The regulatory storm is showing no sign of abating, and it’s unclear whether the outcome will be worth the effort. BNY Mellon’s Paul North explains
This inversion of the well-known proverb nicely captures the sentiment among delegates attending BNY Mellon’s 2015 Europe, the Middle East and Africa (EMEA) Tax and Regulatory Forum in London. Our clients, like BNY Mellon itself, see benefits and potential opportunities arising from the ongoing storm of market infrastructure, regulatory and tax change, but there is also a recognition that a lot of heavy weather still lies ahead in the next couple of years.
Given this volume of regulatory change, for four years now we have been running the EMEA Tax and Regulatory Forum to share our understanding of these changes. This event also gives us a chance to take a pulse check on the impacts, challenges and priorities for the year ahead. Certainly, the sheer volume of regulation under discussion is unprecedented—our current regulatory timeline includes no less than 20 changes that will hit between 2015 and 2019, with a concentration of activity in 2016 and 2017.
On this basis, our sense is that 2017 will see a peak in terms of the volume of change, effort and cost, hopefully meaning that after this, more resource can be focused on business growth—part of the silver lining to very large cloud. A survey of delegates attending our most recent forum found that 53 percent of respondents believe they will spend more on regulation in 2016 than 2015. This represents an increase over last year’s survey (41 percent) and certainly aligns with our own plans and budgets for 2016.
So what do investment firms consider to be the priorities for 2016? Broadly, there appears to be three segments of priorities. In the first segment, three regulations clearly stood out in our survey: the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS); the Markets in Financial Infrastructure Directive (MiFID) II; and UCITS V.
FATCA/CRS and UCITS V are perhaps no surprise, but MiFID II has raced up the priority order in the past six months. The poll was taken before news broke of a potential delay to MiFID II’s implementation date, originally planned for January 2017. While not confirmed at the time of writing, such a delay would seem desirable given the scope, impacts and complexity of the proposed changes.
That said, in some cases a delay may be unwelcome. For example, overlaps between MiFID II, UCITS and the Regulation on Packaged Retail and Investment Products (PRIPs) may have been helpful. Each of these changes will require updates to client documentation, such as the Key Investor Information Document (KIID). Previous schedules meant it may have been possible to combine the work required to effect those changes and so save time and costs, but a delay to MiFID II means any potential synergy is lost.
The next segment of priorities includes Target2-Securities, the European Market Infrastructure Regulation, Solvency II, the Financial Transaction Tax, and money market fund regulation. The fact that these are seen as a lower priority overall perhaps hides the scale of the associated impact on specific firms, which should not be understated. Delegates’ responses may also reflect the fact that some of these regulations are still at the proposal stage, and there may yet be work, investment and costs linked to them in 2016. This uncertainty around final requirements and timings poses real challenges when trying to lock down budgets for next year.
The final segment, and seemingly the lowest priority, included the Base Erosion and Profit Shifting (BEPS) initiative, PRIPS, the Volcker Rule of the Dodd-Frank Act, the Capital Requirements Directive IV, the Central Securities Depository Regulation, the Shareholders Rights Directive, the Institutions for Occupational Retirement Provision Directive II and the capital markets union. In some instances this is perhaps not surprising, as in the case of the Volcker rule, where the impacts have been largely addressed. Others, such as PRIPS and BEPS, have similar impacts to other changes such as CRS and MiFID II, both in terms of their potential impact and their timing. We suspect views on these two will change in 2016 as their impacts become clearer.
Of course, this list of potential priorities misses a number of changes that will affect some firms in 2016 and 2017. This includes Securities Finance Transaction Regulation reporting, the fourth Anti-Money Laundering Directive, banking structural reform and the European Long Term Investment Funds Regulation.
So, as noted, 2016 and 2017 look to be particularly busy in terms of planning for and managing regulatory change. When asked if these regulations would have a material impact on their firm, 85 percent of delegates polled said they expect that to be the case over the next 12 to 36 months. The immediate impacts are expected to be felt around resourcing, projects and IT. When asked whether firms are having to delay product development in favour of other investments due to regulatory related work, 42 percent said they were.
