If 2018 was a year of regulatory recalibration, 2019 will focus more on high level regulatory themes rather than detailed specifics. 2019 will be a year where global regulators assess certain common strategic themes impacting global investors. In no particular order, here are five regulatory trends we believe will shape the asset management landscape in 2019:
1. Brexit, Brexit, Brexit
This year, the only thing anyone can truly be certain of is that Brexit will remain a major area of focus for the asset management industry. Given current politics, we can’t predict the future with any degree of precision. There are several “known unknowns” that require resolution affecting asset management and will play out as we move through the Brexit process in 2019.
In the event of a no-deal Brexit, many areas of the economy have existing global rules and can fall back on bilateral agreements. For example, when it comes to trade between the UK and the EU, World Trade Organization tariffs would apply – far from ideal but at least there is a known construct. However, the UK financial services sector is based largely on the EU passporting regimes, EU Directives, and EU-branch permissioning. The industry would be left with several uncertainties until both sides agreed on new arrangements.
If UK asset managers do not have funds set up under EU-domiciled management companies, any existing UCITS funds instantly revert to AIFs and they will not be permitted to passport into EU Member States.
Firms that have invested significant resources in restructuring their business have not taken action in vain given the expectation that the Financial Conduct Authority (FCA) and politicians will use Brexit as an opportunity to distinguish UK rules from key EU requirements for funds and banks. One of the underpinning political goals of Brexit was to make the UK a distinct and attractive financial market place that can compete globally.
The FCA has long been an influential voice within the EU’s policy making framework. It has often led the way with regulatory requirements as well as critical financial services architecture such as MiFID 2. Now, through EU Trialogues and FCA Q+As, the industry has a clear indication as to how the FCA views certain requirements and where it may seek to re-assert its own standards in the UK market. We expect in many areas the requirements may become more, not less, stringent.
There remains a wide spectrum of possible scenarios which may play out before we have any kind of clarity on the manner of the UK’s exit from the EU and any detail on the nature of the future relationship. Follow the continuation of the Brexit story and what it means for asset managers throughout 2019 here.
2. The Value for Money Debate
The investor “value for money” debate in asset management has been ongoing for several years now. Regulators and the industry have discussed the meaning of the term “value” at length, but it generally refers to the provision of a fund for an investor’s risk and whose costs are considered reasonable given the nature and complexity of asset classes involved. 2018 became the year of the “zero fee fund” where certain fund providers acknowledged investors shouldn’t have to pay much or anything at all for very simple low-cost strategies. Regulators too have become increasingly focused on fees and are taking measures to ensure they are adequately disclosed, fair, and capable of being understood by investors. Global regulators have already enacted a wide number of investor protection regulations and the focus on fee levels and value to investors will likely only intensify in 2019.
“Closet tracking” is a concept also coming under the watchful gaze of regulators in more jurisdictions. In short, the practice refers to investment portfolios that claim to be actively managed, but actually so closely track a chosen benchmark, that they are in effect a passive strategy. Previously, regulators in the US and Asia have raised concerns about this practice, but now regulators in Europe are looking even more closely. The most recent example of this scrutiny may be found in Ireland, where the Central Bank announced in December that they would review UCITS funds for closet tracking behavior. In the UK, the Financial Conduct Authority (FCA) also places investor value high on their agenda. The debate will persist in the coming year, but the ultimate European response to mitigating closet tracking risks to investors, as in so many of these rules, is likely to shape future regulations on a global basis.
As asset management continues to grow, it is increasingly geographically dispersed in terms of investments, distribution and operations. Given this, regulators are now looking at each asset manager’s operating model, including third party providers, to ensure that they have appropriate levels of knowledge, governance, and control where they use globally disbursed, delegated, and subcontracted business models. Regulators are also challenging firms on the adequacy of their contingency plans. The concern being that any weak link in a global chain can result in disruption to regulated firms and their investors. In other words, do you have a plan B if any part of your operational chain is rendered out of commission for an extended period of time? Regulators are likely to raise questions such as “Could you switch providers quickly?” or “Could you substitute at any level in the chain if you had to?” more frequently throughout 2019.
