The report, titled Keeping ahead of the curve, was conducted by KPMG’s Global Investment Management Group. It is the result of in-depth interviews with senior executives from 17 Investment Management firms in the US, Europe and Asia who together represent more than US$6.5 trillion in assets.
Given the increased scrutiny and regulation now affecting the Investment Management industry across the globe, we felt it was important to understand the impact that these new regulations would have on global and regional markets. In a tightly-intertwined global investment market, regulation in other parts of the world can directly affect our investment industry in South Africa.
Conducted in early 2010, the research identifies several areas of operation that may be significantly impacted by new and proposed regulation.
Achieving cost containment
With little room to raise fees, the survey found that investment managers expect to absorb the implementation, compliance and management costs of new regulatory requirements, which will spur the search for greater efficiencies and cost-cutting measures.
At the same time, regulation aimed at increasing capital requirements will remove some liquidity from the market and force Investment Management firms to reserve more of their capital to cover these obligations.
“It is going to be harder to make money, either because [you] are holding more capital...or because you have to spend more money on systems or processes,” noted one executive. “I think organisations will be more cautious in the goals they set.”
Innovation in product design
Many Investment Management executives are therefore seeking to reduce costs and increase alpha through innovative product offerings. A number of respondents expected to limit management costs through a move towards more passive management, while others are finding ways to incorporate ‘secondary guarantees’ such as capital protected strategies and guaranteed minimum withdrawal benefits to offer products that are more transparent and bear lower risk to investors.
While increased regulation is widely thought to hamper product innovation, European executives note that certain regulations – such as the latest iteration of the Undertakings for Collective Investment in Transferable Securities (UCITS) - offer a number of product and investment strategy flexibilities that many investment managers are still not fully exploiting.
However, “if some of the regulation does get really intense,” admits one executive, “it might actually increase indiscriminate risk-taking as opposed to not, because people still need to get returns from somewhere.”
The onshore vs offshore debate
In an effort to enhance oversight, many jurisdictions are enacting regulation designed to bring investment vehicles onshore, while at the same time, institutional investors are demanding their funds be onshore to provide greater clarity and access. For multi-national and global investment firms, this shift may increase costs as organisations struggle to manage disparate locations, unique reporting systems and regulatory requirements from jurisdiction to jurisdiction.
However, for many of the larger, more sophisticated Investment Management organisations, key offshore centres like South East Asia will continue to provide access to operational cost savings and reduced taxation burdens when compared with the benefits of moving onshore.
This may change as regulation becomes clearer. Investment managers “are beginning to realise it doesn’t make a lot of sense to have things offshore,” comments one respondent, “even if they are ‘legitimate,’ it just attracts unwanted fiscal authority interest.”
Retaining and rewarding talent
Tied closely to the onshore vs offshore debate is the drive to retain and adequately compensate key talent. With headline-grabbing investor revolts over executive compensation moving some jurisdictions to propose remuneration limits and special taxes aimed at curtailing ‘excessive’ compensation, many investment executives are exploring alternate formulas with a move towards higher base salaries, lower bonuses and compensation packages that are deferred for two or three year periods.
The survey also found that many organisations expect to relocate key talent to other developed markets where they can take advantage of lower-tax regimes that offer a higher quality of life and more competitive marginal personal tax rates. For many, a lower taxation rate is more important than proximity to Head Office. “It is a global world now, particularly in asset management,” explains one executive, “and they are now saying ‘why bother [being located there]?’.”
Rebuilding trust and increasing transparency
An overwhelming majority of executives identified trust and transparency as one of the most critical issues facing both regulators and the Investment Management industry. Regulations that introduce more transparency - such as the review of the Markets in Financial Instruments Directive (MiFID) - are much needed, argues one executive. “Unless the investor recovers trust in the industry, we are all dead.”
Fees charged throughout the value chain are also under particular scrutiny by regulators and investors. Many jurisdictions including the EU, Australia, the UK and the US are considering reforms to enhance and enforce transparency in commission arrangements. In turn, this will force investment managers to rethink and restructure their traditional intermediary compensation arrangements, and may conversely add a level of complexity to their product offerings. “To my mind, the jury is still out on that,” adds one respondent, “whether in the interests of pure transparency, we forget consumers like the approach of pure simplicity.”
Market consolidation and acquisitions
Significantly, many executives felt that increased regulation may spur a bout of consolidation and acquisitions as smaller firms seek scale to reduce the individual cost of complying with regulation. At the same time, asset managers in more restrictive jurisdictions may choose to exit some or all of their business activities rather than deal with the growing compliance burden, thus creating opportunities for market leaders to further consolidate their position.
“Overwhelmingly, the attitude of the Investment Management industry is positive and upbeat in the face of increased regulation,” notes David Seymour, KPMG’s Global Head of Investment Management. “Our survey shows that most of these organisations will embrace new regulations knowing that – in the long run – they will bring about a stronger business and investment climate, and rebuild investor trust. Overall, we believe the Investment Management industry is adapting well to the challenges of increased regulation.”
About the research
The research for “Keeping ahead of the curve” was conducted in February and March 2010 by KPMG International and KPMG member firms. The interviews represent the views of 17 Investment Management organisations, which combined had more than US$6.5 trillion in assets under management. In total, 12 chief executives and five other senior executives were interviewed from across the United States, Europe and Asia-Pacific.
A copy of the study is available here.