Gerard Dique MCSI, Senior Compliance Officer at AXA Investment Managers Real Assets, outlines some important topical points
1. A perfect storm of fears for asset management jobs and profits
Daniel Garrod (Barclay’s analyst) is quoted as saying in a Financial Times article that UK fund managers face “a ‘triple whammy’ from reduced investment inflows, cuts in performance fees and reductions in their assets under management”. Following the Brexit (see full Brexit Article) vote, a number of listed UK fund companies are being hit hard by significant share price drops (Henderson and Jupiter dropped 21% and 18%). The article adds that the US asset management industry has also fallen (Invesco and Legg Mason saw share process fall 13.7% and 9.5%).
In the UK, the FCA is refocusing on asset management, aiming to establish whether competition is working in the fund management industry and whether investors are getting value for money, putting pressure on the industry to reduce fees. In addition, UK asset managers fear the overheads from unbundling of research costs under the revised Markets in Financial Instruments Directive (MiFID II) could wipe off 30% from fund houses profits. CRISIL Global Research and Analytics predict MiFID II’s unbundling provisions could reduce European and US asset managers’ profits between 17% to 29%.
On top of these there are pressures rising on active fund management performance (given the rise of passive index performance or robo-advisors against active asset managers). BI Intelligence fears that tech will take half of financial services jobs, noting that in regards to wealth management: “Robo-advisers are becoming more widespread, building and adjusting clients' investment portfolios instead of human managers, or in collaboration with them.”
This is not just a triple whammy but a perfect storm on asset management jobs and profitability. For larger asset managers there is now the added pain and cost of stress testing and higher capital requirements (see section 2 below). For small asset managers, survival not competition is the highest priority as the avalanche of regulatory rules, access to investors and technical advances is set to wipe them out over the coming years. With the significant costs of a deluge of regulatory rules and IT cost implementation (ie, MiFID II and European Market Infrastructure Regulation (EMIR)), asset management minnows might not survive, which is ironic given the FCA aims to enhance competition and outcomes for consumers.
2. FCA stresses asset managers
Post 2007, banks and insurance companies have had to deal with enhanced stress testing (which check that firms’ balance sheets can withstand material economic stresses) and meeting capital requirements, to make them more resilient and reduce systemic risk in financial markets. Asset management businesses have historically had low capital requirements and regulatory scrutiny. In June 2016 the Financial Stability Board (FSB) recommended to the G20 nations system-wide and individual stress testing of asset managers.
The FCA has now a much more focused and interventionist approach to asset management. In September 2016 it asked Aberdeen Asset Management (Europe’s third largest listed fund manager house) to increase the level of cash it held for regulatory purposes from £335m to £475m, to cover any “unsighted and unquantifiable risks”. This appears to suggest the FCA is upping the ante for oversight of the asset management sector (at least to firms which are big enough where there might be systemic risk). This follows last year’s rule amendments which stopped fund houses relying on insurance to cover unexpected losses, now requiring cash to be held to cover these costs.
It’s possible that one of the factors impacting on the FCA’s decision to raise the capital requirement for Aberdeen may have been that, following the Brexit vote, a number of UK funds (eg, Standard Life and Hendersons), including Aberdeen Asset Management, froze funds, stopping redemptions, because they did not have enough cash to pay investors wanting to leave these funds. Stress testing and capital requirements are here to stay for some asset managers.
3. The FCA’s aggressive approach to flexing its new competition law powers
The FCA gained additional competition powers on 1 April 2015, adding its objective to protect consumers and promote effective competition. While most asset managers have market abuse and insider dealing procedures and training, most are not so up-to-speed in regards to competition law in the UK. The FCA now has new competition staff of 90 people who are probing the asset management industry for anti-competitive practices. It has now begun its first Competition Act investigation, and has started to use its powers which include ‘dawn raids’, but also includes ‘softer’ measures such as ‘on notice letters’ (evidence of potential infringement relating to concerns identified but no formal investigation) or ‘advisory letters’ (educational and to increase awareness to achieve greater compliance). The Competition and Markets Authority (CMA) is the UK’s primary competition authority, but works concurrently with the FCA to enforce competition law in financial services (regulated and unregulated). The FCA has civil powers (sanctions include fines up to 10% of group wide turnover, damages, lengthy investigations), while personal criminal sanctions are carried out by the CMA (jail up to five years and an unlimited fine; 15 years disqualification for directors). The FCA is the only EU member state regulator with powers that extend beyond its conduct focus.