3. Greater China Remains Key to Global Asset Managers
Despite recent volatility in China’s stock markets (major indexes in Shanghai and Shenzhen saw significant losses last year), China remains on a path to regulatory and market liberalization, which should continue in 2019. This is true for both Mainland China and Hong Kong. There continues to be a broad range of opportunities in the Greater China region each developing on their own timelines, including US and European asset managers entering Greater China, and Greater China asset managers expanding beyond their own region. Here they are broken down into three primary categories:
- Increased access to Mainland China investment opportunities
- Addition of China A-shares to various global equity indices
- Implementation of third pillar pension schemes in Mainland China
- Increased quotas and access to China Stock and Bond Connect
- Continued internationalization of Renminbi, leading to full convertibility of China’s currency
- Approval and increases to Renminbi Qualified Foreign Institutional Investor (RQFII) licenses and quotas to foreign asset managers allowing them to invest into onshore Chinese assets
- Increased distribution opportunities in Hong Kong and Mainland China
- Conclusion of ETF Connect or cross-listed ETF sales through the Hong Kong China Mutual Recognition of Funds (MRF) program
- Complete ongoing enhancements to the MRF regime
- Growing recognition of open-ended fund company structure for funds in Hong Kong
- Increase of quotas within Qualified Domestic Institutional Investor Programs (QDII) allowing China funds to invest more freely in non-Chinese assets
- More relaxed Wholly Foreign Owned Enterprise (WOFE) rules in China to launch domestic private funds
- Use of Hong Kong funds to access various cross border mutual recognition and passporting programs
- MRF programs between Hong Kong and other countries (China, UK, Switzerland, and France)
- Expected market growth of Hong Kong ETFs in Greater China region
4. Technology Revolution
Global regulators are trying to get a handle on how to regulate the profusion of financial technologies that are coming to market. Regulators are really trying to position themselves to understand these technology innovations and the areas they should and shouldn’t regulate. This is an area that requires a balance between ensuring investors are protected and not stifling competition or new product solutions which may benefit markets and investors. Much of this technology remains nascent or aspirational, and regulators are waiting to weigh in, but we expect 2019 to represent a period of rapid product development and regulatory reaction.
For example, there has been a lot of market activity recently around cryptocurrencies. There is also a tendency to regulate after the horse has bolted on an event. It is highly likely that regulators will address areas such as Initial Coin Offerings (ICOs), Distributed Ledger Technology (DLT), as well as the use of artificial intelligence in asset management in 2019.
The amount of data generated, consumed, and transferred globally has increased exponentially in recent years. That growth has created new regulatory risks around the protection of such data, especially personal data. The EU is proceeding with implementation of its Directive on Information and Network Information Systems (NISD), a set of rules first issued in 2016 aimed at cybersecurity. In the US, the New York State Department of Financial Services cyber security regulation becomes fully effective in March, heralding in a higher standard that will likely influence future Federal US cyber regulation.
Global asset managers have another critical challenge: country or area specific regulations often do not consider how to integrate their rules with other cyber security regimes, greatly complicating the efforts of global firms to establish and maintain global compliance structures.
5. Making Investments More Sustainable
There’s little doubt that there is a strong political will in Europe to move forward with fostering a greater degree of sustainable investments in the markets. The European Commission made a commitment to make the EU carbon neutral by 2050. Within the EU Capital Markets Union (CMU) plan is a “Climate Action Plan,” which basically means tilting all European financial institutions, asset management, and assets and allocations, from pensions to banks, lenders to retail investors, toward a more sustainable focus on environment, social, and governance (ESG) issues. In rounding off 2018, the European Commission released a consultation paper related to potential ESG amendments to UCITS Directives and AIFMD, the two main regulatory pillars of European investment funds. Regulators and government officials are working on policy initiatives and the market is starting to see more activity and new launches of ESG and sustainable funds. These are likely to continue to grow in 2019 in reaction to market demand.
One issue still to be ironed out is environmental, social, and governance (ESG) taxonomy – global stakeholders still can’t agree on definitions connected with ESG investing. The European Banking Authority (EBA) and European Securities and Markets Authority (ESMA) are working to issue an agreed upon taxonomy that will make it possible for European funds to use standard measures of ESG for the first time. Like certain previous EU policy initiatives such as the MiFID 2, the decisions made within the EU are likely to become a basis for global standards for ESG investments, and as such should be of interest to global asset managers wherever they reside.