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Today New City Initiative is comprised of 47 leading independent asset management firms from the UK and the Continent, managing approximately £500 billion and employing several thousand people.

Displaying articles for 2 2019

Is the Big Data Risk to Big to Bear?

Is the Big Data Risk to Big to Bear?

Depleting returns interlaced with excessively crowded trading conditions have forced asset managers to contemplate alternative approaches towards generating better performance for clients. By systematically integrating bottom-up, in-depth data – often supplied by external technology providers or bank counterparties – and then leveraging AI to conduct deeper analysis of securities, sectors or markets is one way fund managers could suppress the post-crisis downward return spiral, and revert to profitability. Or at least that is theory.

The reality is more ambiguous. Not only are genuine doubts being flagged about the actual reliability of data (i.e. its authenticity in the context of unchecked fake news and the superfluity of online misinformation) being used to furnish investment research, but firms are also being warned they risk inviting regulatory scrutiny if data is acquired improperly or used inappropriately. If managers are found to have inadequate controls or weak data governance, the consequences could be severe. A prudent data strategy is therefore key.

Know where the data comes from

Service provider (e.g. fund administrator, custodian,) selection requires asset managers to conduct intense vendor due diligence beforehand. A similar approach needs to be adopted by managers when engaging big data providers so as to validate that their service offering is robust and the information being supplied is accurate. Equally important is that managers corroborate that these providers are obtaining data responsibly through legitimate channels, and that they have full oversight over where the information is sourced from.

Aside from the obvious risk of nursing steep losses by incorporating imprecise or inexact data into the investment decision-making process, firms could also find themselves in trouble for breaching GDPR (General Data Protection Regulation) rules if they acquire or use information illicitly. Regulators including the Financial Conduct Authority (FCA) have put the financial services industry on notice warning them that misuse of consumer data will not be accepted.[1] As the regulatory tide turns against big data, caution must be exerted by firms.  

Big data and a possible regulatory onslaught

Regulation is perhaps the biggest threat to the big data industry. With the increasing repudiation of technology companies unconstrained use of consumer data, the financial services industry needs to tread carefully. More alternative data firms are moving into the market offering fund managers everything from anonymised, aggregated reports on consumer credit card spending habits right through to cellular phone location information – all of which are designed to give investors additional insights into underlying market trends.

Firstly, it is crucial that data used by managers does not contain any personally identifiable information on the end consumer, although this is something institutions appear to be reasonably vigilant about. In addition to privacy protection, it is entirely possible regulators may start deliberating on whether some of the alternative data providers are bestowing investors with an unfair competitive advantage. While the US Securities and Exchange Commission (SEC) has not yet issued any enforcement action against users of alternative data, it is reportedly monitoring developments carefully.[2] Given the SEC’s takedown of expert networks in the early 2010s following a series of hedge fund insider trading scandals, alternative data providers could be a potential target for future regulatory investigations.

Big data as an operational enabler

On the investment side, firms need to be careful about where they source information from, and how they use it. Increasingly, however, fund managers are making more use of data as it applies to their operations. For instance, a number of custodians are scouring through clients’ trade settlement data to see whether they can prevent trade fails using predictive analytic tools thereby netting investors’ cost and risk benefits.  Elsewhere, big data from multiple sources and counterparties is being mapped with AI technology and used to help firms with their regulatory compliance requirements. This can expedite and improve the quality of regulatory filings, to the benefit of both managers and their market supervisors.  


[1] Reuters (July 11, 2018) FCA warns financial firms over big data

[2] Financial News (December 6, 2018) Risks and opportunities in fund managers’ big data boom

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M&A: Too Much Activity?

M&A: Too Much Activity?

In the aftermath of the financial crisis, many asset managers saw M&A with their competitors as a means to survival, principally a necessary evil by which to preserve their businesses amid the tumbling markets and as a counterweight to offset the sheer volume of client redemptions. Since then, M&A activity at asset managers has grown progressively year-on-year. According to data compiled by Sandler O’Neill, a US investment bank, there were 255 recorded deals in 2018, involving $3.71 trillion in AuM (assets under management), up from 210 and $2.88 trillion respectively in 2017.[1] This trend is not decelerating, and it is something that is likely to disproportionately impact boutiques firms.

