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Today New City Initiative is comprised of 51 leading independent asset management firms from the UK and the Continent, managing approximately £400 billion and employing several thousand people.

The Next Reporting Challenge for Asset Managers

The Next Reporting Challenge for Asset Managers

ESG having once been an outlier issue for most asset managers, is becoming increasingly important, and it is a metric which more organisations are utilising in their portfolio construction processes. The primary motivations for applying ESG measurables in stock selection are the purported performance benefits it brings, investor pressure and growing regulatory intervention. As such, ESG is something which investment managers must understand and have a clear position on.

The regulatory drivers

While governments are actively pursuing green policies, regulators are not far behind. The EU recently announced that it would implement rules to help enable asset managers and institutional investors to incorporate ESG consistently into their decision making, adding their policies would need to be fully disclosed.  Similar provisions are already in play in France, where asset managers and investors over a certain size now have to document and publish how they apply ESG into their day to day operations, and disclose their carbon footprints

Simultaneously, the FSB launched its own voluntary climate financial risk reporting template - the Task Force on Climate Related Disclosures (TCFD) – which is being increasingly adopted by market participants. Disclosure obligations like the TCFD are not currently mandatory but a minority of institutional investors are beginning to request managers provide it. Meanwhile, the UN PRI has upped its game and threatened to de-list signatories which they do not believe are living by the PRI guidelines.

Performance benefits

Admittedly, the data evidencing that companies which score highly on ESG deliver better shareholder returns versus those that do not apply ESG, is mixed but the initial results do look promising, and should not be disregarded entirely. After all, a company which is not sustainable can hardly be described as being a solid long-term investment play in a political backdrop increasingly dominated by ESG concerns, and where agreements like UN SDG and COP21 are radically altering corporate behaviour.

Take plastics. An asset manager with exposure to a company heavily dependent on single-use plastics, must carefully consider that holding given the EU’s recent announcement that it intends to outlaw single use plastic utensils such as straws and cutlery. The same is true for managers with investments in heavy carbon emitting industries, as governments globally implement gradual bans on diesel vehicles. If companies do not have transition plans in place to deal with these challenges, then institutional investment will dry up.

Investors are also becoming more conscientious about where their returns are sourced from. Charities and religious endowments have long demanded that managers root out so called sin stocks from their portfolios such as companies linked to alcohol, firearms or tobacco, but such requests are now becoming far more mainstream. A lot of this is down to demographic change as younger investors appear to be more attuned with sustainable investing than previous generations, prompting reform at a number of institutions.

Asset management initiatives like documenting and monitoring internal carbon footprints are a potential starting point, whereas other firms – resources permitting – might even begin filling in the TCFD. Not only would this demonstrate resolve to ESG aware clients, but it could make it easier for firms to adhere to climate risk regulations and disclosure obligations as and when they are eventually introduced. 

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EU Cross-Border Marketing Proposals Fall Short

EU Cross-Border Marketing Proposals Fall Short

In 2015, New City Initiative (NCI) partnered with Open Europe and produced a paper – Asset Management in Europe: The Case for Reform – which acknowledged that despite the availability of passporting under the UCITS and AIFMD regimes, various impediments levied at a national level stifled the seamless cross-border distribution of EU-regulated fund products across member states.

These restrictions, NCI calculated, created 1.5 million euros of initial costs to a UK-based fund manager distributing across the EU-27 (plus Switzerland), and a further 1.4 million euros in on-going Annual maintenance costs. NCI notified EU and UK regulators about this anomaly and the detrimental impact it was having on boutiques raising EU funds at a time when Growing regulatory and operational requirements were eating into margins.

Shortly thereafter, it was announced the Capital Markets Union (CMU), an initiative welcomed by NCI at the time, contained among some of its policy objectives a commitment to make cross-border distribution of EU fund structures (AIFs, UCITS, ELTIFs, EUVECAs, EUSEFs) more efficient, by removing some of these national barriers and obstacles flagged by NCI among other industry bodies and associations.  

