Change: Buy-side asset managers – regulatory developments June 2016

Gerard Dique MCSI, Senior Compliance Officer at AXA Investment Managers Real Assets, outlines some important topical points

1. The EU Referendum’s impact on asset management

This has polarised the public, politicians, economists – and buy-side asset management.

Scenario 1 (Brexit)

In a report in the Financial Times (FT) in February, Terry Smith, currently CEO of Fundsmith (but previously CEO of Collins Stewart), is quoted: “Most of the arguments for staying in the EU are either facile or [play on fears that] if we leave, we won’t be able to trade with Europe on the same terms. I think this is utter garbage”. Smith is one of a number of outspoken city investors supporting a British exit, seeing a better future outside the EU. Crispin Odey (hedge fund manager), and Helena Morrisey, CEO of Newton Asset Management, are also those who argue Britain’s economic interests would be better suited outside the EU.

Scenario 2 (Bremain)

A vote to leave will trigger at least a two-year renegotiation with the EU, and instability. The UK will need to set up trade agreements with the rest of the world. This will instigate a period of uncertainty and may impact adversely on investment in the UK. A report by the FT in February highlighted a less optimistic view. “European investors account for more than a fifth of the £5.5tn assets in the UK investment industry … In the worst-case scenario, UK-based fund managers could be stripped of access to EU investors ‘overnight’ [which would be] ‘profoundly negative for the export of UK asset management services’.”  

The article references a report by Morgan Stanley (which arguably represents the majority of bank and insurance companies’ Referendum views): “Investors assume if Britain were to leave the UK, a deal would be struck allowing investment management to be delegated back to the UK … [But analysts at Morgan Stanley believe] the chances of a ‘friendly split’ in which the UK maintains full access to the single market are low.”

Comment. As someone who studied economics at university, where there can be extreme and unrealistic assumptions, I suspect the reality of the impact of a Brexit will likely be a middle ground between the extreme views of the optimists, who see blue skies and a clear path to freedom from the dark side of EU injustice, as well as increased profits, wealth and political freedom; and the pessimists who see five years of instability, under-investment, recession, inflation, possible EU disintegration and political and economic isolation, with likely UK and possibly worldwide recession. We will find out which camp wins following the vote on 23 June, but I suspect the divorce analogy may be apt. Given that Article 50 of the Lisbon Treaty states that when agreeing a new deal, the EU acts without the involvement of the country that is leaving, and requires unanimous agreement of EU member states, it is unlikely to be a dream deal for the UK. The Economist expands on the divorce analogy: “Imagine a divorce demanded unilaterally by one partner, the terms of which are fixed unilaterally by the other. It is a process that is likely to be neither harmonious nor quick – nor to yield a result that is favourable to Britain.” But the good thing is we will have our sovereignty.

2. The fund management industry fees probe

In November the Financial Conduct Authority (FCA) announced its competition review terms of reference market study, assessing:

  • how asset managers compete to deliver value
  • whether asset managers are motivated and able to control costs along the value chain
  • what effect investment consultants have on competition for institutional asset management.

Christopher Woollard (Director of Strategy and Competition at the FCA) confirmed the UK as Europe’s largest asset management market, with around £6.6tn invested. The FCA said it would be scrutinising several aspects of how fund managers operate, including charges it levies on investors which could have a “large impact on investors’ returns”. The Irish regulator is also carrying out its own probe into fees, as high fees for active asset management are charged despite some closely following an index (known as ‘closet tracking’). Norway and Sweden are also reportedly increasing their scrutiny and investigating closet tracking.

FT Pensions Correspondent, Josephine Cumbo, noted that Daniel Godfrey, former CEO of the Investment Association, was ousted after pushing for greater transparency on fees and charges borne by investors. It is clear the FCA has focused on this issue as part of its competition agenda, so it needs to be monitored closely by the buy-side asset managers in the UK, Ireland and, increasingly, other jurisdictions.

Comment. Asset managers should review their own fee structures as well as the closet tracking issue, since investor transparency for services provided is not going away.

3. Fund managers – the FCA’s areas of concern

David Lawton, Director of Markets, Policy and International at the FCA, delivered a speech in March at The 9th Financial Risk International Forum in Paris, talking about the systematic risk posed by investment funds to the financial system.

