Making its name as being one of the most advanced players in Europe, the time is now for the UK’s custody markets to up its game; with industry experts observing that larger asset managers and owners have been consolidating the number of custodians they work with, with fewer regional or UK-specific mandates.
Additionally, as the UK makes its preparations to negotiate Brexit agreements, the time is also of the essence for the UK’s fund industry, as Brexit will likely to impact this area too.
Speaking on 24 January, IQ-EQ’s Justin Partington, group head of funds, noted that “with alternative fund assets forecast to reach $14 trillion by 2023, the industry’s alternative investment fund managers are facing complex decisions about their fund domiciliation, and the stakes are high”.
With much to ponder over the next 12 months, industry experts walk us through the UK’s fund and custody markets; experts from IQ-EQ, Maitland and Crestbridge discuss Brexit and how it will impact the funds industry, while BNY Mellon’s Ileana Sodani, head of international business development, talks us through the UK’s custody market.
Brexit
The last day of January 2020 marked the end of an era as the UK left the EU. We now sit in the transition period until the end of 2020 while the UK and the EU negotiate additional agreements. Prior to 31 January, industry experts observed that the impact of Brexit on UK asset managers had been “relatively minimal amid ongoing political certainty”.
But now, the time is ripe for asset managers to adapt to the post-Brexit world. Robert Ophele, chair of the Autorité des Marchés Financiers (AMF), recently predicted that the EU’s fund industry would be “profoundly transformed” by Brexit.
Previously, Partington stated that it remains possible that funds domiciled in the UK could lose their EU passport; “although UK asset managers should be able to make use of national private placement regimes or reverse solicitation as is the case in the Channel Islands”.
Speaking more recently, post-Brexit, Partington adds that although it is still possible that the EU might not allow the UK to use the passport, “it would be a wholly political move given that the UK rules today are fully harmonised with the EU”. Adding to the uncertainty, Partington observes that until we have further clarity on the regimes that will be available to alternative fund managers post Brexit, “those running a close-ended alternative fund as a UK manager will likely have three choices: they can appoint an AIFM in Europe, relocate the fund, or restrict their customer base by cutting back on European investors and simply marketing their fund to UK investors”.
Meanwhile, Luxembourg’s financial regulator Commission de Surveillance du Secteur Financier (CSSF), has introduced enhanced substance requirements. Partington explains that this is set to prevent the setting up of ‘letter-box’ entities, with just a handful of back-office staff, in EU jurisdictions, while driving investment processes back in London. Brexit, therefore, means more substance in EU jurisdictions where funds are domiciled, according to Partington.
Patric Foley-Brickley, managing director, funds services at Maitland, says that “UK asset managers intending to passport the services of UK management companies to support investment funds in key EU domiciles like Luxembourg will need to establish management companies themselves in these jurisdictions, or more likely, seek the services of independent management companies”.
Discussing the future horizon for the UK’s industry in terms of Brexit, Foley-Brickley suggests that at the end of this year, “industry-defining questions” such as whether the UK remains ‘equivalent’ with EU rules or diverges will need to be answered”.
He says: “In the meantime, asset managers must remain compliant with the EU rules already in force under the Alternative Investment Fund Managers Directive UCITS and second Markets in Financial Instruments Directive (MiFID II)”.
According to Foley-Brickley, during this period, alongside the necessary due diligence – carrying out strategic, structural and business assessments to determine a Brexit roadmap or contingency plan – UK asset managers are looking at their product suite and relocating to jurisdictions that can provide access to the continent.
“Even if firms do not relocate any of their operations (from or to the UK), they will need an advisory partner to navigate complex contract law, employment law and tax law challenges,” he adds.
Meanwhile, Michael Johnson, global head of fund services at Crestbridge, comments: “Brexit has had limited impact on servicing given most credible players, like Crestbridge, are global service agents and can host fund structures in the main fund domiciles, should the managers switch.”
Johnson adds: “The longer-term horizon poses the most challenges from a servicing perspective, but it’s difficult to opine on those until more details emerge of the exact form of Brexit.”