A number of asset managers in the industry have received on notice letters, which still require full investigation, review and response to the possible infringements. It’s clear the new FCA competition law team is looking out for cases that will ensure it remains busy and employed in the coming years. Regulated firms are subject to Principle 11 (open and co-operative with the FCA), with all the industry required to ‘self-report’ for significant infringements. There are also leniency and full immunity possibilities, which, given the potential hefty fines, firms will no doubt have to seriously consider. So for asset managers who have not considered competition law, it is now live and you will be expected to have procedures in place and train staff of the risks. The penalties for ignoring this could be nasty.
4. Asset managers move to Brexit-proof their funds
Economic forecasters at the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development and the Bank of England see significant impacts on growth. Sterling has fallen 20%, but, importantly, what are asset managers doing to combat the possibility of no access to the internal EU market (no passport, see Brexit article)? A lot of UK fund managers have bases in Luxembourg and/or Dublin for their mutual fund ranges, so in theory should still be able to sell these funds (Undertakings for Collective Investment in Transferable Securities) to the EU market.
However, it’s yet to be clarified if fund managers in London would be subject to some additional tougher rules (for example, Citigroup notes the EU could require investment management and support staff to be based in the country of domicile). M&G has begun already to set up a new range of Irish funds to sell to European investors.
For smaller asset managers without an EU presence but who require access to EU investors, Brexit potentially could prove very damaging unless a compromise in regards to access and passport rights can be agreed.
5. Investment Association – Statement of Principles now “non-binding”
In April 2015 the Investment Association (IA) proudly launched its Statement of Principles by chief Executive Daniel Godfrey, publishing a list of 25 initial signatories in August 2015. There was a mixed reception from the industry. The FT Adviser on 26 August 2016 noted while it was hailed by adviser-focused organisations, a number of fund groups opted out, citing it was too “prescriptive”.
The backlash saw the departure of Daniel Godfrey in October 2015, and the IA deciding in December 2015 to begin a “discussion period”. The IA’s website on 26 August 2016 confirmed the principles, which were perhaps not what individual firms found easy to articulate to their current values and existing or prospective clients, would now act as “a useful framework for firms when reviewing their values”.
I suspect the Principles have been launched when asset managers are struggling to keep their heads above the avalanche of regulatory rules (MiFID II, Solvency, EMIR), and when asset management firms are already subject to the FCA 11 Principles for Businesses. Another ten Principles, some of which overlap with current FCA requirements, was perhaps with hindsight optimistic to introduce at this time, let alone implement new requirements from a trade association. Sometimes you can have too much of a good thing.
6. Blockchain – what does it mean for asset managers?
The Financial Times recently asserted the belief that blockchain (the technology behind bitcoin, the controversial digital currency, “will cause huge disruption to how the fund industry operates, prompting significant changes to its business model”. Asset managers (including some UK fund managers) are considering using the technology to trade directly with one another, excluding the traditional broker middleman, thereby reducing costs and possibly eradicating the need for clearing and settlement. Given that asset managers (see previous articles) are under considerable pressure on their costs and profit margins, new technology that might reduce such costs is not to be taken lightly. In addition, given Brexit might impact on clearing and settlement activity in the UK (see Brexit article), this could again suggest that this new techy option will have a long-term future.
The jury is still out over the impact of blockchain in the asset management industry, but it’s an illustration of how technology is changing, and asset managers need to understand and take advantage of anything that will help reduce the ever increasing costs on their profit margins.
Views expressed in this article are those of the author alone and do not necessarily represent the views of the CISI.