A combination of challenging performance conditions, surplus regulation, rising internal costs (i.e. growing operational, technology and compliance spend) and the increasing ubiquity of ultra-low cost passive funds have helped create an environment that is ripe for consolidation to thrive. With excessive consolidation, however, comes a number of problems. Firstly, it means that the big shops have accumulated even greater, dominant market share. Analysis by Willis Towers Watson, for example, found the combined assets overseen by the 500 largest fund managers had reached $93.8 trillion, of which, the top 20 firms controlled an unprecedented 43% of assets, accounting for around $40.6 trillion. [2]

In addition to creating concentration risk in just a handful of large asset management providers, uncontrolled consolidation is depriving investors of much-needed choice. The decision also taken by some high-profile distributors to rationalise the number of fund products they sell has not helped matters either. For instance, Deloitte found five out of the eight leading US distributors have culled around 4,900 funds in the last two years alone.[3]  Boutique fund managers have been hit the hardest by this. As these managers are often the ones providing customers with access to niche or specialist markets, anything that threatens their collective existence could have adverse consequences on the investor community.

Even though rampant consolidation may result in fee compression across the industry, it could potentially preclude investors from acquiring diversification, potentially leading to a weakening of returns. Echoing these comments, the US Securities and Exchange Commission (SEC) has publicly confirmed that it is worried about the impact asset management consolidation is having on investor access to small and medium-sized funds. In fact, the SEC has since acknowledged it will review the barriers currently facing boutique managers as part of an industry outreach initiative over the course of 2019. NCI firmly welcomes this SEC stance, and would strongly advise the UK FCA to do something similar.

 

[1] Pension & Investments (January 7, 2019) Alternatives firms fuel 2018’s increase in M&A

[2] Willis Towers Watson (November 16, 2018) The World’s Largest 500 funds managers – year ended 2017

[3] Deloitte – 2019 Investment Management Outlook: A Mix of Opportunity and Challenge

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Are We At The Technology Tipping Point?

Are We At The Technology Tipping Point?

Innovation is something asset managers should absolutely embrace. Simply disregarding change is a sure-fire catalyst for disintermediation, either from more forward-looking peers or new market entrants. At a time when active managers are losing assets and clients to cheap passive providers, it would be foolish for firms to ignore some of the technological advancements that are happening right now in financial services. Simultaneously, asset managers need full assurances that these technologies actually deliver value and are safe. As many of these technologies have been sensationalised, NCI takes an unbiased look at the progress made so far by disruptors, assessing how they may or may not benefit members.

Blockchain: Unfinished business

Blockchain is a product synonymous with unadulterated hype. Not only have most proof of concepts (POCs) at service providers led to nothing, but the Blockchain start-up market has undergone massive consolidation. Blockchain over-promised and under-delivered, although it is unfair to label the technology a failure. At only 10 years-old, Blockchain is still in its infancy and some trials – especially in post-trade equity markets, mutual fund distribution and trading of digital securities– have shown promise. In time, more tangible use cases will become visible, contingent on market-wide standardisation and interoperability being achieved. While Blockchain has lost its momentum lately, the technology should not be written off, as it may well play a meaningful role in asset management in the next few years.

Big data and AI

As returns receded, some institutional asset managers believed they could acquire a competitive and information advantage by using AI technology to disentangle big data, thereby energising performance. The reality has been somewhat different. Firstly, a lot of data  – it turns out - is fake (often generated by malicious chat-bots or through spurious social media channels), meaning firms need to be extra diligent about inputting information into algorithms, particularly if those AI tools are being used to identify key trends and potential investments. As fiduciaries to client money, making an investment decision off the back of badly constructed or misinterpreted data could be fatal for any asset manager.

