Managing Director & Senior Partner
Banks with asset management operations may soon experience a sense of regulatory déjà vu. Although global regulators focused their reform efforts on large banks and other systemically important financial institutions in the wake of the 2007–2008 financial crisis, they have since been increasing their scrutiny of asset managers—both independent and bank owned—looking for activities and products that might pose systemic risk.
We believe that it is a matter of when—not whether—asset management activities will face rigorous regulatory scrutiny.
Indeed, asset managers themselves have started to formalize a collective view of risk management frameworks and best practices through industry forums such as the Global Association of Risk Professionals. (See Global Asset Management 2016: Doubling Down on Data, BCG report, July 2016.) Such efforts will assist the industry in preparing for further regulatory inquiry.
The evolving proposals by regulators emphasize issues that are most closely related to systemic failure and investor protection, and they would require independent risk functions and ongoing risk governance.
EU regulatory frameworks—such as the Undertakings for Collective Investment in Transferable Securities (UCITS), the Alternative Investment Fund Managers Directive (AIFMD), and the Markets in Financial Instruments Directive (MiFID)—are ahead of those in the US, where an initial set of three rules has been issued by the Securities and Exchange Commission (SEC), with more to come.
With basic risk management frameworks and governance now a norm, the three SEC rules, plus an additional proposal, focus on the key topics for mitigating systemic risk:
Additional proposals by the SEC, along with international recommendations by the Basel-based Financial Stability Board, cite the importance of measures such as liquidity stress testing, business continuity, transition planning, anti-money-laundering, and proper controls for securities-lending activities.
In the US, mixed messages during the presidential campaign suggest that twists and turns lie ahead for US regulatory policy and postcrisis financial reform efforts.
Nevertheless, on balance, we believe that there is strong bipartisan consensus on the need to address market liquidity and leverage. These goals are embodied in the new SEC rules and the additional proposal described previously, which would require formal risk management of liquidity and derivatives, as well as extensive regulatory disclosure and reporting on individual funds.
While asset managers, especially the larger and more complex organizations, have generally made progress in developing risk management frameworks, the level of readiness across the industry as a whole is still very low. The largest readiness gaps are in liquidity risk, leverage through the use of derivatives, stress testing, and reporting.
Given the expected regulatory changes, asset managers with SEC-regulated funds—both independent and bank owned—should act now to do the following:
The most effective and proactive asset management firms are beginning to prepare for the regulatory changes of tomorrow. In doing so, they should leverage the experience of banks and other financial institutions with regard to previously implemented regulations in the wake of the financial crisis. Using stress-testing concepts in risk management, for example, would improve a firm’s resilience in the face of severe events regardless of regulation. Consequently, best-in-class firms will invest to accommodate the emerging trends in asset management that affect investors well before regulators take action.
This article is an excerpt from Global Risk 2017: Staying the Course in Banking.