Financial regulators know — even if they don’t act on it — that what they worry about is probably not what they should be worrying about. That sentiment guides their deliberations around new regulation of the asset management industry, which arguably contributed little to the last financial crisis. The rules police are trying to ward off the next conflagration and thinking hard about how asset managers might figure into it.
Many of the rules are still embryonic, particularly in the U.S., but regulators have raised issues that won’t be easily settled. The role that asset managers play in a healthy financial system lies at the heart of discussions: Would they pose a risk to the system if they collapsed? That question is driving U.S. regulators’ evaluation of whether some of the biggest firms, like BlackRock and Fidelity Investments, should be defined as systemically important financial institutions, or SIFIs, and thus required to share more information with the government or write a plan on how they could be dismantled in a crisis. Not surprisingly, asset managers are fighting back against the SIFI designation.
In Europe similar regulations would compel asset managers to follow the lead of banks by holding more capital on their balance sheets. Although many firms rightly argue that the capital they invest belongs to investors and so doesn’t pose the same risks as a bank’s borrowed money, some say it’s not a bad idea.
Robert Higginbotham, head of global investment services at $738 billion T. Rowe Price Group in London, points out that in addition to possibly being a good requirement, having a bigger cash buffer would do little harm to asset managers’ profitability. European rules are a way off, but “asset management businesses are typically quite capital-efficient,” Higginbotham adds. “I think it is unlikely that any further capital requirements will be excessively onerous.”
Rules mandating increased capital may be a positive in European markets because asset managers there offer more capital-preservation-type products that promise investors a certain level of protection, says Benjamin Phillips, a partner at Casey, Quirk & Associates, the Darien, Connecticut–based investment management consulting firm. With principal protection products, asset managers could be on the hook for investor losses, a very different role than merely acting as an agent as they do in a traditional mutual fund. But they could also have a chilling effect by hiking the cost of doing business, he warns.
Higginbotham raises other questions about regulation. For example, judging firms as systemically important by their size is the sledgehammer approach. “Assets under management is too crude a measure,” Higginbotham says. Regulators are discussing other attributes, including whether managers offer highly leveraged funds, deal in illiquid products, or cater to short-term investors or those with longer horizons, such as participants in defined contribution plans.
Despite the trillions held in its funds, the asset management business is still a young industry that could benefit from new or different regulations. “The penetration of mutual funds as the core vehicle for medium- to long-term savings is still relatively low,” says Higginbotham. But as the middle class in the developing world and aging Westerners start to seriously save for retirement, funds will boom. “Asset managers are a transmission mechanism between savers, corporates and governments, and the markets,” he notes.
One of regulators’ top targets in Europe is the financial advice industry. Finance cops are looking to root out conflicts of interest arising when investors pay one bundled fee on their funds and managers distribute rebates to advisers separately. In the U.K. the Retail Distribution Review rule has banned commissions to advisers from intermediaries like asset managers and insurance companies for selling their products. The Netherlands and Sweden have done the same; the European Commission is debating Markets in Financial Instruments Directive II, which aims to integrate regulation of investment services across the European Union, and may introduce a similar ban in the EU.
Many believe that these changes make sense, but the new rules could have a big impact on asset managers and advisers. Now that investors are being charged separately for advice, intermediaries are outsourcing some of these more complex services to asset managers. Fidelity and T. Rowe Price, for instance, offer complete asset allocation services, determining when client portfolios should include high-yield bonds or emerging-markets debt. Brokerage platforms such as Charles Schwab & Co. also offer services to investors.
Under the new U.K. rules, some of the biggest asset managers may start going directly to customers, Casey Quirk’s Phillips predicts. “Many clients aren’t going to pay their advisers separately,” he says. “This could be good for fund managers and change the dynamics of retail distribution.”
Rulemakers are trying to be creative in their thinking and imagine scenarios that could unfold under duress. “I have some sympathy with regulators,” T. Rowe’s Higginbotham says. “A future crisis won’t look like the last one.” • •
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Follow Julie Segal on Twitter at @julie_segal .