The next big obstacle is that asset managers need to validate where the information came from insofar it has not been obtained from illicit sources (i.e. stolen records) or in breach of the EU’s GDPR (General Data Protection Regulation). Such data due diligence is not a small endeavour, and many firms – especially boutiques - may struggle to carry it out effectively. In the context of growing consumer opposition towards organisations profiteering from data, some asset managers may feel it is not worth the risk. For now, the asset managers using big data analytics – are doing so to complement their research, not replace it. In time, this may change as firms become more sophisticated in how they acquire and analyse data.

Robo-advisors

Like Blockchain, robo-advisors promised an awful lot but delivered an awful little. With retail customers deprived of advice as a result of MiFID II (Markets in Financial Instruments Directive II), experts were confident that cheap robo-advisory services would democratise the investment process. This has clearly not happened yet. The profitability of robo-advisors is linked to scale, and most providers have been unable to build large enough customer bases. Equally, research is beginning to show that robo-advisory platforms have not delivered adequate performance. For instance, a recent study showed that robo-advisory users with low-risk portfolios achieved a return of 0.8% in the 12 months leading to June 2018, versus the 1.17% they would have accumulated had they invested in a cash ISA.[1] At present, robo-advisors are not a threat to the wealth and asset management business.

What the future holds…

Even though some of the so-called disruptors have not uberised or dramatically reshaped the asset management industry yet, that is not to say they won’t. Technologies like Blockchain, big data and robo-advisory platforms will evolve and it is something NCI members should pay attention to. At present, the most significant challenge to asset managers lies with existing large technology companies.  Asset managers only need to look at China – where the Alibaba-owned Yu-e Bao fund – has become one of the world’s biggest money managers, having only launched in 2013. Agility and open-mindedness will be critical if boutiques are to flourish as disruptors mature and become increasingly ubiquitous.


[1] Financial Times (August 24, 2018) Robo advisers fail to beat market benchmark

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Some Regulatory Changes You May Have Missed

Some Regulatory Changes You May Have Missed

The next few months are going to be challenging for NCI members. Firstly, the constantly interchangeable dynamics around Brexit are generating enormous regulatory and market uncertainty. In addition, asset managers are bracing themselves for a raft of regulatory changes including a tightening up of ESG (environment, social, governance) investment provisions; the possible introduction of amendments to the Alternative Investment Fund Managers Directive (AIFMD) and a roll-out of stricter margining obligations for bilateral, un-cleared OTC instruments under the European Market Infrastructure Regulation (EMIR). With so much activity underway, other equally pressing matters have received far less air time.

The LIBOR bugbear facing boutiques

From 2021, LIBOR, which benchmarks interest rates for a whole stream of financial products (securitisations, loans, derivatives, etc.) will not exist. Admittedly, some asset managers have spent a lot of time readying themselves for the move to overnight risk free rates, but a lot of firms are still unprepared.  So why does it matter? Any boutique firm trading bonds or using derivatives could find the behaviour, valuations and risk modelling underpinning those instruments changes markedly as a consequence of this shift to alternative rates. Asset managers therefore need to begin inserting fall-back provisions into their contracts, or repapering them altogether, in what could be a very costly and time-consuming exercise.

Why the buy side should start caring about settlements

For many boutiques, the responsibility for ensuring their trades settle on time lies with their custodians or brokers. Under CSDR (Central Securities Depository Regulation), this could change. CSDR, having introduced a t+2 settlement regime inside the EU, is now fixated on imposing better settlement discipline in the market. The CSDR rules give CSDs the authority to fine guilty counterparties in instances when settlements do not complete on the contracted settlement date. As such, boutiques could find themselves incurring large fines if they do not deliver securities in good time to their brokers.  If NCI members are to avoid these penalties, they need to start delivering securities to their brokers much faster.

More to the EU than just Brexit

While Brexit has dominated discussions in Europe, much less has been said about the EU’s increasingly fractious relationship with Switzerland. The root of the EU-Swiss dispute lies with MiFIR (Markets in Financial Instruments Regulation) Article 23, a clause which states that any trading of shares by EU investment firms must take place on a recognised trading venue. While Switzerland’s trading venues currently have EU equivalence, that designation is up for review in June 2019, which is causing widespread uncertainty. If equivalence is refused, EU investment firms could be prevented from trading equities at Swiss venues.

