An evolving risk and regulatory landscape

The regulatory agenda for asset managers and investment funds is now set against the most challenging economic and operational backdrop in living memory. In large measure, regulatory agendas have been re-prioritized rather than completely rewritten.

• Even before COVID-19, regulators highlighted the persistently low interest rate environment as a key risk. Subdued profitability poses challenges for firms and incentivizes search-for-yield strategies, giving rise to financial stability concerns. Debate was already beginning to re-ignite about whether certain trading practices or fund types – computer-led trading strategies, short selling, money market funds and exchange-traded funds - contribute to systemic risk 
• During the pandemic, asset managers were granted certain concessions, including the use of capital buffers, easing of reporting and disclosure requirements, changes to market position limits, and delays to implementation or consultation deadlines. New requirements included short selling bans in a handful of European countries, restraint in dividend distribution and remuneration, and increased reporting on the liquidity positions of open-ended funds
• The aim now is to encourage recovery and growth, but to ensure that happens in a controlled way, in the interests of financial stability and investor protection. Meanwhile, regulators are becoming more digitally aware, as regards market developments, investor communications and their supervisory procedures.

All parties will need to embrace the evolving new reality, including an increasingly digital society, changes to working practices, demands for sustainable finance and greater awareness of global inter-connectedness. Regulators will demand that firms take greater care of customers. Strong governance and good conduct have long been regulatory imperatives, but as we look ahead, firms’ duty of care will be reshaped and brought to the fore.

• A focus on operational resilience will move to the top of the agenda – business continuity planning (BCP), IT, cyber security, AML, protection of client assets and data. Regulators will require firms to show that they have thought about lessons learned through the pandemic and that they are actioning them accordingly
• The key topics of liquidity management of open-ended funds and use of leverage will also remain top areas of focus
• Regulators are keen to enable technology that makes investing simpler and cheaper for investors, but they wish to protect the investment ecosystem from technology that facilitates crime or can lead to poor investor choices. Firms’ technology and digital transformations will therefore be kept under close scrutiny
• Firms’ duty of care will be re-articulated. Regulators are requiring firms always to put clients’ interests before their own and are asking questions about stewardship and short-termism. Firms must ask themselves not ‘can we?’ but ‘should we?’ Increasingly, regulators are likely to threaten enforcement action if firms’ culture and conduct do not meet regulators’ and clients’ expectations
• The search for meaningful disclosures to investors over costs and performance will continue. Regulatory approaches to commissions and payment for investment research are once again under review, and performance fees are on the agenda.
• Sustainable finance or ESG will continue to be driving forces. The pandemic has added to the momentum. Regulatory initiatives will spread around the globe, with a growing focus on social issues (including diversity) as well as environmental ones
• There will be significant opportunities too – new fund vehicles, a loosening of rules on underlying assets, and increased opportunities in the retirement savings market. Regulations that prevent cross-border distribution, registration and foreign ownership are being eroded, and there is an easing of the extra-territorial impacts of national rules. On the other hand, regulatory and fiscal demands for firms to have ‘substance’ in a jurisdiction have increased, and the UK’s departure from the EU has created new borders that the industry must navigate

• Re-evaluate processes and controls to ensure compliance with requirements on operational resilience, including BCP, IT, cyber security, AML, protection of clients assets and data
• Assess risks deemed by regulators as systemic – regulators are focusing on liquidity management of open-ended funds as well as use of leverage. Enhance your stress testing scenarios
• Think about ‘what you should do’, not ‘whether you can do it’ in terms of fiduciary duty: individual accountability, culture/ethics, governance and distribution will be at the forefront
• Adjust to new disclosures on commissions, payment for investment research and performance fees as rules evolve
• Demonstrate that ESG factors are fully taken into account during the investment decision making process
• Stay alert to opportunities, rather than simply managing downside risks. What new product and market opportunities might open up? Are you well-placed to navigate rising and falling borders and the challenges and opportunities they will bring?