In March 2018, the European Commission (EC) came up with a set of proposals designed to expedite cross-border distribution of EU regulated fund products. To summarise, the proposals do not exactly tally with what NCI or other industry associations had in mind, mainly because they introduce even more obligations and complexities for firms marketing into the EU to deal with. Arguably, this is the exact opposite of what was being called for by the industry.

Nonetheless, there are some small wins for asset managers to take home, primarily around local regulatory costs and charges. A persistent irritation – and one that was outlined in NCI’s paperback in 2015 – was that home and host state regulators levied fees on AIFMs and UCITS during the authorisation and registration process, which were not homogenised, thereby discouraging EU funds from distributing beyond just a handful of markets.

A report on the CMU proposals by law firm William Fry said that while local regulators can still levy charges on AIFMs and UCITS during authorisations and registrations, these must be proportionate to the regulator’s own costs, and they must publish all fees and charges on their websites, and notify ESMA accordingly. The same report said that while this change was modest, it was welcome, a view shared by NCI.

Less welcome, however, is the EC’s stance on pre-marketing, a vaguely defined concept that allows firms to avoid notifying EU regulators and complying with AIFMD and UCITS while they make preliminary contact with investors provided they adhere to some very strict conditions. The lack of EU-wide standardisation has always meant that pre-marketing in one jurisdiction (i.e. the UK) may contradict the marketing rules in another country.

Having not previously demarcated where the boundaries for pre-marketing actually were, the EC has sought to instil some clarity under CMU for the benefit of its member states and fund managers. The EC said that pre-marketing was the “direct or indirect provision of information on investment strategies or investment ideas by an AIFM or on its behalf to professional investors domiciled or registered in the Union to test their interest in an AIF that is not yet established.”

In addition, pre-marketing does not allow managers to share draft prospectuses or offering documents with investors. This latter proposal is certainly more constraining than the existing approach taken in the UK where it is permissible under pre-marketing rules to share draft documentation with investors – provided prospects are not obliged to enter into a binding agreement afterwards.

In the short-term, the rules are likely to rile the UK, which takes a fairly tolerant attitude towards pre-marketing versus other constituents in the EU27, but its lasting impact may be felt elsewhere, especially among third country managers. Many non-EU firms (including UK managers post-Brexit) have expressed alarm that legitimate practices under reverse solicitation could well be outlawed under the new pre-marketing rules.

This leaves few options for third country managers looking to run EU money after Brexit. Firms can either comply with AIFMD and then build the appropriate infrastructure around it, or just assiduously study the pre-marketing rules being put forward by the EU and ensure they do not break them (i.e. do not market inside the EU period).

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Enabling Technology Change at Boutiques

Enabling Technology Change at Boutiques

Advancements in technology bring benefits, but boutique asset managers need to embrace change in a way that is considered and not impetuous. While fin-tech is an exciting premise, fund managers must ensure they do not get overwhelmed by the hype that some of these innovations have generated. This will require asset managers to be engaged on fin-tech matters, but equally pragmatic so as to reduce the risk of wasting money on products that deliver limited or zero value to their businesses and clients.

Finding the right use cases

Fin-tech innovations like Blockchain and AI offer a number of advantages, but asset managers need to be selective about how and where they integrate this technology into their organisations. Firstly, a lot of fin-techs have been established, some of whom are marketing products which are unsuited to the industry’s needs, or that solve a non-existent problem. Such providers need to be avoided.

Furthermore, not all inefficiencies within a business warrant a fin-tech intervention. Existing software providing automation can solve many of the current operational inefficiencies which are present across the industry. Spending money on fin-tech when it is untested and expensive is not a sound business judgement, so boutiques may want to wait until the technology becomes more commoditised and homogenised before adopting it.

Managing risk

The risks posed by innovative technologies to businesses are only now beginning to be understood. As such, human intervention is still necessitated when managing these new technologies. While a lot has been written about robotics removing jobs in the middle and back office, there will still need to be human oversight to check that the data being inserted into these AI programmes is accurate, alongside the trends that are identified by the software in order to spare fund houses from serious losses.