Somewhat irked by this prospect, the authorities in Switzerland have announced countermeasures which will bar foreign trading venues from listing or admitting to trade any Swiss companies [1] unless that venue is recognised by FINMA, the national regulator. For third country venues to qualify for FINMA recognition, a precondition is that the venue must be operating out of a market which does not prevent its local investment firms from trading Swiss shares in Switzerland. Again, not only does this create challenges for investment firms but it risks leading to companies listing outside of Switzerland or holding off their IPOs. [2]


[1] Loyens Loeff

[2] Loyens Loeff

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A Brexit Breather for U.K. Fund Managers

A Brexit Breather for U.K. Fund Managers

The risk of a no-deal Brexit has now become unacceptably high for financial market regulators. Conscious that the uncertainty was fuelling instability, European and UK regulators signed two significant MOUs (memorandum of understanding) at the beginning of February 2019 in what should help ease industry concerns about the risk of a Hard Brexit. Both MOUs will only take effect if there is no deal in place ahead of March 29, 2019.

The first MOU, which was announced on February 1, 2019, applies to fund management. In short, it is a multilateral MOU between European market regulators and the UK’s Financial Conduct Authority (FCA) covering exchange of information and delegation of portfolio management to UK authorised firms. This comes more than six months after the FCA announced its temporary permissions regime (TPR) for EEA funds passporting into the UK.

The fact that European securities market regulators have reciprocated on the FCA’s TPR is a positive development, as it confirms that existing delegation frameworks can be retained should there be no deal. Not only does this give UK managers a degree of continuity in the event of a Hard Brexit, it also safeguards fund hubs such as Luxembourg and Ireland. These MOUs will therefore help insulate asset managers in the EU and UK from significant disruption, and it is something which is strongly supported by New City Initiative (NCI) and its constituents.

In its statement, the European Securities and Markets Authority (ESMA) also confirmed an MOU concerning information exchanges about the supervision of credit rating agencies and trade repositories had also been signed too and would cover a no-deal Brexit. Given the EMIR (European Market Infrastructure Regulation)-mandated oversight role that trade repositories play in monitoring the on-exchange and over-the-counter (OTC) derivative markets, this MOU will help regulators in their efforts to prevent build-up of systemic risk.

Last week, ESMA also announced a further MOU had been agreed with the Bank of England (BOE) whereby it confirmed it would recognise UK CCPs (central counterparty clearing houses) and CSDs (central securities depositories). This MOU was expected, particularly as ESMA had repeatedly acknowledged at the end of 2018 that it supported continued access to UK CCPs and CSDs in order to limit any possible disruption post-Brexit. Ensuring the continuation of clearing and settlement activities post-Brexit was critical to market stability.

While some European leaders insisted that certain derivative transactions be cleared inside the EU post-Brexit, the practicalities of forced relocation never made much sense. Firstly, repatriation of euro-denominated clearing risked sparking a protectionist battle between major economies (i.e. US and Japan) whose currencies are overwhelmingly cleared outside of their home markets. Secondly, the policy would have caused fragmentation at CCPs inflating margin costs, a point made by a number of EU derivative users themselves.

Even though the EU has some CCP infrastructure of its own, it does not come close to rivalling London in terms of product solutions and talent depth. This was – again – an argument made by some pragmatists within the EU. The final issue impeding repatriation of clearing was politics (of course) whereby some markets insisted euro-denominated clearing take place in Eurozone economies only, a demand that was met with fierce opposition from non-Eurozone countries such as those in Scandinavia and Poland.

The MOU covering CSD recognition was also urgently required, mainly because only CSDs regulated under CSDR (Central Securities Depository Regulation) could settle EU trades, an issue that was likely to prove awkward for the Irish. Ireland is something of an oddity within the EU insofar as it does not have its own national CSD, because its securities’ market is so small. Instead, Irish securities are settled on Euroclear UK’s CREST platform. The MOU assuages Ireland’s securities market and precludes the country from setting up its own CSD. 

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