Post-crisis fund regulation pushes data to centre-stage

A decade after the financial crisis of 2008-09, the fund industry, along with the rest of the financial services sector, is adapting to the new regulatory landscape that has evolved in response to the lessons learnt from the turbulence that rocked countries and economies around the world a decade ago.

While the investment management and fund sectors played only a peripheral role in the unfolding of the crisis, they have found themselves subject to new rules, especially regarding transparency toward regulators and clients, designed to improve understanding of the sector's impact on the overall financial system and to address information imbalances between providers and their customers.

The European Union has played an important role in this regulatory evolution, reflecting the importance of the European single market within the global financial services landscape. Legislators and regulators have been at work for a decade to fine-tune the rules and ensure they meet the new challenges of an ever-expanding and increasingly globalised market.

From the AIFMD to PRIIPs

One of the earliest responses to the crisis was the passage in 2011 of the EU's Alternative Investment Fund Managers Directive, providing for the first time a common legal and regulatory framework for the alternative funds sector in Europe.

At the same time, the UCITS regime for the pan-European management and distribution of funds (mostly) aimed at retail investors has been updated to align the rules, especially regarding investor protection, with those governing alternative funds.

MiFID II, a revision of the 2004 Markets in Financial Instruments Directive, has upgraded rules applicable to providers of financial products and services in areas such as client segmentation, best execution of financial transactions and trading transparency across Europe’s securities markets. It notably adds significant data provision requirements on all market participants, including fund managers and distributors.

The EU regulation on Packaged Retail and Insurance-based Investment Products introduces standardised information requirements designed to enable customers to compare different types of financial product offering similar underlying investments. The PRIIPS regulation is currently scheduled to apply to UCITS funds from the end of 2021.

Meanwhile, global initiatives and European legislation aimed at curbing financial crime, especially money laundering and the financing of terrorism, are also leading to new requirements on fund managers, along with other financial institutions. They are now responsible for monitoring and where necessary reporting the origin and destination of funds passing through the financial system, including stricter new rules on the disclosure of ultimate beneficial ownership of assets.

The importance of information

Although UCITS funds are already required to provide a key investor information document to potential investors, the future introduction of the PRIIPs requirement represents a fresh demand on the industry to collate, compile and publish information in the format required by EU and national legislation.

The substantial increase in these new requirements reflects an important lesson of the crisis - that the financial meltdown was exacerbated by inadequate awareness and understanding of the often complex nature of financial products and strategies, not only on the part of retail customers but in some cases members of the financial services industry.

Remedying that information shortfall is now the direct responsibility of the investment management industry, but it is one they struggle to meet without assistance from service providers whose duties already require access to a vast range of data generated by the sector on a daily basis.

Complying with the new rules requires the tracking of information throughout the investment value chain, including on the decision-making process, individual securities, pricing, costs, the fund product itself and the investors.

This involves the difficult task of extracting and collating data from a range of often unconnected and sometimes incompatible IT systems. It has also helped to spur the emergence of providers whose business is connecting parts of the value chain, at a cost that has become an extra burden for an already stretched asset management industry.

The cost factor

The issue is a critical one for the sector, whose revenues were severely impacted by the effects of the crisis on asset prices and investment demand, even though these have subsequently recovered. At the same time, companies have been obliged to make substantial investments in IT systems and human resources in order to meet the heightened regulatory requirements. The sharply increased penalties for breaches and lapses worldwide mean this is not an aspect they can ignore.

Benchmarking, for example, is no longer as simple, or as inexpensive, as in the pre-crisis days, as a result of legislation such as the EU Benchmarks Regulation, which is designed to provide a harmonised regulatory framework to protect investors in regulated products from the risk of benchmark manipulation.

As with fund providers' own reporting, the benchmark provisions represent an extra expense for the industry arising from the cost of data from vendors. Already coming over the horizon is reporting on, and in the future compliance with, environmental, social and governance criteria.

Preparing for the next wave

Until recently a narrow segment of the industry, sustainability is fast emerging as a mainstream issue affecting investment in its totality. With the European Commission preparing to incorporate sustainability requirements into legislation including MiFID II and the AIFMD and UCITS regimes, it is set to have an increasing impact on asset selection and the assessment of risk in the future.

A few years ago, fund providers used to console themselves that the wave of new regulation developed in response to the crisis would soon be complete, and that the pace of rule-making would slacken. Today this seems less likely as rule-makers in the EU and beyond focus on areas that are taking on a higher profile, such as protection of personal data.

The importance of the role of fund service providers in gathering and assembling the data required for regulatory compliance and customer transparency is poised to grow further in the future, beyond the upcoming impact of measures such as PRIIPs. But the message for fund firms is clear: they cannot afford to take their eye off the ball.

PaperJam - September 2019 - Supplément ALFI