Improving governance within family offices

Written by: Dominic Dudley Posted: 02/03/2020

familyOffices illoThey are an increasingly prominent part of the wealth management sector, but family offices can also be secretive entities – and they face some very particular governance risks

One of the big growth areas of the financial services industry in recent years has been the rise of family offices. These private wealth management firms now hold an estimated $5.9trn of assets under management, according to Campden Research, and the number of firms grew by 38% between 2017 and 2019. 

It’s hard to know how many have a base in the Channel Islands. Many prefer to remain under the radar and, in the case of single-family offices (SFOs), there are often very limited regulatory requirements – although multiple family offices (MFOs), which deal with the assets of several families, are subject to greater oversight. 

Jersey and Guernsey are keen to attract more of both, however, promising financial and political stability and an extensive range of professional services for any wanting to base themselves on either island.

As the sector expands, it is being subjected to less welcome attention too. A recent survey of family offices by Swiss bank UBS found at least 20% had been targeted by cyber security attacks, including phishing, malware and ransomware attacks. The true figure may be even higher, the report suggested – ‘Cyber operations are often covert, leaving a proportion of victims unaware of the assault on their systems’.

Other governance risks are at play too, not least because family offices differ from traditional financial structures. For one thing, personality and emotion can be a bigger factor in how they are run, and every new generation that comes of age can throw up even more issues – something evident in Germany, where the battle between members of the Albrecht family, heirs to the Aldi supermarket fortune, has played out in the courts and the media.

“For family offices, it all comes down to relationships with people,” says Alison Parry, Head of Private Wealth at Intertrust Guernsey. “It’s less of a business and more about family dynamics. You have people who are emotionally invested. You’re talking about money, family, business. You’ve got personal goals as well as collective goals. There is the ability to be hugely successful or for it to go wrong; there are both extremes.”

Word of mouth

The nature of a family-run enterprise means it may also rely on more informal decision-making, with more agreed verbally and less written down. That, in turn, can make it harder to share information around.

Heath Martorella, Head of Family Office at Bellerive Trust, says key governance risks and failings include “poor communication between the family office and family members and the need to educate family members on the family office’s activities”.

A strong approach to dealing with many of these issues is to add a dose of formality to the proceedings – by setting out a clearly defined corporate governance structure, with statements on investment principles as well as the mission and values the family wants to pursue. However, these shouldn’t be so strict that they become a hindrance over time – something that is not always easy to get right.

“Generally, we find with family offices that you need to have strong corporate governance in place that’s going to provide a flexible approach so it will survive through multiple generations,” says Parry.

“The governance standards provide the code under which a family interacts with each other with regards to business. The establishment of that code can be very difficult to get agreement to from the various family members. We see the problem quite a lot.”

The difficulty in setting out clear rules of engagement may be the reason why so many family offices fail to do so. The UBS survey found some notable gaps, with 74% of family offices having investment guidelines in place and just 54% having mission statements.

No two families are the same, so there are no firm rules about the nature of a good corporate governance structure, but formulating one is almost always a good idea.

“Families come in all shapes and sizes and it follows that there’s no ‘one size fits all’ approach when it comes to establishing an effective governance framework,” says James Campbell, a Partner at Ogier. “Nonetheless, early investment in an effective governance structure is likely to pay dividends. Weak governance standards can be disastrous.”

Martorella agrees, adding: “The family and its family office should be aligned around a shared objective – for example, to multiply wealth, manage succession or philanthropy. A shared objective will then drive the family office’s spending rules and the investment management policy to support it. This leads to more effective, longer-term investment decisions.”

Families also change over time, so an exit strategy can be a good thing. “We’ve had situations where family offices have gone for three generations and at that third generation, the decision among all parties has been to split the assets into individual ‘family offices’ for each branch of the family,” says Parry.

“When you get to that third generation, you really do need to have the flexibility to start moving it out and evolve with the future business and family strategies.”

When founders flounder

Another critical element in the family business world is personnel. The initial wealth often comes from an entrepreneur building up a family business. But having the nous to establish and successfully run a company does not always mean they will also be good at running their own wealth management operation.

“The classic problem for a founder is the difference between running a family business and running a family office – and not really understanding the differences,” says Geoff Cook, an independent Director based in Jersey.

familyOffices illo“The risk is that, if they’ve run a family business very successfully, they think those skills are immediately transferable and they can also run a family office successfully.

“Most will probably make a fantastic contribution because they’re probably very able people, but it’d be rare for all the necessary skills to be wrapped up in one person: the legal capability, the tax advisory capability, the regulatory capability, the investment management insights, the technology knowledge. You’re not going to wrap that up in one, two or three people.”

One solution to this tripwire is to bring in a wider range of expertise, with a board including effective non-executive directors and, more broadly, a board structure in which no single voice dominates to the exclusion of others.

“Increasingly these days, the more sophisticated family offices will bring independent directors onto their governance boards,” says Cook.

That also makes it easier to cope when the founding patriarch or matriarch is no longer around. “The death of the founder can be a pivotal moment,” says Campbell.

“If the family office has not planned for the future and interposed an effective governance framework, there may well be family discord and, with no governance framework in place, there will be no effective means by which the family can make decisions on key issues.

“The consequences here can be dire – loss of investment opportunities and ultimately the family office breaking apart. Long-term forward planning is absolutely key and there needs to be an appropriate focus on succession planning.”

But that’s not always an easy thing for the individual concerned to wrap their head around. “Many founders cannot envisage anyone other than themselves taking key decisions, and simply avoid making these fundamental changes,” adds Campbell. “Likewise, many founders find it difficult to prefer one child over another.”

If the leading family member can face up to such decisions, however, it will be easier for the family office as a whole to continue successfully. 

Adapting to change

In essence, it all comes down to sensible forward planning. Adopting that principle also makes it easier to adapt to the changing demands of family members. Generations will come through with new priorities – whether that involves differing attitudes to work/life balance or a call for more ethical investments that take into account environmental and social issues.

“As the younger generation comes through, it’s got different interests. It doesn’t have the same emotional connection to the origination of the wealth, because it hasn’t worked in the business that made it. That can create real tensions,” says Cook.

How often things go wrong is all but impossible to know. Public rows such as the Albrechts’ bickering are rare. “By their nature, family offices, particularly SFOs, likely resolve any disputes confidentially and internally,” says Martorella.

In addition, in many jurisdictions where family offices choose to base themselves, the opportunity for people to alert the authorities or the public when things are going wrong can often be limited, not least in the Channel Islands, where there is no statutory protection for whistleblowers. 

“As premier international finance centres, it is an area that the islands might wish to explore at some point,” says Martorella.

“However, as many family office services are provided by regulated industry providers, such as trustees, investment managers and so on, the risk of extremely serious breaches is very low, barring serious misconduct or flagrant collaboration between parties. In these situations, the ability for individuals to whistleblow – with legal protection – could act as a useful deterrent.”

In the longer term, if the many unusual governance risks facing family offices can be properly managed, they have a better chance of success. “A family office with a good governance structure is much more likely to give better returns because it will be better run and better managed,” says Cook. 

“If you’re laissez-faire, not very organised and not very structured, you’re almost certainly going to get poorer investment returns.” 

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