Ensuring technology is future-proofed against embryonic risks is also key. Take Blockchain, for example. Blockchain theoretically protects the data it holds through encryption and cryptography, but concerns are growing about how effective these defences will be as and when quantum computing enters the mainstream.[1] Highly-powerful quantum computers – if exploited by cyber-criminals – could unlock Blockchain’s encryptions thereby

undermining one of the technology’s chief selling points. 

Service provider risk is a serious issue for managers when working with fin-tech firms. While banks are cushioned by balance sheet capital, many fin-techs are reliant on VC or private investor funding, with a limited runway to achieve success. With fin-techs aggressively burning through these cash reserves, many are anticipating a consolidation of providers. As such, managers need to make sure they work with fin-techs which have a long-term strategy and strong balance sheets.

Not disregarding the rules

Regulators have been highly supportive of disruptive technology and are encouraging financial services to innovate, but abuses will not be tolerated. The big tech industry has been left rattled after data mismanagement was exposed at Facebook, and some financial services firms are understandably nervous about whether some of their own big data strategies could incur scrutiny.

As the General Data Protection Regulation (GDPR) becomes law later this year, innovations in big data need to be counterbalanced carefully with clients’ privacy rights, otherwise firms could be on the receiving end of some severe regulatory reproaches.  Adopting a strategy which puts client data at risk of being misused would be a very dangerous approach for any manager to take in the current political environment.

Don’t be afraid of the new competition

While boutiques should not prematurely implement innovative technology without a clear-cut strategy, they cannot afford to ignore the lurking competition which could potentially challenge the industry. The big tech companies are moving into financial services courtesy of open banking rules. Apple and Amazon already facilitate payments, while Facebook has obtained an electronic money license in Ireland.

Many of these big tech providers will also be monitoring developments at Yu’e Bao in China, a subsidiary of Alibaba which now operates one of the biggest money market funds in the world. These firms are undoubtedly identifying ways to tap into asset management to complement their existing services.

For boutiques to succeed in the future, they must be willing to face this new competition head on, and not bury their heads in the sand.  History has shown in many industries that large incumbents can struggle to deal with disruption if they move too slowly and focus on protecting their existing business.  Boutiques are smaller, nimbler and more innovative, giving them an excellent advantage.

 

[1] Global Custodian – Quantum computing threatens Blockchain security

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Reflections on NCI’s Blockchain Event of 28 March 2018

Reflections on NCI’s Blockchain Event of 28 March 2018

On 28 March 2018, New City Initiative (NCI) held a discussion and panel event on the topic of how Distributed Ledger Technology (DLT) and other technologies would likely affect the boutique asset management industry. In some of NCI’s recent policy papers we have explored the unique culture within small and medium-sized boutique asset managers: that culture promotes innovation and use of DLT is likely a trend that will advance rapidly in the industry.

The evening was structured as follows. Firstly, I gave a brief introductory presentation on DLT, including some usage cases across industries such as banking, insurance, music and public services. The common perception of DLT is its usage in Bitcoin, yet that is merely one usage case and moreover presupposes that public blockchains will dominate. The transformative effect runs more deeply and is likely not yet fully perceived, just as early use-cases of the internet in the late 1990s were not necessarily those that thrived: companies such as Amazon have used the internet as an enabler to drive changes in real-world businesses and, in my opinion, that is how the effect of DLT will ultimately be seen. This was followed by a panel discussion featuring three expert panellists: Liliana Reasor, who is CEO of SupraFin; Richard Maton, Partner at Aperio Strategy and Founder of the Financial Institution Innovation Network, and; Nick Bone, Founder and CEO of EquiChain.

Liliana talked about how the traditional IPO market can be disrupted by the processes used in Initial Coin Offerings (ICOs), transforming the operation of capital markets and empowering individual investors: SupraFin is a leader in this space. Nick commented on how DLT can be used to automate middle and back-office functions, but how there should be an awareness of vested interest in resisting change. Rather, investors may ultimately access securities and the custody chain directly, a usage case that EquiChain is developing. Richard commented on the need for changes in organizational culture and collaboration models to create and develop solutions that incorporate DLT and other technologies such as Artificial Intelligence (AI) and the capacity to be self-critical: by way of example, Kodak, Xerox and the like could not adapt, and perhaps actively avoided change; the result is self-evident.

