The Lesser Told Story of Regulatory Upside

While often unheralded, good regulation doesn’t always receive the attention it deserves.

When people talk about financial regulation it is usually in a negative light, discussing the adverse impact on their chosen business model, or the cost of implementation. However, it’s important to also highlight areas that would benefit from new, increased, or enhanced regulation. While often unheralded, good regulation may increase market confidence, create harmonization, and establish best practices.

Perhaps more than other industries, this is particularly true for asset management, which in a lot of ways exists because of regulation, the bedrock that gives investors the confidence to engage with regulated financial firms and their products. Regulation provides a high barrier to entry which means well-run incumbents in the regulated asset management space are not very easily displaced in their chosen segment. The growth of UCITS to $8 trillion with product sold in eighty-six countries, for example, is due primarily to the adoption of the regulatory framework, which has been continually enhanced since 1985.

There are a myriad of ongoing regulatory initiatives not only focused on investor protection, compliance, and governance but also on aiding financial market growth. These initiatives are obviously very positive for asset management. Here we focus on a couple of significant ones.

Fostering Long-Term Retail Investment

A primary geopolitical goal is to increase participation rates in pension provision, saving, and longer-term investment opportunities globally. There are multiple initiatives ongoing at national levels, with the most ambitious plan being the EU’s CMU (Capital Markets Union) project.

There are two significant initiatives designed specifically to increase investor participation rates by harmonizing products and creating opportunities for asset managers to expand their distribution.

The first is the PEPP (Pan European Personal Pension Product), which is an initiative between EIOPA and the EU Commission to create a cross-border retirement vehicle for EU investors, akin to Individual Retirement Accounts in the US. Currently, the EU pension space is highly fragmented and normally conducted locally by individual countries. A harmonized EU framework for pension products would improve the transparency and comparability of pension products, and increase the target distribution market for asset managers. At the same time, PEPP would increase competition and create greater economies of scale, reducing the cost of provision and ultimately providing EU savers with a wider range of products at lower costs within a robustly regulated framework.

The second initiative is looking at some well-known barriers to European cross–border fund distribution. In June, the EU Commission published a consultation paper looking at potential solutions to this challenge. The paper suggests that despite 80% of UCITS being “cross border,” only one-third sell only to one other country beyond its own domicile and another third are not sold in more than four countries. The paper acknowledges the following local country requirements that work against a fully harmonized EU marketplace and will require harmonization or enhancement:

  • National financial promotion rules
  • Regulatory fees
  • Paying agent requirements
  • Barriers to online distribution
  • Regulator “gold plating”

Removal of these well-known constraints in the market would amplify sales opportunities, increase investor choice, and reduce costs of selling across the EU.

Tax is also identified as an area of inconsistency but one that may not be solved any time soon.

Asian Passporting

Currently, there are three distinct Asian fund passporting schemes either in effect or under discussion: the Hong Kong – China MRF (Mutual Recognition of Funds), the ARFP (Asia Region Funds Passport) and the ASEAN passporting initiative. Each regime broadly operates in a similar manner. The participating countries enter into memoranda of understanding that allow reciprocal fund sales across one another’s borders under an agreed set of rules. While political union across Asia is unlikely anytime soon, the bilateral contractual arrangements still provide consistency for participating countries, which has been one of the primary foundations of UCITS growth and has expanded distribution beyond the EU.

The Asian passports are still at the nascent stage and will probably continue to be refined as the UCITS passport has over the past thirty years. However, with such a solid and harmonized regulatory base and collaboration between the respective countries, the ASEAN and ARFP have the potential for significant growth over time. If successful they could provide asset managers with a great avenue for Asian cross-border distribution and provide more diverse product options for investors across the Asia.

None of the above represents a silver bullet resulting in instant dynamic market shifts, however it is worth noting that well-framed regulation can greatly assist market segment growth. It is also noteworthy that on a global basis governments acknowledge the importance that both regulation and international collaboration play in aiding financial recovery and growth. Ambitious regulatory projects such as CMU and Asian fund passports, which focus on industry growth rather than addressing compliance failures, highlight explicitly the positive power regulation can bring to bear within the asset management sector.