It is already becoming clear that many of the themes and trends that dominated the asset management and investment funds agenda in 2017 are likely to continue throughout 2018 and it is very much a case of more of the same. Such continuances include the trend of consolidation within the asset management industry as managers seek to alleviate cost pressures through increased economies of scale, the growth of exchange-traded funds (ETFs) and passive strategies as well as the growth in alternative asset classes, such as private credit. The launch of alternative investment funds employing debt-focused strategies is a particular trend that we continue to see our clients following. However, it is the shadow of Mifid II and Brexit that continue to loom over the industry as we head into 2018, and these items are likely to place significant demands upon the asset management industry during the year ahead.
MIFID II
On 3 January 2018, Mifid II finally came into effect following a drawn-out implementation period which, in case anyone needs reminding, also included a one year delay. The collective effort exerted by the asset management industry in preparing for the implementation of Mifid II cannot be understated. Although last year was an intensive period when the industry did all it reasonably could to get ready for technical implementation, this year will be a very important period for the industry, which many will face with some uncertainty and trepidation as the impact of some of the measures introduced under this expansive piece of legislation become clearer. There has been much discussion and commentary around the potential consequences, both direct and indirect, of Mifid II. The supervisory approach that Esma and the national competent authorities adopt with respect to Mifid II compliance will play a significant role in defi ning these impacts. A case in point is the area of inducements.
Under Mifid II, inducements such as commission payments or rebates cannot be retained by firms who provide advice on an independent basis or portfolio management services. Where firms do not provide advice on an independent basis – i.e. they identify themselves as being nonindependent – they are entitled to retain inducements subject to certain requirements, namely that the inducements they receive are designed to enhance the quality of service to the client and do not conflict with their obligation to act in the best interest of the client. In a fund distribution context, the distributor’s client is typically the underlying investor in the fund.
Although certain EU countries have already introduced similar rules around the payment of inducements – the UK having done so as part of its retail distribution review (RDR) – the introduction of these measures on a pan-European basis has been the focus of much att ention. Initially, during the original legislative process, an outright ban on commissions had been proposed but these proposals were ultimately rejected. The actual impact of the current rules on the distribution landscape is uncertain and much of this hinges on how conservatively the industry interprets the quality enhancement requirements and how closely the regulatory authorities scrutinise this area.
While there was an expectation that the new rules might cause many distributors to abandon rebates and move to an independent model, it is too early to predict the longerterm outcome and the shift is likely to be more of a gradual one. It will be a matt er of time before fi rm conclusions can be drawn on this but subtle changes in the distribution approach can already be seen, with increased pressure on fund manufacturers to tailor their product offerings to the specifi c needs of the fund distributors. It is expected that as distributors move away from the non-independent model and towards a clean share class offering, this is likely to support the continued growth of ETFs as distributors become disincentivised to sell traditional open-ended funds, particularly amid the increasing investor appetite for passive strategies in certain asset classes.
The enhanced rules under Mifid II relating to transaction costs disclosure is another area of Mifid II that remains firmly in the spotlight. While few would argue with the underlying objective of providing investors with greater transparency in order to enable them to make better investment decisions, the approach to achieving this has created confusion and in certain cases has resulted in misleading information being produced given the nature of the proposed methodologies. Similar requirements exist under the Packaged Retail Investment and Insurance- based Products Regulation (Priips), which came into effect on 1 January, and although Mifid II is not as prescriptive in terms of the particular methodology that must be used, asset managers have raised concerns about disclosing different transaction costs data under two separate regulations and many have adopted the full Priips methodology to ensure uniformity. This is also consistent with the recommendation of Esma. However, due to the lack of available intra-day pricing information for certain asset classes, such as fixed income, the results can vary significantly and in some cases have even produced negative transaction costs figures. Asset managers have expressed legitimate concerns about the prescribed methodology and the risk of providing investors with misleading information. Aside from the obvious risk to investors, this also carries legal risk for firms that manufacture and distribute the investment funds.