Another interesting topic discussed was how DLT, and the security it can give, could allow emerging economies to leapfrog legacy economies, a process assisted by demographic change and a modern dependence on the state in Western countries. I walked away feeling excited about the future yet thinking that the asset management space, and financial services generally, will change rapidly in the face of technology: DLT intersects with AI and the increased data processing capabilities often called Big Data.

Panels such as these are a good opportunity to consider major changes in our industry and make us rethink certain assumptions. For instance, it may not be Brexit or regulation that turns out to be the biggest threat and opportunity to asset managers, but instead the adoption of disruptive technologies such as DLT and AI, amongst others.

Furthermore, the insightful questions from the industry audience put paid to the view that asset management is conservative and resistant to change; instead they demonstrated an appetite for innovation.

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Brexit - Still far from settled

Brexit - Still far from settled

To say the timing of AIMA’s (Alternative Investment Management Association) Global and Regulatory Policy Conference in Dublin was fortuitous is an understatement, happening less than one day after the UK and EU announced a conditional agreement for a transition or implementation period, potentially giving businesses an additional 21 months to finalise their Brexit planning. The word conditional here is very important because the transitional arrangement will only be formalised if the withdrawal treaty is fully agreed.

To summarise one AIMA attendee, "it is an agreement conditional on an agreement." Any number of issues could wreck UK-EU negotiations over the next 12 months including the future status of the Northern Ireland border; Spanish disagreement over Gibraltar; or even insistence from nationalistic Greeks that a Brexit transition be somehow linked to the immediate return of the Elgin Marbles (sadly not a joke).

If no withdrawal agreement is ratified, a Hard Brexit in March 2019 beckons. Despite all of the vainglorious media reports over the last 48 hours, it is very difficult to see what has actually changed. EU regulators – conscious of this misplaced optimism - have been at pains to stress that the risk of a no-deal is not a remote possibility, but something which organisations should still be actively provisioning for.

As such, fund managers must not over-analyse this relative thawing of Brexit negotiations, but should continue making preparations to ensure EU access – assuming they still want it – is still available to them following the UK’s departure. With delegation and reverse solicitation’s future both looking increasingly precarious in the AIFMD review, now is the time for firms to consider whether they create subsidiaries in the EU-27.

On the basis that there is unlikely to be any certainty around Brexit until early next year, the decision to relocate will have to be made blindly.  However, regulators at the AIMA event warned UK fund managers and banks that establishing shell companies inside the EU to game market access will not be tolerated post-Brexit. A number of EU regulators have also told managers that authorisations could take time if submissions all occur concurrently, and are recommending that firms send over their applications by mid-2018.

The other big risk for asset managers is fragmentation. Recent statements from EU regulators have been revealing. While fragmentation is not ideal, many EU regulators seem resigned to the fact it will happen, and have urged firms to plan for it.  For boutiques, this risks adding more costs to their operations if they are marketing into the UK and EU. Managers should start factoring these potential costs into their businesses, and build buffers accordingly.

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liquidity - avoiding a mismatch

liquidity - avoiding a mismatch

Liquidity – when markets are volatile – is a priceless commodity for fund managers to have, which is why UCITS’ products – for example - have seen strong, regularised inflows from investors globally.

However, some NCI members are warning that certain daily dealing products are at risk of facing a liquidity mismatch, causing significant damage to their reputations. UCITS’ brand strength is attributable to several factors, not least of which is the daily liquidity these funds provide clients. Nonetheless, there have been warnings that macroeconomic conditions – most notably in the fixed income market – could present liquidity challenges for UCITS managers running bond funds.

In 2016, Fitch issued a statement warning that 90% of UCITS running fixed income strategies were at risk of suffering a liquidity mismatch amid volatility in bond prices. While not a UCITS, a high-yield mutual fund in the US shuttered in 2016 after it failed to satisfy client redemption requests during the bond market volatility. Similar outcomes for UCITS cannot be ruled out if fixed income trading conditions take a turn for the worst.

