The European Union’s third Capital Adequacy Directive (CAD 3) will distort profitability among European asset managers and force them to improve their risk management processes, a UK consultant predicts.

As it is currently drafted, CAD 3 will require European asset managers to hold significantly more capital, reducing profitability and prompting industry shakeouts, according to risk management consultants Mercer Oliver Wyman.

“If the present Basel II requirements are implemented, we estimate that the average European asset manager not deemed to be exempt would have to hold back around 10% of profits over the next three years to build up the minimum capital requirements,” said Thomas Garside, head of Mercer Oliver Wyman's finance and risk practice.

This will lead to a shake up of the European asset management industry. Asset managers falling under the CAD3 directive who do not form part of a larger banking group may choose to relocate outside the EU or be forced to rebuild their balance sheets.

The directive will also encourage the asset management industry to catch up with the banking and insurance industries by improving risk management practices. “There will be need for a significant upgrade in risk management practices in the asset management industry in general, as peer pressure from non-exempt players hits those without regulatory pressure to change. “ said Garside. “Asset managers will have to take a fresh look at how they perform risk management, including formalising processes for reducing everyday errors, using independent teams of experts to audit the mandate process and monitoring investment managers on a risk/return basis.”