Viewpoint - Cost management in a more regulated asset ...
Cost management in a more
regulated asset management industry
This paper reviews some of the current cost reduction activity in the
asset management industry, some familiar and some not seen so often
in the past. It also considers the most recent indicator for the future
of regulation of the industry, issued by the European Commission,
and looks at the impact that this, and other regulation in the pipeline,
is likely to have on the cost base of an asset manager.
Cost reduction activity – the crude, create a robust operating model that could cope with precisely
this sort of downturn. This ‘weatherproofing’ may have resulted
the painful and the constructive in a more expensive operating model paying a fee to outsource
Cost is a measure that tumbles down the priority list when providers based on a percentage of assets under management.
markets are buoyant and investors are abundant. However, However, it is currently being proven to be more robust as the cost
when the sun stops shining, the issue of cost is promoted, of the operating model drops with the AUM.
almost overnight, to the top of the asset management executive
agenda. Large outflows of funds and markets that have fallen
significantly from their levels 18 months ago have led to a
Who will regulation affect the most?
contraction of the asset management industry (the European The alternative asset management sector is, unsurprisingly,
asset management industry shrunk by €2.9tn in 20081). This has likely to be the target of much of the expected new regulation.
placed increasing pressure on profit margins. Although some asset At the time of writing, the most recent document released on
managers entered the financial crisis in better shape than others, future regulation was the EU framework proposal for managers
all are now in a period where cost reduction and cost management of alternative investment funds, issued by the European
are in the minds of senior management. Commission (EC). This draft legislation is the next step in an EU
program designed to ensure financial markets across Europe
As has been the case in other downturns where asset managers
are secure and that market actors operate responsibly. The
focus on cost, their first reaction is to stop or significantly reduce
EC believes that the oversight and supervision of activities of
discretionary spend. Only business critical projects are not iced
managers of alternative investment funds (AIFs) across Europe
overnight. The second reaction is redundancy or ‘right-sizing’
need closer regulatory engagement and supervision. The key
as the industry would prefer to have it. Non-revenue generating
principles include an increase in the focus on what the EC believes
and non-business critical business areas are usually the first to
to be the sources of systemic and operations risk, enhanced
be targeted; more recently, with globalization, firms are looking
investor protection and regulatory disclosure.
at their business models and stripping out layers of management
that they deem superfluous. For example, some are questioning Highlighted below are the elements of the recent proposed
whether they need a business head in each region in which they directive on alternative investment fund managers (AIFMs) that
operate. It is of course important that resource cuts are not will have greatest impact on the cost base.
made too deep, preventing the organization from reacting
The most eye-catching element of the operating requirements
quickly to gain market share when the industry eventually starts
for AIFMs is the requirement for the assets of the fund to be
to recover. It remains to be seen who got ‘right-sizing’ right and
valued by a valuator that is independent of the AIFM. While third-
who got it wrong.
party pricing sources of market and private trades is common,
Asset managers are also reducing cost through less familiar and this appears to be a requirement for the annual valuation to be
perhaps more constructive activity. First, it is widely recognized struck independently. The Commission will in due course define
that product proliferation has led to far more products in the the conditions for determining independence. The organizational
marketplace than is either necessary or desirable, which is design is a common theme throughout the proposed directive.
leading to product rationalization. Asset managers are taking the It requires independent depositaries and custodians to be
opportunity to consolidate products that have accumulated as the appointed to the AIF – EU credit institutions subject to prudential
result of earlier mergers or to close products that have failed or regulation – which is a significant change in practice and a
become inefficient to manage. Secondly, many asset managers challenge for the existing prime brokerage and private equity
are reviewing their third-party service providers with a view to models. The AIFM shall have a structure to prevent, identify and
consolidating and thereby reducing cost through scale or, at the disclose conflicts of interest. There is also a requirement to have
very least, to renegotiating contracts. Thirdly, many are a functionally separate portfolio risk management function,
reviewing how the money managers and traders in the although again it is unclear how independence should be achieved.