He reminded delegates that after 2008, the world focused on the systemic risks from large global banking groups. However, he confirmed he had been looking as other sectors “intensified around the role of asset managers, and others controlling private pools of capital for investment purposes, including funds and collective investment vehicles as separate legal entities (the potential non-bank, non-insurer global systemically important financial institutions – G-SIFIs)”.

He said: “The International Monetary Fund estimates that the asset management industry intermediates assets amounting to $76tn – 40% of global financial assets in 2015; and there has been a significant increase in investment in mutual funds and other open-ended fund vehicles in recent years. ICI Global reported in 2014 that the global mutual fund industry’s assets had grown more than sevenfold in the last two decades.”

Lawton also confirmed regulators’ concerns about the high-profile failings of investment funds, like Long Term Capital Management in 1998 and the recent closure of Third Avenue’s Focused Credit Fund. The FT’s Madison Marriage has said that regulators would have noticed (and likely encouraged) that BlackRock and Amundi are among a dozen investment houses that last year confirmed they had established new credit lines or increased existing facilities to help deal with outflows if investors all tried to sell up at once.

A third concern was the large and growing investment in collective investment schemes, including by retail participants. Specific risks Lawton outlined (but about which more detail can be found in the full FCA speech) include:

  • the possible mismatch between the liquidity of fund investments on the one hand and the terms and conditions for the redemption of fund units on the other
  • the high levels of leverage within (certain) investment funds
  • the operational risk challenges in transferring investment mandates from a fund manager in a stressed condition to another manager
  • the securities lending activities of asset managers and funds
  • the potential vulnerabilities of pension funds and sovereign wealth funds.
Lawton did acknowledge that banking and asset management differed, where imposing additional capital requirements would impose costs on investors (fund investors) without a material benefit. Further analysis was required but large and medium asset managers need to keep an eye on this issue.

4. Asset management firms could be forced to double capital requirements

Just when asset managers thought they were getting enough capital requirements oversight, Dylan Loo’s alarming Citywire article asserts: “Just under half of investment firms could be forced to hold double their capital requirements, according to research from KPMG.”

The KPMG report, Right from the start, studied responses and mandatory internal capital adequacy assessment process (ICAAP) documents from 32 firms.

Dylan says insurance mitigation and diversification are popular methods employed by investment firms to reduce significantly their capital requirements. In 2015, 42% of firms used one of these methods, while 25% used both methods to reduce their capital requirements by an average of 56%.

The study points out the FCA has raised the bar on how firms can apply insurance mitigation. If regulators disallow both a firm's insurance mitigation and diversification benefits alone to fill the gap, Dylan suggests firms could be forced to hold double the amount of capital they originally calculated. Across all prudential categories, the average additional capital is £30m, and for larger firms this can rise to as much as £54m.   

To meet these higher capital requirements, firms could be forced to dip into retained profits and their dividend pool, KPMG said.

This could have major implications for investment firms.

“Being forced to hold higher levels of capital is bad news now more than ever for investment firms. Firms could be missing out on a huge market opportunity in front of them,” said KPMG investment management partner David Yim.  

Basic errors or poor articulation in ICAAP submissions to the FCA can have substantial consequences.

Comment. Firms therefore need to reassess their ICAAPs, review if insurance is a factor, and ensure operations risk assessments are fed into the updated ICAAPs.


It’s mid-year, and suddenly the Markets in Financial Instruments Directive II (MiFID II) extension is looming ever closer for buy-side asset managers.

Transaction reporting

This is a serious issue, both in scope and building the systems and controls to provide the data. The Trade News (8 April 2016) reported in April that BlackRock, Citadel and Amundi have demanded further clarity on the reporting of certain transactions (eg, cleared derivatives trades). “We would appreciate confirmation that for exchange traded derivatives and cleared trades, we do not need to report the trade with the executing broker if it is given up to the clearing member on trade data,” BlackRock said.

Similarly, Citadel requested further guidance from The European Securities and Markets Authority (ESMA) on how to report cleared over-the-counter derivatives, such as interest rate swaps. Given firms have to build systems and controls to meet the demanding MiFID II requirements, they are anxious to clarify, and, where possible, simplify the transaction reporting requirements, and time is running out. If not resolved, could this result in another extension?

