By Jason Sumner
Ever since the financial crisis, global markets have being through a period of transformation, massive reform pressures and capital impacts. The markets are seeing a radical change and where once there was a clear view of the financial regulations and their impact across businesses and operations now the raft of new rules brings a multi dimensional impact. All of this of course also provides opportunity. The sell-side are making the best of this, dealing with the wave of regulation, legislation and directives, through complying, exiting or developing new businesses.
For the buy side, they too have been impacted, although not all have reacted at the same pace. Typically operating under a more self-assessment governance model this is changing and the spotlight is now firmly on this side of the sector. For those impacted, its time to really think about the future.
Recent legal cases have seen some financial service managers punished for not only financial matters, but also not having a robust and importantly transparent operating model. Regulatory fines have seen firms punished for weak or non-compliance within Custody.
Increased regulatory scrutiny continues to drive the need for rigor for the appropriate operating models. Historically, Asset Managers, Investment Managers and Hedge Funds have had a fairly standard model to operate under with a number of variable execution options available to them. Now Wealth Managers, Private Equity, Private Banks and Family Offices are also under the refocused spotlight of the regulators and lawmakers. They all need to adapt to ensure the business models, operating models, operations, systems, processes, documentation, transparency and governance within their firms evolves in line with regulatory reform and the evolving markets. This requires considerable expertise, access to technical and subject matter research, resource and time to execute and deliver.
So where is the change? The buy-side has at least three major areas of focus (if not more)
UCITS V, AIFMD and the big one MIFiD II
Directionally they all require the same thing of the buy-side community: Transparency, Reporting, Client Protection, Documentation and Risk data aggregation. The challenge is the requirements and impact are all slightly different and in some cases overlapping especially once cross-jurisdictional legislation is brought into the equation. The further challenges are ensuring initial compliance, implementation into internal structures, on-going demonstration and evidencing of compliance and finally implications to business strategy and operating models.
UCITS V for example seeks to focus on depositary functions, remuneration policies and sanctions. The directive introduces new rules on UCITS depositaries, such as the entities eligible to assume this role, their tasks, delegation arrangements and the depositaries’ liability as well as general remuneration principles that apply to fund managers.
- Single depositary for each UCITS, disallowing the appointment of multiple depositaries
- Harmonisation of the duties of a depositary to keep the assets of the UCITS safe, monitor cash movements to and from the fund and oversee the fund manager’s performance of its key functions
- Specific safe-keeping requirements that a depositary needs to comply with in respect of financial instruments that may be held in custody as well as for other assets, including segregation requirements for assets that are held in custody
- Member state requirements to ensure that assets held in custody by a depositary or its delegate are protected in the event of the depositary or its delegate becoming insolvent
- Liability regime making the depositary liable for the avoidable loss of a financial instrument held in custody
- UCITS management companies to have remuneration policies, complying with certain remuneration principles
AIFMD for example has required a comprehensive framework for regulation of alternative investment fund managers, including a more robust reporting regime, duties of the depositary, passporting and remuneration rules as well as marketing requirements for non-EEA managers with some challenges across member states.
- Reporting regime requiring firms to provide a comprehensive set of reporting to the appropriate member state authority
- Passporting designed to encourage fund managers to bring their fund structures within the EEA to benefit from a harmonised distribution market, however discrepancies between Member States in their implementation have resulted in confusion and challenges for managers expecting to benefit from a single entry point into the EEA.
- Marketing for non-EEA managers when marketing non-EEA alternative investment funds to professional EEA investors will require firms to navigate a number of hurdles across the Member States
…and lets not forget MIFID II, quite possibly the biggest set of requirements to ever be slapped on the buy-side. Given its an extension of the original MIFID directive which pretty much bypassed the sector, it starts at a disadvantage.
For MiFID II, thematically five key areas need to be addressed by each buy-side firm, although this list is by no means exhaustive.
- Best Execution and order flows, impacting pricing, trading flows, order systems and execution venue publication
- Transparency regime brings big data implications for pre and post-trade management and flows, highlighting a need for centralised data management. Request for Quote transparency also needs to be managed
- Transaction Reporting, requiring an increase in trade flow information, more than EMIR
- Client Categorisation with focus on service provision and a rather extensive and onerous re-papering programme. Retail vs Professional Client treatment and surveillance
- Product Governance and Manufacturing, focusing of fees, client information, un-bundling and research
In addition to these is the vast potential scope of products/ instruments likely to be covered, subject to a classification and impact. Vast simply does not do it justice, however, like the sell-side, the buy-side sector will need to seriously think about the products they wish to offer their clients and also the instruments they trade underlying those products. Restrictions, definitions, offering memorandums, prospectuses, trading obligations, transparency, processes, reporting, client safeguards, conduct rules, documentation, governance, organisational requirements / models and costs are all considerations for the buy-side to address.
This month the MiFID II RTS will finally be published and the sector will have better clarity to react and although they will still need to be adopted, surprises are unlikely. With this big thought provoking impact and with the window to implementation and compliance being relatively small, unlike previous compliance programmes this one will make firms really think about their future, its businesses, models and cost base. Smaller boutiques could even exit completely.
It doesn’t end there either. The buy-side can look to expect the unprecedented reform focus the sell-side have experienced going forward, certainly with an outlook over the next five years. Systemic and operational risk concerns continue to highlight the ‘scrutiny approach and governance’ of the third-party outsourcing relationships of the custodians, TA’s, Fund Accountants and pure outsourcing, leading to model reviews, process and control challenges. The sector can also look to expect more regulatory on-site visits, inspections and requirements to provide data swiftly to demonstrate compliance. All of these things require not just the immediate need to initiate a compliance programme, but more strategic thinking and planning programmes.
Print version here Time to really think about the future