Keeping pace with the regulators

Increased regulation at both national and international levels has been a feature of the funds landscape for the past decade. At least part of the reason for this was the fallout from the financial crash of 2008 which led to calls for greater protections for investors as well as for new approaches to risk management and increased transparency in terms of fees and product structures.

Regulators were quick to respond, and their actions have been seen as broadly positive by the industry. “Changes to implement new product initiatives are always welcomed by both the funds industry and investors as they provide more flexibility and a new range of products to invest in and generally do not result in higher costs,”says Gayle Bowen, investment funds partner and head of office, at Pinsent Masons Dublin.

“In my experience, investors demand higher transparency and measures designed to enhance investor protection from asset managers,” she adds. “This is why Irish funds are so popular, as they are heavily regulated. Managers generally respond to this demand from investors even before it is provided for in legislation.”

According to Paul Ellis, global head of regulatory product development with HSBC Securities Services, the most significant piece of regulatory change to affect the sector in recent times was the implementation of the second generation of Europe's markets in financial instruments directive, commonly referred to as MiFID II, in January 2018.

Regulators also took significant steps to improve investor protection in Ucits and non-Ucits compliant funds, based on learning from material adverse events deriving from the financial crisis, Ellis notes. “There is more to come too. New requirements are emerging in 2019 and beyond for money market fund managers and funds using securities financing transactions – for example securities lending transactions, as well as new strict mandatory buy-in obligations for failed trades.”

Supervisory engagement

Niamh Mulholland, head of asset management regulation with KPMG in Ireland, agrees. "For the asset management sector, the transition from a period of adoption of new post-financial crisis regulatory and legislative measures to a period of implementation is set to continue in 2019," she says. "This is likely to see an increased level of supervisory engagement by the Central Bank of Ireland (CBI), as they seek to assess how firms have implemented and embedded recent regulatory changes within their operations and governance. These interactions were a key feature of the second half of 2018, in key areas such as MiFID II, Ucits performance fees and the Investor Money Regulations and the CBI has indicated that this is likely to continue by means of thematic reviews, targeted inspections and data analytics in 2019."

A relatively new area to come in for the attention of the regulators is environmental, social and governance (ESG) investing. “Until recently, sustainable investing was considered a matter of asset manager discretion and investor preferences,” says Mulholland. “However, sustainable finance has now become a regulatory imperative, with initiatives relating to environmental, social and governance factors and socially responsible investing have been an increased amount of investor interest and regulatory support in several countries.”

She points out that the European Securities and Markets Authority (ESMA) recently published a consultation paper containing its proposals to the European Commission for the future amendment of the AIFMD and Ucits directive in order to integrate into the investment decision process a consideration of sustainability risks when selecting, monitoring and understanding the investments a fund management company makes.

“ESMA’s final advice is to be delivered to the commission by April 30th, 2019,” says Mulholland. “Further, on January 4th, the European Commission published draft rules as to how investment firms and insurance distributors should take sustainability issues into account when providing advice to their clients. These measures form part of the broader Sustainable Finance Action Plan which is part of Europe’s Capital Markets Union’s (CMU) efforts to connect finance with the specific needs of the European economy.”

Impact on fees

There can be negative aspects to regulatory reform, however. “Regulatory changes can have a significant impact on fees and can be expensive to implement, as they can require the hiring of new staff to implement and monitor the changes, new technology and systems, higher liability, and so on”, says Gayle Bowen. “Both investors and fund managers will therefore judge the value of reforms by assessing them against the benefits they provide. If this is not proportionate, the changes will not be welcomed, even by the investors that they are seeking to protect. It is estimated that regulatory compliance costs will double over the next five years, which could have a material impact on returns.”

Separate to costs, another issue causing concern among fund managers is the increasing volume of regulatory changes all happening at the same time and a shortening of the implementation timeline for them, Bowen adds. “Financial services legislation can be difficult to implement and agree at EU level, as a result, what often happens is high-level principles are agreed with an agreed implementation date, however, it can be difficult to finalise the details. As a general rule, managers were given 12 months to prepare for and implement significant legislation. When AIFMD came into effect back in 2013, the more detailed regulations were only finally agreed at EU level six months before the implementation date. As this was generally considered too short a timeframe to implement all of its provisions, most local regulators granted a further 12-month grandfathering period to give managers enough time to implement.”

HSBC’s Ellis believes the industry has risen to the challenge presented by the increased burden of regulation. “All told, the industry in Ireland has responded well to the changing regulatory landscape,” he says. “The volume of regulatory change implemented since the financial crisis has been without precedent. It is probably true to say that the industry has never been so well-regulated and that arguably the cost of compliance is such that it raises barriers to entry for smaller players. However, the industry here in Ireland is now at a maturity level that naturally coalesces with that fact.”