The growth of alternative UCITS operated by hedge fund managers typically replicating their flagship products albeit under more regulated conditions is also a worry for some NCI members, mainly because they believe unsuitable or illiquid strategies are at risk of being distributed under the UCITS banner. If markets were to seize up, and redemptions grounded by one of these firms, the UCITS brand could be seriously undermined.

However, it is important to note that most hedge funds running UCITS will do so within the confines of the rules, while regulators are very proactive at flagging strategies down which they believe are unsuitable for the brand. Equally, esoteric or complex strategies should not be misinterpreted as being illiquid in nature. 

NCI members also expressed misgivings about the proliferation of daily dealing open-ended property funds. It was well documented that a handful of such funds were forced to temporarily suspend redemptions following the shock Brexit vote, and its immediate hit on UK property prices. Despite these funds having large cash reserves to satisfy redemptions in ordinary market conditions, these holdings are not always sufficient during periods of high volatility.

In extremis, firms could be forced to unwind property in fire-sales at uneconomic prices causing widespread losses for end clients. Even if a property fund was able to sell its underlying investments, it would be very difficult not to suspend redemptions as it is physically impossible to offload a building in a single day to a buyer. In response, some NCI members feel regulators should scrutinise the liquidity terms offered by daily dealing property funds.

NCI will produce a white paper exploring whether or not some fund types including alternative UCITS, daily dealing open-ended property funds and certain ETFs are at risk of facing a liquidity mismatch, a scenario which if played out would undoubtedly result in serious damage to the industry and its standing among investors. NCI will be consulting with its membership on this paper shortly.

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Blockchain and Boutiques

Blockchain and Boutiques

Having begun its life as a fairly unimposing piece of technological infrastructure supporting the then peripheral and arguably mysterious world of cryptocurrencies, Blockchain is now seen as being one of the biggest potential enablers of cost reduction and efficiency in financial services, including fund management.  

Blockchain or shared, immutable distributed ledger technology (DLT) is forecast to save the financial services industry approximately $110 billion in costs over the next three years, according to McKinsey, with cross-border B2B payments, trade finance, P2P payments, repo transactions, derivatives settlement, AML and KYC likely to be the areas targeted for streamlining and disintermediation.

Fund managers – at least in the short term – are likely to find Blockchain technology being increasingly used in client and regulatory reporting, corporate actions, proxy voting and automation of transactional processes in the distribution cycle. Over time, the use cases will expand with the technology – which can process transactions in real-time -  potentially disrupting clearing and settlement. The elimination of intermediary costs – certainly in the custody chain – will bring cost savings for managers which can be passed on to customers.

Boutique asset managers will not be omitted from the Blockchain revolution. Admittedly, most boutiques will not develop proprietary Blockchain solutions, mainly due to the initial costs of the R&D being too high, but also because service providers should do it for them, providing industry-wide solutions and infrastructure. As fiduciaries, however, fund managers have a responsibility to investors to mitigate operational risk, and this applies to how they use Blockchain.  

Interoperability: Getting it Right

System upgrades and transformations rarely go ahead without some form of inconvenience or impediment to the end client. The legacy technology supporting the fund management industry and their service providers can be antiquated, making it very difficult to introduce new systems without causing massive disruption. If Blockchain is to work, it must be able to operate with legacy infrastructure, which can be decades old.

This may require service providers to maintain their existing technology simultaneously to rolling out a Blockchain solution in parallel. A dual infrastructure should help avoid IT meltdowns as and when Blockchain becomes more customary in financial services, but the cost of running two systems may result in the industry and its customers being saddled with higher fees during that interim or transition period.  

Making a Complex Ecosystem More Unnavigable

Given the gravity around unwanted disclosure of confidential information and cyber-crime, most fund managers do not support the idea of a public Blockchain despite the efficiencies it will bring. As such, most service providers are developing private Blockchain solutions.

This has scope to exacerbate complexity in an already convoluted and crowded financial ecosystem, particularly if different Blockchain solutions cannot interoperate, or were fund managers to find themselves working across dozens of distinctive and arbitraging DLT interfaces. Rather than saving costs, this could potentially add to them. 

