COLUMN John Forbes: Raising the bar in corporate governance

Pressure is growing for global corporate governance standards in the real estate investment management industry, writes John Forbes in this column.

The global financial crisis exposed a number of weaknesses in the open and closed-ended fund model as well as shortcomings in the industry in respect of governance, transparency, communication with investors, risk management and controls environment. International investors, regulators and standard-setters are driving change.

Investors are much more focussed on the operational aspects of the businesses of fund managers and joint venture partners with whom they invest. In the aftermath of the crisis, much of investors’ attention was focussed on either resolving legacy issues or taking positions in existing funds. Much of the new investment was through separate accounts, joint ventures and club deals where the investors have more direct control.

It is only over the last year as the raising of blind pool funds has recovered that the changed environment has become more apparent. Based on interviews with investors, consultants, fund managers and placement agents, it is evident that the direction of travel over the last year is likely to continue.

Many of those interviewed identified two broad industry trends that are impacting fund managers in the area of governance and transparency as well as more broadly. These two trends - polarisation and consolidation - also have an impact on investors and others.

• Polarisation - some very large fund managers with a very strong track record are able to raise funds as they have in the past without making significant concessions on either fee arrangements or on other demands from investors. For all other managers, the environment has changed very significantly. They need to meet much higher standards in terms of meeting the increased demands of investors. Coupled with the burden of regulation, this has significant cost implications for managers at a time when there is also considerable downward pressure on fees.

• Consolidation - changes in the industry are creating pressures for consolidation. Regulatory changes and the cost of dealing with stronger governance and greater transparency are contributing to this. Real estate trade press attention has focussed on consolidation among managers. However, some of those interviewed also commented on consolidation amongst investors and amongst consultants, resulting in increased concentration throughout the investment process.

As would be expected, due diligence has, in the view of those interviewed, become significantly more thorough in response to the failings identified in the crisis. There remain, however, significant differences in approach:

• Although the use of extensive due diligence checklists has become increasingly the norm, some large investors value a more pragmatic approach, remaining keen that formalising the due diligence process is not at the expense of its current flexible approach. This approach is highly dependent on sufficient resource being allocated to the task;

• There are also significant differences over the use of standard questionnaires, in particular the INREV due-diligence questionnaire. This is gaining increased acceptance and more investors are using it at least as the starting point even if they subsequently ask additional questions. Some of those interviewed who currently do not use the INREV questionnaire have plans to introduce its use. This included investors from outside Europe. Investor concerns are feeding back into the trade bodies which are in turn revising their guidance, with both INREV and AREF updating their guidelines on fund governance.

• Investors are increasingly seeking to apply good examples they see in one area to their investments in another. This is partly through exporting the application of trade body guidelines, but also individual examples of good governance. Australian examples were cited by a number of respondents. There is an interesting Australian model with the general partner having a majority of non-executive directors and an obligation under the statutory documents of the company for the fiduciary duty to investors to override the corporate law obligations to shareholders;

This focus by investors is going to become increasingly important with changes to the broader fund model. Both closed-ended and open-ended funds for institutional investors are evolving into long-term investment vehicles with limited liquidity. Investors and managers both need mechanisms for providing protection, dispute resolution, management of conflicts of interest and oversight over liquidity arrangements.

John Forbes is an independent consultant advising real estate investment management clients
This article is based on a keynote presentation by John Forbes to the RICS and SPR 'Cutting Edge' Conference in London on 22 October entitled 'The pressure for global corporate governance standards for the real estate investment management industry'