It will be interesting to see how those views evolve as we move through 2016. And in passing, we should perhaps sympathise with the 3 percent of poll respondents who said work on regulations is all they do.
In theory, all of these regulations should benefit the end investor. In many instances, their genesis can be traced back to the response of regulators globally to the credit crisis of 2008, and their determination to make financial institutions more resilient to future shocks and so protect the broader economy, governments and investors. Within the EU there are also the objectives of promoting the single market, a single rule-book and, more recently, the objective of promoting economic growth. Again, all of these objectives should benefit investors across the EU.
However, views expressed throughout the survey are somewhat at odds with these laudable objectives. Among those polled, 81 percent felt investors will ultimately have less choice and 76 percent felt investors would get less value.
More positively, 78 percent felt investors would be better protected. So, why do firms seem more pessimistic about benefits for investors?
In part, I believe this is because firms, at this point, see increasing costs, falling margins and possible barriers to product innovation that result in fewer products being available to investors. However, this appears to be at odds with recent statistics published by the European Fund and Asset Management Association (EFAMA), which stated in its Quarterly Statistical Release N°62 (Q2 2015) that “the number of UCITS funds at the end of June 2015 stood at 29,276, reflecting a steady increase from 28,945 at the end of March 2015 and 28,798 funds at the end of December 2014”. This would seem to suggest the investor has more choice.
Similarly, when it comes to alternative funds, there appears to be little evidence of an erosion in choice. Again, EFAMA said: “The total number of alternative investment funds stood at 26,784 at end June 2015, compared to 26,984 at the end of Q1 2015 and 26,797 at the end of Q4 2014.”
The responses around investor protection seem more clear-cut. Issues such as the restitution liability with AIFMD and UCITS, the drive for greater transparency on costs and product disclosures, and proposals on commissions within MiFID II, would all seem to enhance the level of information available to clients, the oversight of funds and the protection of their assets in the event of fraud.
The responses in respect of value are the most puzzling. If value is deemed a combination of choice and cost, then external evidence would suggest that investors are in fact getting better value than ever. Based on EFAMA’s data, there are more funds on offer than before, despite the fact that the total number of UCITS funds is down from its September 2008 level of 37,475.
Nonetheless, the number of funds in Europe still dwarfs the US market. Back in 2008, the average net asset value of a UCITS fund was $180 million. As of June 2015, this was approximately $300 million, a 60 percent rise. Setting aside the impact of market and currency movements since 2008, this would suggest net asset values have grown.
In parallel, anecdotal evidence suggests that the management fees for funds have decreased over time. Indeed, investment firms have often mentioned pricing pressure affecting their margins. This, combined with the Retail Distribution Review in the UK, which created a wave of cheaper share classes, suggests investors are enjoying better value than in 2008. Perhaps our survey results offer a view of things to come, and the costs of implementing new regulations will ultimately lead to price increases and the consolidation of funds.
For now, let’s return to the silver lining. Our survey suggests a small majority of firms (54 percent) see opportunities arising from regulatory change to create value for their business, either in the form of costs savings, new products or new revenues. When asked about their priorities regarding new investments, cost savings came out on top (55 percent), perhaps understandably, given comments on costs and margin pressures.
A quarter of respondents said they would look to invest in new products, and 15 percent in new markets for distribution. There are certainly opportunities for new products—developments such as the capital market union actively encourage it, and aspects of other regulations such as UCITS V and MiFID II could help drive the growth in cross-border distribution with the EU.
On the product front, new vehicles such as European long-term investment funds, charity authorised investment funds and tax transparent funds in the UK, create opportunities for product innovation.
Finally, when it comes to innovation, the focus on digital strategies cannot be ignored—90 percent of our respondents expressed interest in, or confirmed they were already active in, the digital space. In that sense, the combination of new digital services, product innovation and a reformed and consistent regulatory landscape for the EU could be viewed as another silver lining.