The European Parliament has now approved the one-year implementation delay to MiFID II, which will come into effect in January 2018.

Research (unbundling) – how will research be paid under MiFID II?

Proposals to unbundle payments for investment research from trading commissions are a key part of MiFID II. By forcing brokers/asset managers to price and charge for services separately, the aim is to increase transparency and accountability, and achieve both best execution and best research. European investment managers will be required to implement the changes on a global basis when they take effect in January 2018.

The FT in May claimed that 25% of asset managers will stop charging clients for research they may use for investment decisions (according to a poll of 100 asset managers by EY). Instead of passing on the cost to the investor, 26% would rather pay for the research themselves.

Those who choose to charge for the research need to budget the cost of research in advance and make clear to investors what they are being charged for (ie, increased investor transparency). The FT article notes passing costs on to investors will become increasingly “difficult to justify” if rivals pay for research themselves. Challenging times indeed for buy-side asset managers under MiFID II.

6. What other regulatory buy-side asset manager issues should you be aware of?

Executive pay

Banker CEOs are not the only sector that has received increasing oversight from shareholders. The FT in May noted that 75,000 people signed a petition urging BlackRock to review excessive remuneration, where compensation may be disconnected to performance. This greater scrutiny may also make a few highly paid asset managers feel nervous, given they could also be seen as being overpaid in an environment where investment returns have not been stellar, cascading down to the pay of middle managers. This trend may well become a financial services theme, given returns for investors have been challenging, while remuneration at CEO and manager level has not reflected this. There are also Undertakings for Collective Investment in Transferable Securities (UCITS) conditions for senior managers to consider.

Market Abuse Directive II

Don’t forget that the second Market Abuse Directive (MAD II) is here and has not been deferred until MiFID II comes into force. The FCA’s May 2016 Regulation round-up reminds us that the new MAR regime is coming into force on 3 July 2016 (see Implementation of the Market Abuse Direction). Norton Rose Fulbright’s March 2016 update provides a handy reminder of areas asset managers need to concern themselves with:

  1. managing insider information (the definition has been broadened and a new market soundings regime has been introduced)
  2. algorithmic trading and manipulation
  3. detecting and reporting suspicious orders and transactions
  4. investment research
  5. whistleblowing.


This continues to be a hot topic for the FCA, so ensure you have reviewed and monitored all material outsourcing arrangements, checked all legal agreements are in place, and that service level agreements and key performance indicators are up-to-date, with appropriate management information escalated up to the business and compliance governance committees.

Cyber crime/technology

The FCA Business Plan (2016/17) is always worth reading. Technology is ever changing and aids innovation and competitiveness, but the FCA stresses “it also creates risks, including for operational resilience, cybercrime, protection of information and financial exclusion. Firms need to focus on both infrastructure and culture to ensure that new technologies benefit both consumers and markets”. Systems and controls weaknesses, lack of expertise and increasing cyber attacks (posing risks to consumers and markets) are relevant for both new entrants as well as firms with legacy systems. So firms need to ensure defence, business continuity plans and operational resilience risks have been considered and mitigated.

Culture and governance

The FCA in its Business Plan has also highlighted a firms’ culture and governance “as one of our seven priorities because experience has demonstrated that poor culture and poor conduct are closely related”. Certainly the biggest FCA regulatory fines in 2015 in relation to the London interbank offered rate (LIBOR) and FX (Barclays fined £284m for failing to control business practices), stressed the importance of culture. Georgina Philippou, Chief Operating Officer at the FCA, said: "This is another example of a firm allowing unacceptable practices to flourish on the trading floor. Instead of addressing the obvious risks associated with its business, Barclays allowed a culture to develop which put the firm’s interests ahead of those of its clients and which undermined the reputation and integrity of the UK financial system. Firms should scrutinise their own systems and cultures to ensure that they make good on their promises to deliver change." 

These comments still apply. Asset managers with weak culture and governance should be aware the FCA will bring firms to task if they don’t take this seriously. 

Opinions expressed in this article are personal to the writer so should not be interpreted as being those of the CISI or anyone else.
Published: 16 Jun 2016
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