In addition to the above, Mifid II requirements relating to the ongoing exchange of information between fund manufacturers and distributors is another area that will continue to evolve in 2018. In summary, although Mifid II has now finally been implemented, there is a long way to go to fully assess its impacts from a trading and investor protection perspective, and it is likely to remain a key focus of the asset management industry throughout the next 12 months. The indirect impact upon Ucits fund management companies and AIFMs should not be underestimated either, and it is anticipated that these entities will have increased engagement with their distribution networks over the course of 2018.
BREXIT
Although Brexit was a key issue for the asset management industry throughout 2017, it was somewhat overshadowed by the immediate pressures of Mifid II implementation. The order of priorities is likely to reverse in 2018 as Brexit becomes the predominant issue. Many asset managers have been adopting a wait and see approach until now, but it is anticipated that many firms will move into the implementation phase of their Brexit planning in early 2018. From an investment funds perspective, there are a number of key concerns related to Brexit. One of the most important issues relates to the continued ability of Ucits management companies, AIFMs and self-managed investment companies to delegate portfolio management functions to UK firms. On 13 July 2017, Esma published three sector-specific opinions relating to the anticipated relocation of financial services providers from the UK to other EU member states in advance of Brexit. One of these opinions covered Mifid firms and another covered Ucits management companies, self-managed investment companies and authorised AIFMs. Although the scope of these opinions was limited to the relocation of firms from the UK to the EU, the principles which were outlined in the opinions raised concerns of a broader agenda relating to the issue of delegation by existing EU firms to third countries outside of the EU.
In particular, the investment management opinion and investment firm opinion focused on the need for there to be objective reasons for the delegation of activities to firms outside the EU. Initially, these principles appeared relatively innocuous but they have been the focus of further scrutiny as a result of the subsequent European Commission proposals for reform of the European Supervisory Authorities, under which Esma would be granted powers to assess and potentially override the authorisation of firms which delegate to third countries in a manner which does not meet their requirements. These proposals have been a cause of concern for fund management companies and investment firms that delegate portfolio management activities to UK firms as well as to firms in other third countries, such as those located in the US and Asia. It has also raised broader questions about the longer-term attractiveness of the Ucits brand as third country managers may hesitate to establish products under this regulatory framework if there is a question mark over the ability to utilise investment management resources outside the EU.
In addition to the delegation point, the ability to continue to sell EU-domiciled funds into the UK post-Brexit remains another area of concern for managers. Currently, section 264 of the Financial Services and Markets Act 2000 (FSMA) is the mechanism under which Ucits established outside of the UK are generally recognised for sale to the general public in the UK. In the event of a no-deal scenario, it is unclear whether this mechanism could continue to be used, particularly for newly established Ucits which have not previously been recognised for sale in the UK. Although there have been some encouraging statements on this topic recently from the UK, like everything else with Brexit, the outcome is more likely to be decided upon political issues rather than upon an interpretation of the legislative provisions contained within FSMA.
From an Irish funds perspective, Brexit remains a key priority for the Central Bank of Ireland. It has recently written to the boards of Irish fund management companies and self-managed investment companies, outlining its expectation for proper Brexit planning to have been conducted by those entities. In some cases, it has required formal plans to be submitted to it for review during January and February. Although not characterised as being specifically related to Brexit, the Central Bank of Ireland has also recently conducted a cross-sectoral outsourcing review, requiring firms to submit details of their existing outsourcing arrangements.
Firms that intend to move to the implementation phase of their Brexit planning in early 2018 will also be keeping an eye on the details of any transitional period which may be agreed between the EU and the UK. This is particularly relevant for UK managers that may be assessing the timing of any additional EU authorisations.
In conclusion, although the industry would much rather focus on their product offering and the associated investment related opportunities that exist, it is likely that the compliance and organisational demands of Mifid II, Brexit, GDPR and many other regulatory and political issues will continue to dominate the agenda in 2018.
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