Asset managers are increasingly taking steps to manage risk and compliance issues in a rapidly changing regulatory environment.
Concerns include preparing for new SEC reporting rules and modernizing operational infrastructure to address evolving markets. Money Management Executive reached out to industry execs for their take on these trends.
"Meeting the growing demands of regulatory scrutiny has required asset management firms to dramatically grow their compliance and data management teams," says Melissa Norris, partner at recruiting firm Jamesbeck Global Partners.
Challenges also include how managers oversee internationally focused products.
"Chinese markets come with their own rules and regulations, of which we must be cognizant," notes Blockforce Capital CEO Eric Ervin.
In addition, there's an increased focus on regulating products with controversial underlying assets, including cannabis and cryptocurrencies.
For more on what Norris, Ervin and two other experts consider crucial regulatory issues for the industry, read the rest of our special report.
Growing compliance teams
Jamesbeck Global Partners Founding Partner Melissa Norris
Since the financial crisis, the asset management industry has seen increasing regulation regarding the information firms can share, as well as how and with whom. Enforcement has also grown stricter, with the SEC and Department of Labor at times immediately fining infractions during audits instead of first writing a letter.
Meeting the growing demands of regulatory scrutiny has required asset management firms to dramatically grow their compliance and data management teams. In addition, thinly stretched research teams at broker-dealers are unable to evaluate every strategy deeply.
Thus, product teams are making economically driven decisions about consolidating their offerings. These decisions can, in turn, jeopardize investment performance when they impact how capital and risk are allocated.
Pension funds have also had to respond to regulations and the requirements of being fiduciaries by ramping up their own internal capabilities. This has forced asset managers to offer more transparency and deeper product knowledge to clients.
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The regulator's investor advisory committee approved a set of recommendations for commission to clarify "best interest" advice for advisors and brokers.
November 8 -
New York legislators are set to reconsider a previously stalled fiduciary bill.
November 7 -
The regulator proposed a "clear and concise" summary for clients considering the products, but the impact appears limited.
October 31
Investment managers say all this is compounded by allocators now needing to put out most if not all new bids, instead of renewing with the same investors. This shifts the process from a relationship-building exercise to one that is far more complex and demanding. Managers are constantly under evaluation from prospective clients, and thus require larger, more sophisticated RFP and compliance teams to provide the necessary information and data.
To address these challenges, asset managers must focus on finding the right people and capitalizing on inherent advantages. Ideally, salespeople will have a CFA/MBA, ensuring they have the knowledge and work ethic required to follow the strict rules around sharing information with clients. One salesperson sending a deck before it's reviewed, or selectively revealing fund data could put a firm in jeopardy.
Mid- to large-sized asset managers can afford to make the infrastructure investment to meet compliance demands. This can make it more challenging for new firms to launch, or smaller firms to thrive and remain independent. On the flip side, asset managers say the process of allocators putting up each new bid eliminates one barrier for entry. This allows the newer and smaller firms to show their capabilities and win more business.
International challenges
Blockforce Capital CEO Eric Ervin
As an asset manager in the blockchain space, managing ETFs and private funds with global publicly traded equities as well as derivatives, we are constantly on the hunt for alpha opportunities both here and across the globe.
When considering international regulations, China is one area where managers must pay closer attention. Working with Chinese assets is by no means straightforward, and we face several operational hurdles that come with accessing such a market.
On the compliance/legal front, Chinese markets come with their own rules and regulations, of which we must always be cognizant.
In some instances, domestic and international regulatory actions result in extended trading halts, making the portfolio pricing process even more challenging.
The majority of the regulatory hurdles are tied to trading halts due to events such as mergers and acquisitions, experiencing more than a 10% price move in either direction and cross-border tensions.
China only recently opened up its borders to foreign investments through their stock connect program, presenting an opportunity for asset managers outside mainland China to enter the equity market in the region.
However, this new platform comes with its own set of regulatory concerns and obstacles to navigate. We must constantly monitor the securities approved for inclusion, as companies can be disqualified if they no longer meet the program requirements, effectively eliminating tradability for us.
Asset managers must be able to handle the challenges that come with allocating talent and capital to this part of the world.
Regulating crypto and cannabis
Nottingham CEO Kip Meadows
Over the past two years, cryptocurrency and cannabis funds have been hot topics in the ETF universe. Both kinds of funds present operational challenges, with the primary issue being custody of assets.
Mutual fund investment securities are typically held in custody at a bank. The key issue with cryptocurrencies is: What is being held, and how?
Cryptocurrencies aren't traded on traditional markets and do not settle through either the Depository Trust Company or the Federal Reserve system. Thus, pricing of cryptocurrencies can be challenging. Centralized clearinghouses are in development, but they are still in their infancy.
A key regulatory concern is fraud. All trading is electronic, and anonymous counterparties are identified only through codes. There is a history of assets disappearing with little or no way to trace the transaction.
Several firms are working on systems to hold cryptocurrencies, with two or more entities holding a portion of the codes necessary for a trade. As these systems mature, some of the issues relating to custody should subside.
Cannabis funds' challenge with custody comes from a different angle. There's a conflict between federal and state laws related to cash movement for the cannabis industry.
Fees were nearly half the price of the top-performing active funds.
U.S. law prohibits certain bank transactions, in conflict with many state laws. Even with cannabis equity securities having been through the federal SEC effectiveness process, it's still unknown what actions, if any, the U.S. Department of Justice might take.
Bank executives view the risk/reward unjustified considering the potential negative headline risk if any banking relationship to a cannabis fund were challenged.
There is an innovative approach to dealing with custody for a cannabis fund that will likely hit the markets within the next few months. Cryptocurrency may take longer to reach a resolution acceptable to regulators.
Defined-contribution planning
Wells Fargo Asset Management Strategic Business Segment Head Fredrik Axsater
Asset managers today must navigate a volatile environment, most significantly reflected in the evolution of a defined-benefit to a defined-contribution retirement system.
The combination of changes in the cost of Pension Benefit Guaranty premiums and recent tax reform has changed the dynamic ways in which pension plans manage their assets, which in turn affects how asset managers can strategize within plans.
Moreover, in the aftermath of the fiduciary rule, we expect more assets to stay in defined-contribution plans well after retirement.
This is one reason why it will be critical to address investor challenges within these plans.
We must continue to push for both a business and regulatory environment that helps workers achieve the retirement they want and deserve.
In addition to providing ideas and products, we must work on policies that make it easier for institutional and retail investors to reach their goals.
Increasingly, the managers of defined-contribution plans must also consider that investors retire when they want, and also when their organization wants them to.
This in turn elevates the importance of the plans.
These issues represent a call to action for all asset managers. We must play a central role in solving these huge challenges.
For example, we should encourage greater access to defined-contribution plans for working Americans, in part by making it easier for smaller employers to establish retirement plans.