No Standards

Market-wide standards are essential as they help create uniformity across capital markets. SWIFT, for example, has played a vital role in setting the standards for payments and securities transactions across multiple geographies. Nothing of this sort exists for Blockchain although this is symptomatic of any technology’s early stage development and a reluctance among industry participants to impose prescriptive requirements at the expense of innovation.

Regulation of Blockchain is limited for similar reasons. Without some standardisation or regulation, Blockchain’s development is likely to be slightly staggered and uneven across markets, something which will make it harder for the fund management industry to fully embrace.

Secure or Not?

Cyber-security was found wanting in 2017 as a number of multinational organisations fell victim to sophisticated hacks. Information contained on a Blockchain is protected through encryption and cryptography, barriers which make it materially harder for hackers to breach, or so the theory goes.

Advances in technology have cast doubt as to whether Blockchain encryption is sufficiently capable of protecting client information against future threats such as those posed by quantum computers.  Quantum computing is an extraordinarily powerful, theoretical form of computational strength which could decipher or crack even the most sophisticated Blockchain encryptions and cryptography.  

If Blockchain providers do not take note of this potential risk, the technology may only be usable for a decade or less. It is critical for managers to pause before they consider Blockchain, and ensure the technology is future-proofed, otherwise they could end up spending significant sums on a short-lived concept vulnerable to new, unexplored risks.

Blockchain Bubble?

The highly speculative Bitcoin and Initial Coin Offering (ICO) mania which has swept the world over has alarmed some Blockchain providers. For several years, they have worked assiduously to disassociate themselves from Bitcoin, and the big fear now is that any sudden price rationalisation in cryptocurrencies could hurt a number of investors which in turn may sour (unfairly) the reputation of DLT.

Conversely, there is a Blockchain bubble in itself, namely an oversupply of providers, many of whom are hoping to capitalise on the technology’s popularity in financial services. Most Blockchain providers will fail and it is important managers work with established or credible organisations when implementing a DLT strategy to avoid any business disruption.  

The Best Approach

Blockchain will have a positive impact on asset management, but firms still have time to make a decision on how to apply it to their businesses. It is probable the larger asset managers that will embrace the technology initially, before it trickles down to the boutiques unless they collaborate. NCI is hosting a Blockchain seminar later this year for its members. Venue and details will be published shortly.  

 

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2018: Key Considerations for NCI Members

2018: Key Considerations for NCI Members

Mathematical economist Irving Fisher once confidently assured his followers that prosperity would be in a perpetual state, arguing that the stock market had reached “what looks like a permanently high plateau.” The only issue was that he made those comments in 1929 and three days later the stock market nosedived leading to the Great Depression. In short, making predictions is not for the faint-hearted, but New City Initiative (NCI) will have a go, looking at some of the key regulatory trends likely to impact asset management in 2018.

MiFID II

MiFID II will be EU-wide law on January 3, 2018, one year later than its original implementation date. For NCI members, MiFID II will introduce significant change, most notably in their ability to source sell-side research. Inducement bans mean research cannot simply be given to managers in exchange for equity commissions. Instead, the cost of research needs to be unbundled and managers must pay for it out of their own pocket.

Larger fund houses have confirmed they will pay for research out of their P&L, but smaller firms are likely to face more serious cost pressures. Most NCI members and asset managers generally are either paying for research directly out of their P&L; increasing management fees, or establishing separately funded research payment accounts (RPAs) in order to keep accessing sell-side research.

GDPR

GDPR imposes strict standards on data governance and protections across EU-wide companies including investment funds. Breaches of GDPR will lead to significant fines, and potential reputational damage and even client redemptions. Firms need to be preparing for the rules, identifying the location of any client data that they possess, in addition to obtaining consent from clients if customer data is used for purposes of analytics, distribution to third parties and marketing.

GDPR also lays out a framework for organisations to report data breaches, and requires firms with more than 250 people to appoint a chief data officer. For asset managers, GDPR needs to be a business priority in 2018.

