Traditional banks are under pressure all over the world, from online-only banks, cheap smartphone e-wallets and app platforms. But it’s not the only part of the financial industry facing new and at times daunting challenges. For the asset management industry, the aftermath of the financial crisis has led to a massive increase in regulatory reporting and transparency requirements, contributing to cost pressures at a time when returns have been impacted by the persistence of rock-bottom interest rates.
Maintaining regulatory compliance, investor trust and business competitiveness is driving evolutions in processes, corporate culture and outsourcing. And fund managers, custodians, transfer agents, depositaries, brokers and distributors are all feeling the heat.
Long-term stability, environmental sustainability
The pressures are also being felt by the asset managers’ biggest customers, institutional investors including public social security entities, private insurance companies and pension funds. Such entities have faced more than a decade of minimal returns on safe assets such as sovereign bonds, complicated by longer periods of outgoings as customers and pension scheme members live longer in retirement.
However, solutions are complex and often the subject of political dispute. Politicians who cut social security coverage or increase the retirement age are rarely rewarded at the ballot box.
The European Union has taken steps to bolster the solidity of pension provision. The Solvency II reporting requirements for insurance companies place the burden on asset managers to measure accurately the value of assets and the risks they represent over the long term to their clients. Increasingly, transparency is not sufficient; senior management and stakeholders throughout the value chain must demonstrate they are in a position to anticipate risks rather than simply reacting when problems arise. Pension fund stress tests by the European Insurance and Occupational Pensions Authority will further ratchet up the pressure.
In addition to the existing requirements regarding liquidity, funding, solvency, credit and market risk data and analysis, the EU is also moving to incorporate qualitative and quantitative environmental, social and governance criteria into reporting requirements, reflecting both the increased focus on sustainability among investors and the increased awareness of the risks to investments and financial institutions from climate change and other environmental factors. Following the model of existing measures in France and Brazil, fund managers will have to report regularly on the environmental impact of their investments, or disclose their reasons for not doing so.
Meeting the new responsibilities
To meet its heightened regulatory and fiduciary responsibility, the asset management industry is increasingly looking to ease the burden by outsourcing non-core functions to reduce costs and management distractions. Interoperable back-office automation is becoming standard practice throughout the value chain, for custodians, depositaries and administrators as well as fund managers, to extract the maximum speed, efficiency and cost benefits from outsourcing.
The impact of ESG reporting is spreading further throughout the investment ecosystem. Ratings agencies led by MSCI and Standard & Poor’s have made great strides in analysing the impact of issuers of stocks and bonds on the human and natural environment. MSCI now collects more than 1,000 ESG data points per issuer. Analysis does not come free – managers have to absorb the cost of purchasing and incorporating external ESG input to guide their investment decisions and fulfil reporting requirements.
Meanwhile, EU policy-makers and European and national regulators are acknowledging that more reporting is not always synonymous with better reporting, as the recent debate about the benefits of the EU’s PRIIPs regulation has demonstrated. This realisation may impact the future shape of even more complex regimes such as UCITS, AIFMD and MiFID.
On one hand, the increased requirements for compilation and calculation of information may appear good news for third-party service providers such as Kneip. As legislation, regulation and guidance are tweaked, platform-based service offerings can adapt quickly and far less expensively than individual asset managers doing it for themselves.
Ensuring that regulation is fit for purpose
The challenge for policy-makers, and in particular the incoming European Commission, is to ensure that the regulatory requirements adopted over the past decade fulfil their purpose of making markets more transparent, protecting retail investors in particular, and helping to identify and counter threats to the financial system as a whole and the wider economy. In the process, no opportunity to make regulation more focused and attuned to market realities should be missed.
Digitalisation can also play a significant role in this process. Blockchain may one day revolutionise the purchase, sale and reporting of assets as well as subscription and redemption of fund shares and units. However, the technology is still at an early stage, and many questions about scalability and oversight must be answered before it enters the mainstream.
In the meantime, fintech and regtech firms have sprung up with automated tools to make reporting easier and more efficient, while machine learning and artificial intelligence software is being deployed to identify problems that human supervisors may miss.
Firms such as Kneip and their asset manager customers are still experiencing the early stages of this digital evolution. It may not have the same public impact as disruptive newcomers moving in to challenge banks in their core markets, but in the long term the processes of change visible today are likely to have a fundamental impact in shaping the future of the fund industry, and underpinning its competitiveness in the markets of tomorrow.