A push by EU regulators to harmonize asset management regulation, and clamp down on their ability to outsource work to outside the bloc, is designed to level the playing field for the industry and prevent regulatory arbitrage. But critics warn that it could harm firms' performance and ultimately damage Europe's capital markets and fund sector.
Click here to find out more about how plans to increase the powers of market regulator ESMA could negatively affect the EU's capital markets after Brexit.
Currently, "delegation" rules are enforced by national regulators, and allow asset managers to delegate — or outsource — portfolio management to other countries. A fund manager based in Ireland or Luxembourg, for example, can utilize fund management expertise in London, or North America or Asia — wherever they find the most capable managers with on-the-ground know-how — while making use of their home country's regulation and support network of lawyers and accountants. Then they can sell to wherever in Europe the retail customers are located.
Now, though, the European Commission is proposing the give the European markets regulator the power to vet how fund managers implement these rules. This will "promote consistent supervision and help avoid regulatory arbitrage," an EC spokeswoman told S&P Global Market Intelligence.
The EU has voiced concerns that, following the U.K.'s vote to leave the EU, certain other countries in the bloc could bend the rules in order to attract British asset managers with the promise of light regulation and the ability to keep much of their presence in London.
A greater burden
But with the U.K. capital playing such an important role in European fund management, this could have a dramatic impact on asset managers in Britain and elsewhere in the EU. The changes will push up regulatory costs for firms, hurt fund performance and, by making it harder to use experts located elsewhere, lead to funds avoiding the EU, according to Denise Voss, chairman of the Association of the Luxembourg Fund Industry.
Delegation practices are an inherent feature of the European fund model, which is recognized as a success story worldwide, Voss told S&P Global Market Intelligence. The structure is emulated elsewhere in the U.S. and Asia, she said.
Luxembourg's financial regulator CSSF has also warned that the changes could be damaging. If delegating tasks to non-EU countries becomes to cumbersome or expensive, the current size of European capital markets and the fund sector could contract, it said.
Following Brexit, the U.K. will become a third-party country under whatever delegation rules then exist. About £1.3 trillion of the U.K.'s £6.9 trillion in AUM are managed on behalf of clients in the European Economic Area, according to the Investment Association, with £900 billion managed for funds domiciled in Dublin and Luxembourg alone.
Consultancy EY has warned that some 15,000 of the current 45,000 asset management jobs in London may become redundant after Brexit.
Those U.K. managers with the largest EU client bases may find themselves under the greatest pressure to move staff or relocate. In 2016, according to a Financial Times report, they included Ashmore Group Plc, Man Group Plc and Schroders Plc, for each of whom mainland European clients accounted for 20% or more of their total assets. Some managers, like M&G, already established fund ranges in Ireland or Luxembourg to sell to EU investors, but will now need to move fund managers as well, padding "brass plate" offices into more independent businesses.
A level playing field
The impetus for the changes stems from the EC's desire to set limits on U.K. market access following Brexit, Lea Hungerbühler, an investment regulation lawyer at Loyens & Loeff in Zurich, said in an interview. It is "obviously a bad development" for U.K. asset managers, along with those in Switzerland that would be affected as well, she said.
The EU for its part argues that current delegation arrangements are unsuited to a post-Brexit future where an enormous part of Europe's investment market infrastructure will fall outside of its purview.
The bloc's market regulator, the European Securities and Markets Authority, or ESMA, has argued that greater supervisory powers for European regulators will "avoid un-level playing fields."
Meanwhile the secretary general of France's Autorité des Marchés Financiers, Benoît de Juvigny, argues that today's light-touch and nationally led regulatory approach contrasts with a "convergence of supervision in Europe" which he says is key in creating a unified European capital market.
Decision-making will move from ESMA's current 28-member Board of Supervisors, made up of heads of national regulators, to a four-person executive board headed by a powerful chairman, all appointed directly by the EC, according to Kevin Murphy, head of asset management at Dublin law firm Arthur Cox.
After the U.K.'s 36% market share of assets under management in Europe, France is in second place with 18%, and Germany third with 9%, according to the Investment Association. The countries hope to use new post-Brexit regulation to increase their role as a fund centers, and both will strongly press for one of their citizens as ESMA's new board chair, Hungerbühler predicted.
With European Parliament elections and Brexit taking place in 2019, the EC will likely push for its draft regulations to become law in 2018, with the new rules taking place three months afterwards. The consent of a majority of the European Parliament and a qualified majority of the European Council will be necessary, the Commission spokeswoman said.