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Impact Investing

IPE special report May 2018

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Regulation: Scrutiny pushing up costs

Brian Bollen looks at a securities services industry finally experiencing a respite from a decade-long regulatory onslaught which has increased costs for all participants 

At a glance 

• The investment industry and its service providers have welcomed the postponement of MiFID II.
• It is recognised that new regulations entail additional costs.
• There are concerns about new rules for alternative investment managers and pan-European mutual funds.
• Asia looks set to be the next big venue for the automation of investment processes. 

Securities services providers and their clients are calling for a halt to the piling of regulation upon regulation. The recent European Union decision to postpone the implementation of the second Markets in Financial Instruments Directive (MiFID II) would suggest there is merit in their case. 

There is little doubt that the investment industry and its service providers have welcomed the delays, which means implementation will now take place in January 2018. “This is a more realistic timetable for EU members states to transpose the regulation into local law and for the financial services industry including securities service providers to implement the new requirements and build the required infrastructure,” says Sven Kasper, EMEA head of regulatory, industry and government affairs at State Street.

 “Many in the industry breathed a sigh of relief on receiving that news, but there is still more regulation on the horizon,” adds Ann Doherty,  managing director of EMEA investor services at JP Morgan. “We are currently tracking no fewer than 29 major initiatives affecting the UK and Europe alone, but in recent years have become very adept at dealing with regulatory change.”

Another industry specialist turns the spotlight away from the quantity of regulation to its impact on profit and loss: “Every new regulation comes with a cost, and we must all ask whether the expected benefits to be obtained are worth that additional cost,” they say. 

Paul North, head of product management for EMEA, asset servicing, BNY Mellon, calculates that regulation is one of the largest costs to financial services companies this year and next, although he believes it will stabilise in 2018. The costs might have been mitigated had regulators not been under pressure to make the industry more transparent and better governed, suggests another expert. “If regulators could have eased the pace, harmonised the various regulations at source at an OECD level, we could perhaps have created and delivered standardised, cost-effective solutions rather than customised ones which are possibly less efficient and more expensive,” they added.

“Aren’t we regulated enough already?” is a recurring theme, heard most audibly at a roadshow hosted by Societe Generale Securities Services (SGSS) to address concerns surrounding Alternative Investment Fund Managers Directive (AIFMD) and Undertakings for Collective Investments in Transferable Securities (UCITS) V. There was a tangible feeling that there must be a stop to the decade-long practice of continuous regulation, if only to allow participants and their essential service providers to absorb and adjust to the new demands being placed upon them, says Jean Pierre Gomez, head of regulatory and public affairs at SGSS.

AIFMD targets managers of alternative investment funds operating within or marketing to the EU, and hopes to protect investors by improving transparency with new disclosure rules and standards for reporting. It aims to tackle safekeeping of investments through the mandatory appointment of depositaries and custodians as well as issues around conflicts of interest, remuneration, risk management and valuation. 

The UCITS regulation relates to the distribution of funds that are transferable across the EU, and so require regulation to protect investors. The latest directive (V) sets new requirements for managers, depositaries and EU member states to step up investor protection. This includes: mandatory appointment of a single depositary for each UCITS; re-evaluation and harmonisation of depositaries; duties and liability; specifications for funds; remuneration policies; and the responsibility of member states to ensure protection of assets held by a depositary in the case of insolvency.

Regulation forms only one component of the triple whammy that the asset management industry faces in 2016, according to a survey by Multifonds – a provider of investment fund software – published in May. 

It confirms sentiments in numerical terms. MiFID II is causing most concern, identified by over half (51%) of respondents, followed by UCITS V (45%) and AIFMD (31%). Nearly two thirds (64%) say the greatest impact of regulation is increased costs to investors, surpassing the intended positive aspects of regulation such as better investor protection (58%) or increased transparency (54%); less than a third (30%) say the influx of regulation better positions the industry to identify systemic threats.

Almost two thirds (64%) have seen their costs rise over the past year, with over a fifth (22%) spending 20-50% of their IT budget on compliance. The need to change technology systems is seen as the biggest challenge posed by regulation (47%), alongside reporting (47%) and ambiguity (42%).

Asset managers are finding that the weight being placed upon them is diverting them from their core focus. Regulators might have achieved their goal in changing the mindset but this has possibly been at the expense of future pension fund performance. Unless, of course, securities services providers can find ways to deliver their services more efficiently and cost-effectively to compensate. 

Which brings us to the role of technology, and automation in particular. Europe has made great strides in the automation of the investment process over the past two decades, notes Valerie Letellier, senior market manager, Global Funds Markets, at SWIFT, a financial payments and messaging system. But, much remains to be done, she adds. “We need more and more automation to meet increasing regulatory requirements more efficiently,” she says. 

It is clear where the next ‘big bucket’ for automation sits. “Asia,” she states, in particular with cross-border fund flows. It is not only the volume available for investment. It is also the opening of alternative venues for investment as the impact of the passporting initiatives recently agreed and the mutual recognition pact that allows investors in mainland China and Hong Kong Special Administrative Region greater access to one another’s markets.

What next, then, for securities services providers in the face of new regulatory activity? The answer is more of the same, at least until regulators run out of ideas. But the future should be easier to navigate than the years following the global financial crisis. “We have the mechanisms in place to track and plan, and make business and operational changes to deal with future regulatory matters,” says Doherty. “That muscle memory is now well developed here, but the impact on clients so far has been more cost and more governance with resources being diverted from the core activity of investment management.”

Pervaiz Panjwani, head of EMEA fund services at Citi, highlights the emergence of financial technology, or fintech, specialists, as a challenge, in particular the rise of open architecture platform investment facilities. “These are changing the face of the industry, and whilst they offer opportunities, they will present their own demands for future regulation,” he says. “How do you control and regulate them?”

For his part, Kasper, is already looking to the Capital Markets Union initiative, aimed to stimulate non-bank financing across the EU. But that is another story.

Increased volume and automation

Global order volumes and total automation rates increased in 2015, according to a European Fund and Asset Management Association survey. The association is working with SWIFT on the evolution of automation and standardisation rates of fund orders.

Total order volumes received by 29 transfer agents in the cross-border fund centres of Luxembourg and Ireland in 2015 increased by 11% in 2015, bringing the total volume processed by participants to 34.1m. The total automation rate of processed orders of cross-border funds reached 85.4% in the last quarter of 2015, an increase of 2.8 percentage on the fourth quarter of 2014. The use of the International Organization for Standardization messaging standards rose by 1.8 percentage points to 51.2%, while the use of manual processes fell 2.8 percentage points to 14.6% in the same time period.

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