The custody scene
Over in the UK’s custody market, industry experts have identified that the market is working well in pricing bundled services, despite the small number of providers.
BNY Mellon’s Sodani observes that the barbell of investment strategies has continued apace.
She says: “An ever-clearer demarcation between obtaining low-cost beta and finding sources of positive alpha is encouraging investors and asset managers towards higher concentrations of assets in both passive and alternative investment products.”
According to Sodani, to remain competitive, asset servicers have been investing in services and technology solutions to support these areas – integrating key growth segments, including exchange-traded funds, credit and loans, and real estate and private equity.
Adding further to the challenges, Sodani says that client expectations are rising. She explains: “The investment industry is highly competitive and transparent, with an intense focus on performance, pricing, distribution and client service. Our clients are increasingly focused on their core competencies – the areas where they can add genuine value.”
“Finding efficiencies and reducing costs are significant factors, though clients are also looking for ways to improve their operating models that add value and are sustainable. Our role is to help clients deal with these challenges through delivering solutions that provide them with the tools and efficiencies that enable them to survive and thrive within this competitive environment.”
Meanwhile, with asset managers’ fees under pressure, Sodani suggests that they are looking to reduce costs by passing some of that margin compression on to their providers.
“This is an opportunity to show how we can bring extra value – supporting clients with solutions that make them more efficient and effective,” Sodani comments.
Looking to the next five years, she predicts that we will see competition around data delivery, data quality, data accessibility and the organisation of data.
According to Sodani, this is down to increased commoditisation of core products, which makes it hard for asset servicers to differentiate themselves on pure custody, and so fund accounting, transfer agency, delivery and performance data are getting increasingly commoditised and standardised. She also suggests that the ability to organise data and make it more consistent and accessible through APIs, for example, will become the key area of competition in the future.
Elsewhere on the custody industry’s horizon, Sodani outlines that there has been a noticeable uptick in conversations BNY Mellon has been having with asset managers about the direct-to-customer market.
“The knock-on effect for asset servicers is in building global service models that cater for both institutional investors and retail investors – with online portals, enabled with consumer-friendly tools,” Sodani adds.
Keep calm and carry on
Further looming challenges in the UK, in line with global trends, is regulation. With upcoming regulations such as the Securities Financing Transactions Regulation (SFTR), which is set to go live in April this year, the asset servicing industry must also keep on top and already have preparations in place at this stage.
In addition to SFTR, asset managers, pension funds and insurance companies are scheduled to start posting initial margin (IM) for non-centrally cleared derivatives under Uncleared Margin Rules based on their volume thresholds either with phase 5 on 1 September 2020 or phase 6 on 1 September 2021.
Tim Keady, head of DTCC Solutions, DTCC, highlights the pressures firms face, against this backdrop, as market participants are also preparing for the Libor transition and Brexit adjustments.
Keady states: “All of these regulations will impact the operating models of buy-side firms and introduce new costs as well as regulatory reporting requirements. For example, UMR’s waves five and six, which take effect in 2020 and 2021, respectively, will predominantly impact funds and institutional investors, requiring some companies to acquire new skills and competencies in order to undertake functions which they’ve never performed before.”
But despite regulatory challenges, Brexit uncertainty challenges in the fund space, and large asset managers and owners consolidating the number of custodians they work with, with fewer regional or UK-specific mandates in the custody arena, players in the asset servicing industry have an opportunity to raise their game across the board.
Industry experts suggest that London will continue to carry its title as a centre of excellence, and upping the stakes will only encourage further enhancements of innovation in the asset servicing world.
Partington reminds us that in the past, fund domiciliation decision-making has been predominantly influenced by factors such as the reputation of a jurisdiction, investor sentiment, set-up timelines and processes, regulations, costs and the quality of the service providers.
However, Partington suggests that there are three additional factors currently dominating the thinking, including the advent of Brexit, the Organisation for Economic Co-operation and Development’s base erosion and profit shifting, and the drive to introduce local economic substance requirements for companies’ tax residency to prevent fund managers setting up ‘letter-box’ entities.
He adds: “Domicile decision-making for the alternative fund industry has entered a new era of geographic challenges and opportunities.”
