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FCA Investment Management Review

The active asset management community was dealt a shock by the UK’s Financial Conduct Authority (FCA) on 18 November. The FCA’s Asset Manager Market Study castigated the active management industry for collecting high fees and delivering unsatisfactory performance. The FCA found active managers charged on average a management fee of 0.9% whereas a passive provider typically incurred costs of 0.15%, although the latter had generated superior returns.

The FCA’s paper made a series of recommendations around active managers’ cost structuring, including the possibility of “an all-in-fee model”. This approach would force firms to cover all of their costs in a single fee including transaction charges. The FCA’s objective is that it wants investors to understand what they are paying for. As such, this is likely to result in active managers being forced to reduce their fees.

This poses a problem for managers as their compliance costs have been steadily growing. A 2015 survey by Alpha FMC of asset managers running a total of £6 trillion in Assets under Management (AuM) found 78% of respondents expected to spend more on regulatory compliance over 2016, while 89% said they would devote greater time to dealing with regulatory matters. A paper by Citi in 2015 said small hedge funds, for example, were struggling to pay for their operating costs through their management fees alone, estimating a manager required at least $310 million in AuM to breakeven. Active managers, particularly boutiques, are facing huge cost challenges.

Post-crisis regulation has had a significant impact on the industry. A number of US and EU regulations including Dodd-Frank, the European Market Infrastructure Regulation (EMIR), the Markets in Financial Instruments Directive II (MiFID II), the Alternative Investment Fund Managers Directive (AIFMD), the Foreign Account Tax Compliance Act (FATCA) and the Securities Financing Transaction Regulation (SFTR) have bumped up firms’ operating costs in an era of declining profits.

Regulatory reporting is a frustrating and expensive process. Reports across different geographies have a number of parallels, but also marginal differences in terms of data formats, deadlines and calculations. For example, some regulators adopt conflicting mathematical formulas around AuM calculations, meaning managers occasionally have to report inconsistent figures into multiple jurisdictions. Submission deadlines are not synchronised which also adds to workloads.

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Most frustratingly, the submission process is not in tandem even within the EU, whose rules are supposedly meant to be harmonised. A manager may be expected to file an Annex IV, the AIFMD reporting document, to one EU regulator via an online portal, but to another through email, PDF, fax or post. There are also variances in the data demanded by local regulatory bodies. Not only is this chronically inefficient for the manager, it is highly complicated for regulators.

A manager has to check and verify that the data submitted in these reports is in accordance with each regulator’s bespoke requirements, and this takes time, cost and energy. Meanwhile, regulators simply have an information overload, which is unstructured. This undermines investor protection and the regulators’ ability to observe and react to systemic risk events in capital markets.

In short, regulatory demands for managers have shot up, while some national authorities are insisting that firms lower their fees, as are some of their investors. This is calling into question the ability of organisations to run their businesses and operations to an institutional standard. But are there ways in which managers can scale down their operating costs to enable their businesses to withstand this fee pressure? Blockchain technology may hold the answer.

Reporting onto a Blockchain is simple. The data is supplied in sequence and cannot be changed or tampered with. If regulators in the jurisdictions in which managers are based/marketing into can attain permissioned access to the data on Blockchain, then the need for organisations to supply bespoke reports all over the world would be precluded. A Blockchain would also mean that data submitted is harmonised. Standardisation has been a core objective of global regulators and industry bodies for years, and Blockchain is a tool that can make it a reality.

Reporting via Blockchain would also likely lead to data being more timely and accurate enabling regulatory agencies to spot risks/potential frauds rapidly. A Blockchain environment for reporting would make it easier for regulators to flag up spurious behavioural trends at market participants with their counterparts in different countries, leading to a more joined up enforcement approach and enhanced investor protection.

Blockchain adoption would save costs for all parties. Fund managers could dramatically wind down a number of their overheads if data is submitted on Blockchain. Would it be necessary for a manager to appoint a fund administrator to produce these customised reports on their behalf, or for lawyers to continuously review different EU member states’ rule books for minutiae legal changes or subtle adjustments to the reporting requirements? The answer is probably no. In short, managers would enjoy spectacular cost savings if this technology becomes the industry norm.

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