SMCR

The Senior Managers & Certification Regime (SMCR) has been bedded down for more than a year now, although it currently applies only to banks and PRA regulated financial institutions. It will, however, be extended to asset managers in 2018. Its core demands are fairly uncontroversial with a number of organisations welcoming the regulation. Put simply, SMCR introduces prescribed responsibilities for senior managers, and subjects them to greater accountability when rules are breached.

David McNair Scott, CEO at Trailight, highlighted the biggest SMCR challenge for buy-side firms was around allocating responsibilities and functions to designated persons within an organisation. He added a number of asset managers had yet to systematise and document their SMCR processes, something which can be quite painstaking. McNair Scott also acknowledged that most of the contents of SMCR were proportionate and the FCA had sought to curtail any destabilising impacts on smaller managers.

AMMS Consequences will be felt

SMCR is only one part of the FCA’s efforts to heighten standards in asset management. The FCA’s AMMS was released in June 2017, and it was a report many in the industry considered to be fairly even-handed. Most significantly, the industry is not staring down at a Competition and Markets Authority (CMA) probe unlike the investment consultants. Overall, the AMMS is likely to bring about tougher standards and greater competitiveness in asset management.

One of the proposals being put forward is to require managers to independently assess whether they deliver value for money to clients, a process which will be overseen by an impartial board of directors who are all subject to the SMCR. This recommendation is a regulatory reaction to concerns that retail investors sometimes struggled to understand precisely what the objectives of their managers were.

The AMMS also led to the creation of the Institutional Disclosure Working Group (IDWG), a body looking at formulating a template to be provided to investors about cost disclosures across different segments of asset management. Anecdotal reports suggest the template will be detailed, which may be a problem for smaller asset managers, although many will probably outsource data aggregation to third party vendors. Creating a framework for transparency and competitiveness is certainly not a bad thing for asset management during this period of Brexit uncertainty.

And finally Brexit…..

At the time of writing, nearly all newspapers appear to give the impression that Brexit negotiations are finally making progress, as the UK confirmed a willingness to pay a substantial divorce bill to the EU. NCI members have repeatedly urged there be a transitional arrangement in place to enable its constituents and their clients to manage Brexit risk in a calm and composed manner.

A cliff-edge Brexit would be devastating for asset managers, leading to rushed decision-making, potential redemptions and possible relocations. NCI urges the government and the EU to minimise any instability in financial services that may come about through Brexit.

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Complacency is not an option

Complacency is not an option

 

Clarity about the UK-EU future relationship may be provided later this year, a full seven months after Article 50 of the Treaty of Lisbon was invoked by PM Theresa May, which ratified the start of Brexit talks. It is hoped the EU will sign off on a transitional arrangement for the UK in December 2017, a milestone which would significantly reduce the risk of a sudden, hard Brexit. 

A transitional agreement would allow impacted organisations such as fund managers, their staff and clients to accustom themselves gradually to the new UK-EU relationship, with limited disruption. A transitional agreement is fully supported by New City Initiative (NCI), as we believe it will provide essential stability in what could potentially be a highly uncertain process. The likelihood of a transitional arrangement may be assisted by the increasingly rational and pragmatic approach being taken by EU and UK negotiators, who realise that a traumatic Brexit could aggravate systemic risks and economic damage.

The key to any future UK-EU relationship has to be certainty. Even if the net outcome is poor, businesses need to know specifics in order to adapt. At present, there does not appear to be a tsunami of businesses moving operations into the EU. Many firms will probably retain a strong presence in the UK, while partially increasing their footprints on the continent. So far, financial services have not shifted operations into the EU at a pace or scale that many had envisaged following the referendum last year.  

UBS, for example, publicly said the number of staff likely to relocate into the EU post-Brexit would be far lower than initially forecast. Some attributed this to the absence of flexible employment laws in parts of the EU jostling for business. This business commitment, however, should not be taken for granted, as an absence of a transitional agreement and a lack of substantive progress on trade talks could force organisations to execute Brexit contingency plans. This could seriously threaten and impede the UK’s competitive edge over the next few years.

