The independent think tank, The New City Initiative (NCI), created to offer an independent, expert voice in the debate over the future of financial regulation, has published a paper on some of the regulatory issues expected to confront the asset management industry over the coming years and calls for changes to be made to better structure this regulation.
Commenting on the future regulation, Dominic Johnson, Chairman of New City Initiative, says: “Regulation must be sensible and it must be proportionate. Most importantly, it needs to serve the purpose for which it was intended; to protect all investors and guard against systemic risk. As currently proposed, this host of regulatory initiatives will likely prove detrimental to the former, and do nothing to mitigate against the latter.”
He continues: “It is all too often the case that regulations within the financial services industry end up doing the opposite of what they are supposed do – namely destroying competition and making the large firms larger. This not only potentially reduces returns to investors, but also increases risk in the financial system. Despite this, too much of tomorrow’s regulation appears to be heading in the same direction. Risk will be better managed and greater transparency achieved through changing how people ‘think and operate’ rather than through more inefficient regulation.”
The NCI’s research looks at the impact pending regulations are likely to have on the boutique asset management industry and makes a number of recommendations intended to ease the regulatory burden.
Looking at the AIFMD marketing rules, the NCI advocates the extension of the pan-EU AIFMD passport to more third country managers in a timely fashion. The NCI advocates that member states adopt a consistent approach to the rules surrounding marketing and that regulators clarify what is and what is not permissible under reverse solicitation.
In terms of the AIFMD Management Company “Manco” rules, the NCI advises its members to conduct rigorous operational due diligence on AIFMD Manco platforms prior to their appointment. For the AIFMD depositary rules, the NCI calls for the regulators in the EU to clarify whether they intend to extend the prohibition on depositary banks discharging liability to their sub-custodians as mandated under UCITS V to AIFMD, or at least to certain AIFMs.
Common Reporting Standard (CRS) or GATCA is also the focus of the NCI, which advises its members to leverage the expertise they have accrued through FATCA compliance and apply it to the OECD’s CRS. In addition, the NCI would advise managers to analyse the implications BEPS will have on their businesses, and if necessary, make plans on how to attain compliance. The NCI would also urge the OECD to issue guidance as to whether AIFMs will be designated as CIVs or non-CIVs.
Turning to Solvency II, the NCI advocates regulators rethink the capital charges being imposed on insurers’ underlying investments. The NCI advocates its members formulate a strategy to deal with the transparency obligations that will be associated with managing capital on behalf of insurers.
The NCI advocates in terms of Securities Financing Transaction Regulation (SFTR), that regulators learn from some of the challenges they faced during EMIR implementation, and apply them when they enact SFTR.
European Long Term Investment Funds (ELTIFs) are welcomed by the NCI as an innovative mechanism to help return more money into the real economy. In terms of Basel III, the NCI advocates that hedge fund managers think very carefully about how Basel III will impact their businesses and formulate a plan to mitigate the challenges.
Turning to the Financial Transaction Tax (FTT), the NCI advises regulators look at past experiences of FTT, most notably in Sweden, before it introduces a pan-EU FTT.
The organisation writes: “Nearly seven years after the financial crisis, regulators still do not appear to have acknowledged the differences between fund managers and banks, and as such are pursuing a regulatory agenda that many feel is damaging the fund management industry and its competitiveness – particularly for boutique asset managers.”
The NCI finds that a number of managers, who historically ran lean operations, have had to ramp up the number of hires in operations and compliance. “For some, the cost of doing business today has become excessively high, and this risks stifling the emergence and development of promising managers in what has historically been a highly competitive and innovative industry.”
The NCI finds that such an outcome reduces the availability of manager choice for investors at a time when returns are hard to come by. “For investors such as public sector pension plans – many of whom are running significant deficits – manager choice and diversity are central to generating returns for underlying shareholders.”
Further, the think tank believes that by preventing the development of smaller to mid-sized managers through excessive regulation, regulators risk forcing institutional investors to concentrate their assets into a handful of large portfolio managers rather than enabling them to diversify. “This could expose a number of high-profile institutional investors to increased levels of concentration risk. If one of those managers were to enter into a severe credit event, those investors could be seriously affected.”
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