organization are rewarded. Re-aligning the remuneration of Other requirements include measures regarding:
managers with the risk profile of the fund and incentivizing
► liquidity management, stress testing and redemption policies
them in a way that is in line with the investment interests of
clients is a tricky balance to strike, although also long overdue. ► procedures to ensure that short positions are covered at
Fourthly, asset managers are analyzing the operating model to delivery date
identify opportunities to reduce fixed costs and build a more ► requirements that must be met before an AIFM can invest in
variable cost base. Ideally this redesign of the operating model securitized investments
should have been completed in the years prior to the financial
crisis. We have encouraged our clients to review their operating ► authorization by local regulators of the delegation of
model on a periodic basis, one of the principle reasons being to activities and apparent anti-avoidance provisions to
prevent excessive outsourcing.
1 European Fund and Asset Management Association (EFAMA)
2 Viewpoint Cost management in a more regulated asset management industry
The directive proposes minimum capital requirements Conclusion – desperate times call for
calculated as €125k plus 0.02% of the value of the assets under
management, subject to a €250m hurdle. Therefore, the manager
responsible and considered measures
with €5bn in assets under management will need to hold an Asset managers are digging deeper for cost saving than they
additional €1m of capital – not an insignificant amount. have done in the past and they are undertaking a wide range of
activities to achieve the cost reduction objectives.
What will be the incremental cost? The inevitable increase in regulation as a result of this financial
crisis will increase cost and will impact the asset managers on
Increased regulation will inevitably mean more cost to the
a scale inversely proportional to size, to the extent that it may
manager. However, this will vary significantly, depending on the
make operating in the new environment too costly for some small
degree to which the operational infrastructure has the resource
alternative managers to continue.
and data required to undertake the additional regulatory
overhead. For example, the cost implications on AIFMs complying When the new wave of regulation is clear, it is important for
with the proposed EU directive will vary significantly depending these managers to take the opportunity to address the
on the size of the organization. The largest managers will, however demands of the regulator and the investor from an
reluctantly, be able to comply with the proposed directive. Many enterprise-wide perspective and to resist the temptation to
of the proposals embody business best practice, even if shoe- address each requirement (e.g., risk, compliance, control) or
horned into a one size fits all approach. The data is likely to be source (e.g., investor, regulator) in a silo. By looking at the
available albeit in disparate systems and records, but reporting in spectrum of reporting requirements, asset managers will be
a timely and accurate fashion whilst managing confidentiality and able to effectively comply with the demands whilst minimizing
commercial pressure will be more challenging. For those areas that incremental cost.
are different – for example, mandating independent valuations,
independent risk management and custody arrangements – it The views reflected in this article are the views of the
will be challenging to translate high-level principles into practical, author(s) and do not necessarily reflect the views of other
commercially viable guidance. Other provisions, such as notifying members of the global Ernst & Young organization.
regulators of delegations, or periodic reporting to authorities of
leverage, fund profiles or controlling interests, will be burdensome
and require improvements in internal reporting systems.
The larger AIFMs that have evolved with the industry over the last
few years have implemented an operational infrastructure that
can cope with the increased regulation with an acceptable
incremental cost increase. This legislation will however apply to
AIFMs with total assets under management greater than €100
million. This is a low threshold and will catch many small AIFMs
who are less likely to have the entire infrastructure that will be
required by this directive. This required investment may question
the viability of the business itself.
Traditional asset managers, as opposed to the AIFMs, are used
to complying with the voluntary and involuntary demands of
investors and regulators and should be in good shape for when
the additional regulation that applies to them becomes clearer.
They have also come to recognize the additional benefits and good
business sense of complying with some voluntary self regulation;
for example, the SAS 70 report has evolved to be a globally
recognized method of demonstrating transparency and control
in the organization and therefore an important and effective
marketing tool. These asset managers will already understand
whether they have adequate and efficient data architecture to
provide accurate and timely reporting on the aspects of any new
regulation. If they do not, it will be a familiar question that they
face: whether to invest and upgrade the operational
infrastructure to create a more efficient platform or to continue
with the current environment and continue to bear the cost
implications of the inefficiency.
Viewpoint Cost management in a more regulated asset management industry 3