is a worthwhile process” he said. Justin said rotating audit team personnel (partners and other key audit personnel) was required for certain public companies (e.g. every five or seven years) and also used by audit firms as a benchmark for non-public companies. Virginie noted that most banks rotated more frequently than the law requires and that there are also other reasons for audit firm rotation like dissatisfaction of the auditor work and challenge of the audit fees. She cautioned that any transition should be well planned to reduce disruption and to save time. 

Limitation of liability questions

Henry noted that the limited liability clause in audit engagement letters is a hot topic of discussion amongst directors at the moment. While shareholders appoint auditors, directors agree on the terms by which they are appointed and thus the details of their limitation of liability. This potential anomaly may have implications for the governance of Lux funds. The panel agreed it was a sensitive topic, requiring careful consideration and transparent communication with both shareholders and with the appointed auditor. 

 A policy of full transparency does appear to be best practice, but this might lead to difficulties. “Often just one or two percent of shareholders are represented in AGMs,” John said, adding “and if one institutional investor is involved they could vote against the terms and conditions, leaving the fund without an auditor.” Henry noted this but also called for an evolution of practice, and auditors “should make it clear that in the standard terms and conditions that there is a limitation of liability, thus ensuring transparency that the board is fully aware of the commitments it is making.” Justin added that limited liability only goes so far, and doesn’t exclude gross negligence, for example.

Fee transparency

As for fees, the panel was unanimous that it is best practice for directors’ fees to be disclosed. The ALFI Code of Conduct says these should be “reasonable, fair and adequately disclosed” either individually or on an aggregate basis. The panel noted that progress is being made, but that there is substantial room for improvement. Most companies (including banks) have a legal requirement to disclose, but funds have a derogation. 

Should fund shareholders/investors approve directors’ fees? There’s nothing in the law regarding funds and the panel agreed that best practice would suggest that the AGM should have a say. If this is done at present though, most frequently it is an ex post decision. Given that this could cause problems if rejected by shareholders, the panel suggested asking for shareholder approval ex ante.

Code of conduct adoption

Earlier, Justin discussed the results of a Deloitte survey of how fund corporate governance is reported in the annual reports of Luxembourg’s top 100 funds. This suggested that only 30% had adopted the  ALFI Code of Conduct regarding fund governance. Henry thought this was a surprisingly low figure, not least as another  survey on the market had pointed to an 80% adoption rate. Cultural norms might be in play, with UK/US funds tending to adopt the code (in line with standard practice in that country) whereas no German funds domiciled in Luxembourg had. Justin suggested that maybe some funds may simply have forgotten to mention it in the annual report. The audience was reminded that ALFI and ILA have issued a template for Board reporting in the annual report to help avoid such slip-ups.

There was agreement that the production of a directors’ report is best practice. The law requires a report on each company’s activities.,This can be provided for example by the investment manager, but should normally be the board’s responsibility. Carine was clear about the importance of this document, and how it should be scrutinised closely by every director. This would enable the board can stand behind it with confidence. 

Representation letters and auditor meetings

More work is needed on representation letters, which are of particular importance in the Lux funds world which relies so heavily on the delegation of key functions. These need to be scrutinised early enough, so that appropriate comfort letters can be requested from service providers. Henry suggested conducting a mapping exercise to ensure clarity that sufficient assurances are in place from all partners. ILA has issued a guidance note on this topic which the panel recommended. 

Ideally directors should meet auditors during the course of the audit in order to spot potential problems before they arise. In the fund world this is not widespread, but Virginie said for her bank audits she had a meeting at the beginning of the financial year to discuss the audit plan, a catch up mid-way through, and a final backstop just before the end of the year. 

ILA`s new guide on financial statements and related audit aspects for fund directors is now available to members for download at