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Getting The Deal Through

Global overview

Michelle Moran

K&L Gates LLP

Wednesday 31 July 2019


Geopolitical tensions and unfavourable economic conditions in 2018 led to a steady erosion of investor confidence in the asset management industry, and there were significant contractions in the market throughout the year. Global mutual fund assets (not including regulated funds-of-funds assets) dipped to $46.7 trillion by year end 2018, marking a decline of approximately $3.66 trillion since the end of 2017 (when assets held were $50.36 trillion). This decline was likely due to the number of hurdles faced by the asset management industry over the past year, with Brexit and the US–China trade war being notable examples. The increased regulatory burden on asset managers also made the 2018 market a difficult and complex area to navigate, and coupled with unprecedented political instability, this dealt a blow to the industry. Furthermore, bringing new investors to the market has proved challenging. Large pension pots remain uninvested and asset managers are struggling to engage millennials in investment activities, despite growing interest in cryptocurrencies and fintech. In this ever-evolving tech-focused environment, asset managers must rise to these challenges, or face even bleaker results in 2019.

Against this background of market instability, asset managers are facing ever higher regulatory burdens and compliance standards. In the wake of the financial crisis, regulators have focused on the need to limit high-risk strategies and are encouraging managers to focus on long-term value creation for their investors. An emphasis on disclosure continues to be a theme, with regulators and investors alike demanding increasingly more information from asset managers regarding risk, investment strategy and provisions for liquidity management. This focus on disclosure is evidenced by the introduction of Annex IV reporting in the European Union under AIFMD, requiring managers to routinely report key information to their regulators. This continues to reflect the general regulatory emphasis on increasing transparency and disclosure, thereby allowing regulators to maintain a closer eye on the markets, with the aim of preventing another global financial crisis.

The election of Donald Trump as president of the United States in 2016 and the as-yet undetermined outcome of the UK’s Brexit negotiations have perhaps not caused the sharp decline in the markets that was initially feared, but the Capitol’s unpredictable political policies have begun to take their toll on the market. While President Trump has carried out his election mandate to scale back many of the regulatory provisions that arose in the wake of the 2008 financial crisis, this does not appear to have given asset managers the regulatory free rein that was anticipated. Increased sanctions on trade with China have continued to cause disturbance in the markets and President Trump’s UK state visit is likely to raise more questions about the future of the ‘special relationship’ between the UK and the US. The year 2018 was difficult and unpredictable for asset managers across the Atlantic, and indeed the globe, and investors may face low market returns in 2019 if these trends continue.

Amid these challenges, however, the fund industry continues to grow, and some new regimes bring new opportunities. In the UK, for example, changes to the rules governing what retirees can do with their pension benefits have opened up a new section of the market to both asset managers and product providers. Increased interest in environmental, social and governance (ESG) strategies has changed priorities of funds and turned attention to new investments. Some clarity on the Brexit issue could drive a boost in the market over the coming months, and the continued opening of the Chinese market to more foreign investment may bring new energy to the industry as a whole.

Americas

United States

2018 was a volatile period for the US investment fund industry. US regulated open-ended funds held $21.1 trillion in total net assets at the end of 2018, reflecting a decline of almost 5 per cent in total net assets compared to year end 2017 ($22.1 trillion). This decline in the US regulated fund market, which is a clear shift from previous year-on-year growth, is perhaps surprising, considering the overall economic pick-up in the US over the course of 2018, with real GDP expanding at a 3 per cent rate, compared to 2.5 per cent in 2017. However, the federal funds rate was increased four times during 2018, and while this was expected, guidance issued by the Federal Reserve left the market unsure about potential future interest rate hikes and monetary policy. These actions have led some participants to be concerned about the possibility of a recession, which, coupled with President Trump’s erratic policies, has left the market in an unpredictable position.

Key US regulatory themes are discussed below.

Broker dealers and investment advisers

On 5 June 2019, the Securities and Exchange Commission (SEC) voted to adopt a suite of new regulations to govern the relationship between broker-dealers and investment advisers and their clients. The Regulation Best Interest (RBI) policy requires broker-dealers to act in the best interests of retail clients, and put investors’ interests before their own when making any recommendations pertaining to investment strategy. Investment advisers and broker-dealers will also be required to produce a customer or client relationship summary (in the ‘Form CRS’), which will disclose information on fees and expenses incurred in the course of carrying out the service for the client, and set out the scope of any fiduciary duties owed by investment advisers to their clients. The RBI policy and the Form CRS regulation will come into force 60 days after they are published in the Federal Register, and will allow for a transition period until June 2020.

