Seal the deal after small print scrutiny

United Kingdom

Post Pensions Act trustees need to pay attention to the detail of fund manager contracts writes Andrew Crawford

Following a recent beauty parade, for discretionary managers for an equity portfolio, a letter is received from the recently selected fund manager. It ends “..... thank you for appointing us. I enclose our letter of appointment. It is in the usual standard form. Please countersign and return it. I look forward to a successful relationship...”

The reference to being in a “standard form” carries the implication that there is no need to read it as no changes can, or need be made. With the coming into force of the Pensions Act 1995 on 1st April, the “usual standard form” may no longer be appropriate.


When entering into a new discretionary fund management agreement, the most important issue to check is that the fund has the ability to enter into the agreement and, in particular, to confer the powers of investment, indemnities etc which are set out in it. The appointment may also confer on the manager particular powers for example to lend stock or borrow against the funds assets which may not have been previously discussed.


Custody services are provided in a number of different ways. Some managers will have arrangements with a particular bank or other part of their own group to provide custody. For larger funds with several managers a separate single custodian will be appointed. With the new regulations on custody, some fund managers may wish to vary the existing arrangements.

The fund will need to decide which of the functions the manager or the custodian as the case may be, will carry out, and who will be liable if there is a failure to do so.

For example if the custodian is part of the same group as the fund manager, the manager will, typically, accept liability for the defaults of the in-house custodian. On the other hand, if the fund manager is appointing a separate custodian, at the request of the fund manager, then the manager would generally not accept liability for the default of the outside custodian.

It is important to ensure that where there is a separate agreement relating to custody, that that agreement fits seamlessly with the fund management agreement.

There has been a debate as to whether the Pensions Act requires the fund itself to appoint each of the sub-custodians.

However, the DSS has indicated that this was not the intention of the Pensions legislation. Nevertheless, the fun will need to review the arrangements between the main custodian and its existing or prospective sub custodians.

The Barings debacle underlined the fact that consideration will also need to be given to the ramifications of the insolvency of not only the custodian but also sub-custodians.

This is relevant not merely to how cash is handled, but also where the custodian is holding securities in a dematerialised form. For example, a decision will also have to be taken as to whether assets will be in segregated accounts or pooled with those of other customers.


How clean is the ‘clean’ fee? For example, does it include commissions, management charges for manager’s in house unit trusts and custodial fees?

Recently, performance related fees have been discussed, particularly in relation to specialist portfolios.

Under this fee structure, if the manager attains specific performance targets, it is entitled to an additional fee.

While some managers will only work on a performance related fee, others believe that it creates an inherent conflict of interest.

For example, they argue that where there is a limited stock available there is a temptation for the manager to allocate the stock to funds which are subject to performance related fees as opposed to those which are not.

Some investment consultants question whether such fees provide a real incentive - or merely reward luck.

From the legal perspective, it is important to ensure that the benchmark which triggers the additional performance fee is clear. There are arguments for using an official index, such as the FT All Share or the S&P 500, rather than an industry index (for example, CAPS or WM). Another issue is what happens if the manager fails to achieve the performance target? Is there to be a clawback of the fee?

Standard of Care

If the fund management agreement is silent as to the standard of care of the manager, then the law will imply a standard of care.

A term will be implied into the agreement that the manager should exercise the standard of skill and care of a reasonably competent adviser in that field.

The key elements are that the advice should be given carefully and that it should be reasonable.

If trustees with a sufficiently large fund, seek to impose a higher standard of care, the manager will often find it difficult to resist.

Once the appointment letter has been agreed, a decision needs to be taken on who is authorised to sign. That may cause a headache, even if reading all the small print did not.

Custody arrangements

Typically, custody will cover:

  • safekeeping of customer assets

  • settlement of transactions and registration of investments

  • handling cash associated with customer’s assets, such as collecting, and dealing with,

  • dividends and any other income associated with the assets

  • reclaiming taxes

  • providing reports and valuations

  • carrying out corporate activities such as voting

  • appointing sub-custodians to provide custody services, particularly in overseas markets.

Key Changes under the Pensions Act

  • Liability: fund managers of pension funds are unable to exclude or limit their duty of care and skill in carrying out their investment functions; indirect limits (such as imposing conditions on the enforcement of duties) are also precluded. So direct or indirect limitations on liability should be deleted.

  • Performance: check the provisions relating to reporting, to ensure the manager will provide the information required to assess performance, within the agreed fee.

  • Suitability: check the scope of the investment powers under the scheme to ensure that investments will be suitable.

  • Non FSA investments: consider whether the manager will be able to invest in investments not covered by the Financial Services Act, for example land.

For further information, please contact commercial partner Andrew Crawford on e-mail [email protected]