The Risk of Domestic Change

There are other risks to UK businesses not emanating from the EU, but rather domestic forces. The decision to hold an election in June 2017 cost incumbent PM May her majority and there is a very real possibility of a change in government prior to Brexit talks concluding.

This would lead to serious disruption in the Brexit negotiation process, particularly if there was a material change in policies and priorities put forward by an incoming regime. This could result in delays to Brexit and further uncertainty at a critical point. 

Domestic policies by any new government could also exacerbate business disruption. The opposition Labour Party, which many believe could win the next election, has made a number of statements – which if implemented - would seriously impact financial services. These have included calls for an introduction of a Financial Transaction Tax (FTT) and mandatory nationalisation policies. The Shadow Chancellor of the Exchequer also suggested capital controls could be implemented in the event of capital flight.

If such events transpired and domestic policies became hostile to free enterprise and financial services, there is a very real risk businesses that had once remained committed to the UK after Brexit may leave on their own volition, either for the EU, North America or APAC.  Several industry experts have said that Brexit is manageable, but the spectre of FTT or capital controls unleashed by a government unreceptive to free markets could prompt a number of organisations to hoist business from the UK.

NCI is engaging with its members and external service providers about how they would react to the possible introduction of forced nationalisations, the imposition of capital controls and an FTT. This will form the basis of a research paper being produced over the course of the next few months looking at what these potential policies could mean for financial services and most importantly, its customers, and how the industry can best prepare themselves.

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ESMA Delegation

ESMA Delegation

The simplicity by which an AIF or UCITS can structure itself in an onshore EU market (Luxembourg, Ireland, Malta) and delegate the running of its portfolio and oversight of risk management back to the manager in a third country is a fundamental reason as to why both of these brands have enjoyed considerable popular appeal and global success.

Put simply, delegation is a cost-effective way of getting an AIFM or UCITS running without having to invest in onshore physical infrastructure. That the European Securities and Markets Authority (ESMA) is potentially calling into question this existing set-up should alarm not just UK asset managers, but investment firms all over the world.

Brexit is obviously the impetus behind ESMA’s proposals. It is no secret that some of the EU 27 have been trying to capitalise on the uncertainty in the UK to attract business into their domestic markets. ESMA has repeatedly warned these countries that standards cannot be loosened otherwise it risks creating regulatory divergences.

The regulator has also warned UK financial institutions against setting up letterbox entities in the EU 27 as a tool by which to continue passporting cross-border. The funds’ industry opposes the creation of letterbox entities, but the present regulatory structure in major onshore European fund domiciles around delegation is mature and substantive, a point made by industry groups including the Association of the Luxembourg Fund Industry (ALFI).

Some of the core proposals include forcing managers to appoint at least three people in their EU fund domicile, and it is also very probable that delegated activities will be subject to even more regulatory scrutiny. This will inevitably bring added costs and requirements to the funds world, eating into the revenues and returns of boutique asset management providers.

The cost of running an AIFM and UCITS – with its existing depositary and reporting obligations – is high, and many boutiques could end up shunning both brands, particularly if their European flows are small relative to other markets. In short, this protectionist measure would immediately reduce European investor access to boutique providers as non-EU firms look to distribute their fund vehicles elsewhere, and outside of the EU’s regulatory oversight.

UCITS has had a stranglehold on APAC and Latin American markets for quite a few years now. At a recent ALFI Conference in Luxembourg, financial services professionals from APAC and Latin America spoke extensively about their own various regional fund passporting initiatives. If delegation is scrapped or impeded, a manager in Sao Paolo or Hong Kong will likely pivot towards a regional fund passporting solution as opposed to UCITS.

Financial services regulators that comprise ESMA often applauded the UK’s Financial Conduct Authority’s (FCA) contributions to policy discussions, acknowledging that it curtailed some of the worst excesses of protectionist rulemaking in favour of free market thinking. With the FCA's role within ESMA much diminished now as a consequence of Brexit, the risk of protectionist market initiatives such as the restrictions around delegation have risen and UK firms need to keep a close eye on developments.

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