Other future reforms by SEC are expected, including amendments to the framework within which exchange-traded funds (ETF) obtain registration. Such reform would remove the requirement to obtain an exemptive order from the SEC prior to operating an ETF in the US. Registered funds could also see a significant change in the way in which public offerings are approached in the future, as engagement with potential institutional and qualified investors may be permitted by the SEC in advance of a public offering, allowing funds to test the waters. Finally, the SEC has raised the possibility of changes to the rules around Business Development Companies, which could allow more flexibility in how these particular companies are able to operate.

Advisers Act

It is anticipated that there will be revisions to the Advisers Act advertising rule in 2019. Although the details have not been confirmed, possible changes may include the codification of social media and electronic communication guidance, which will be welcome in today’s internet-focused world. The rules may also be split to separately accommodate communications with retail clients and sophisticated clients. It has also been suggested that the restrictive approach to the rules may be revised, as there are concerns that certain communications that are not misleading are being unreasonably characterised as per se fraudulent. It is hoped that a less constricting approach will iron out these errors. Looking even further forward to 2020, amendments to the Global Investment Performance Standards (GIPS) are planned in order to enable a broader adoption of these standards among alternative investment managers.

Cybersecurity

Once again, the SEC has set out cybersecurity as a priority for funds. Key areas of focus include governance and risk assessment, data loss prevention, training and incident response. The SEC has emphasised the particular importance of retail trading information security, and in March 2019 the SEC announced its third cybersecurity-focused sweep exam. It remains to be seen what weaknesses and areas for improvement have been highlighted in this exercise and what, if any, regulatory measures will be taken in response.

Cryptocurrency and initial coin offerings

In December 2017, the chairman of the SEC issued a statement on the recent growth of cryptocurrencies and initial coin offerings, and the potential need for increased regulation of tokens being offered as securities. This focus on cryptocurrencies has continued, and in April 2019 the SEC released new guidance on digital assets. In March 2019, the SEC also sought comment from the industry as a whole, through the issuance of a letter to the Investment Advisers Association regarding the application of the Advisers Act custody rule to investments in digital assets such as cryptocurrencies.

Canada

Total net assets of Canadian mutual funds reached $1.16 trillion by the end of 2018, showing a decline from figures at year end 2017 (total net assets of $1.3 trillion). However, despite optimism from many commentators, and claims that the Canadian funds market has remained buoyant, Canada is not immune from the concerns that plague the rest of the global market, namely a persistent lack of investor confidence. This much is clear from the draft Statement of Priorities released by the Ontario Securities Commission (OSC) for 2019/2020, which stated their intention to ‘champion’ investor protection and pursue ‘fair, vigorous and timely enforcement’ in relation to compliance. The Canadian Securities Administrators (CSA) have recently embarked on a comprehensive reform project to bring Canadian mutual fund rules up to global standards in mutual fund product regulation, and there is a clear intention to protect investors with strengthened regulatory provisions, in order to encourage a resurgence of investor confidence.

Latin America

At year end 2018, despite a dip in net assets to $1.1 trillion, Brazilian mutual funds under management maintained their marked improvement from the significant contraction experienced in 2015 (due to the impact of Brazil’s political controversies). This figure is a decrease on the final position of 2017, when funds had rebounded to exceed $1.3 trillion in net assets. Brazilian mutual funds currently make up 86.6 per cent of the Latin American market (Argentina, Brazil, Chile, Costa Rica, Mexico and Trinidad and Tobago comprising the remainder), and given the way funds have rallied since 2015, Brazilian market dominance looks set to continue.

In the wider region, a tech-friendly environment and rising efficiency ratios have begun to attract millennial investors to the market. This influx of new investment is thought to be a key component of the region’s stable outlook for 2019/2020. Eager to attract global investors, who may already be lacking in confidence, companies are taking a harder stance on corruption, eager to erase any perception that local companies could be supporting volatile or untrustworthy regimes. Changes can already be seen: in Peru, for example, Odebrecht agreed to pay a $182 million fine to Peruvian authorities in order to continue operating, and Peru is also investigating all four of its most recent presidents for corruption charges. It is anticipated that there will be more arrests and fines in 2019.

In Chile, the November 2017 election of new right-wing president Sebastián Piñera was initially thought to be positive for the economy after several years of low growth; however, the government’s popularity is beginning to wane. Unemployment remains high, and with Mr Piñera lacking a majority in Congress, any economic reform will meet with much opposition. Accordingly, many expect that Chile will not perform as strongly as other countries in this region in the coming year or more.

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