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Costly new rules could force Asian fund managers out of Europe

This article is one of a three-part series.

As asset managers prepare for the January 2018 implementation of MiFID II investor protection rules, S&P Global Market Intelligence investigates the impact on firms in Europe and beyond.

Click here to read about the implications for U.K. fund managers and here for how German firms will be affected.

Asian fund managers are bracing for tougher, more costly regulations in Europe, and some may have to pull back from the continent altogether.

MiFID II rules, due to come into force in January 2018, will increase European asset managers' disclosure requirements and restrict their ability to accept third-party "inducements" that relate to the provision of services to clients. They build on the earlier Markets in Financial Instruments Directive, whose main objective was to increase competition and bolster consumer protection in investment services.

Asian fund managers are not directly under the scope of MiFID II, but they are indirectly covered if they distribute funds in Europe — a market that is second only to the U.S. in terms of size, with about €8 trillion in net assets held by European UCITS funds, according to PricewaterhouseCoopers. Those with big European operations include Singapore's Fullerton Asset Management and Lion Global Asset Management, South Korea's Mirae Asset Global Investments, Japan's Nikko Asset Management Co. Ltd. and China-based Harvest Fund Management.

Asian managers have typically relied on revenue sharing with distributors to help them market their funds offshore. But this will be restricted with the scrapping of inducements — fees, commissions or any benefits from third parties that relate to services provided, and which are seen to create conflicts of interest between a firm and its clients. They have already been outlawed in the U.K., the Netherlands and Switzerland, and will extend to all EU nations under MiFID II.

Rising costs

"This is a huge change," said the head of product distribution at a large Asian fund house, asking not to be named. "We don't have a strong presence in fund distribution in the European market. It will be difficult to sell our funds."

His firm has a sales and marketing office in London and distributes several funds, with a focus on emerging economies, to 15 markets in Europe. In aggregate, these funds have assets under management of $1.8 billion, raised from investors outside the firm's home market.

"Our sales and marketing team will have to work harder to develop deeper relationships with intermediaries," he said in an interview. Alternatively, he said, his firm could hire more people, with the accompanying increase in operating expenses.

SNL Image

MiFID II will make it harder for Asian firms to distribute funds in Europe

Photo credit: Associated Press

MiFID II also requires research reports to be unbundled from brokerage fees, as it classifies research as an inducement for fund managers to place trades with a bank. This could force some fund managers to hire more analysts, increasing costs further.

"The way we deal with broker-dealers now is, the more we give in brokerage commissions, the wider access we get to their research," the fund manager said.

This forced unbundling will only apply to firms with full asset management businesses within the EU, and not to Asian fund managers with limited distribution operations in Europe. But there will nevertheless be pressure on Asian firms to adopt the rules. If other companies comply and tell end-investors that they have done so, it will look strange for the Asian firms not to follow suit, he said.

Complicating matters further is Britain's vote to leave the EU, which will become a significant risk for those with a marketing presence in London should the U.K.'s relationship with the bloc deteriorate. But the fund manager said he was confident the U.K. would take a pragmatic approach and try to gain MiFID II equivalence.

He also said the additional compliance would not prompt his firm to pull back from Europe, as there are still a lot of opportunities there. But others may take a different view.

Retreat from Europe

The compliance burden of MiFID II, together with uncertainty around Brexit, has led many Asian fund managers to rethink their strategy and may lead to a retreat from Europe, according to the head of European business at another Asian fund house, who also wished to remain unnamed. Some managers have already liquidated funds in Europe because investment sentiment toward emerging markets has deteriorated, she said in an interview.

Beyond the clampdown on inducements, possibly the greatest impact of MiFID II will be on the financial products themselves, she said. Fund managers and distributors will need to conduct target market assessments in order to gain approval for products, which could prove onerous. Criteria considered may include clients' investment expertise and asset managers' intended distribution strategy.

"Product design will change," she said. "We will see products more targeted and focused on certain investor segments."

Jason Valoti, a partner at law firm Simmons & Simmons, said distribution agreements would have to change and that Asian fund managers will have to share "significant" amounts of information.

It is also far from clear how different countries will apply the rules, and some are likely to be stricter than others. The nature of such "gold-plating" is awaiting guidance from national regulators, making it difficult for firms to get ready.

"There is a limit to how prepared they can be," he said.