It was not the first time that Britain had disagreed with its European neighbours and it surely won’t be the last. But the standoff acted as a salutary reminder; firstly, of the difficulties attached to achieving internationally agreed standards and regulations and, secondly, that governments are in no mood to tolerate self-regulation of the financial sector.
This whole episode will certainly play well with an electorate still coming to terms with the realities of the financial crisis. Yet in certain realms, self-regulation can and does work. What’s more, it can overcome even the most entrenched differences of opinion found on different sides of national borders.
The internal wrangling at the EU level comes just a few short months after the launch of the 2010 edition of the Global Investment Performance Standards (Gips) and throws into sharp relief the success that these industry-developed, self-policing measures have achieved in setting accepted levels of performance measurement, monitoring and attribution.
Indeed, Gips is something of a beacon for self-regulation. These ethical standards for investment performance presentation have been adopted as the local benchmark in 32 regions. What’s more, this is not just a Western phenomenon; countries from Kazakhstan to Korea, Singapore to Sri Lanka, are also on board.
Gips has engendered a level of international cooperation rarely seen in other fields. Its success is derived from its value. The stated objectives of the Gips executive committee mean that individual investment firms, from Hungary to Hong Kong, have a globally recognised badge of honour that attests to their performance measurement operations – and a valuable front-line sales tool as a result. Their clients and prospects gain access to information about the performance of various investment strategies and this enables them to make more informed investment decisions. Even players in the retail investment space, whose mutual funds are covered by separate regulations, are beginning to look at the Gips standards as a means of demonstrating competitive advantage.
Systems in place
There is a clear advantage to establishing the appropriate processes and systems and going through the validation procedure to prove compliance. That advantage has never been more obvious than in today’s highly competitive markets. Risk averse institutional investors are looking very carefully at where they place their money and require greater than ever reassurance as to the quality and probity of their investment managers.
At the same time, international markets are opening up and offering an attractive alternative source of alpha to the crisis-battered Western markets. But because investment practices, regulation, performance measurement, and performance reporting vary considerably from country to country, asset managers, their clients and their prospects benefit from an established global standard for calculating and presenting investment performance. The Gips standard acts like a passport, enabling firms to enter new markets and offer services that are recognised to be of the highest standards. By adhering to these global standards, firms in countries with minimal or no investment performance standards will be able to compete for business on an equal footing with firms from countries with more developed standards. And firms from countries with established practices will have more confidence in being compared fairly with local firms.
In general, compliance with the Gips standards helps improve investor confidence because it requires all-important performance information to be fairly represented and fully disclosed. Success comes from actual results not tired reputations.
Gips also puts the spotlight on data integrity, in fact the Gips standards rely on the accuracy of investment performance data since it is the underlying valuations of the portfolio holdings that drive the portfolio’s performance. With this in mind, the Gips standards require firms to adhere to certain calculation methodologies and to make specific disclosures along with the firm’s performance.
The recent changes, which must be implemented by January 2011, also state that assets must be valued using ‘fair value’ rather than ‘market value’ to help overcome the problems associated with valuing derivative instruments. It is a clear response to the events of the last few years, as is the new requirement to address risk in the Gips standards, with firms being required to present the standard deviation of their monthly returns in both the composite and the benchmark.
The markets have also seen more of a shift from buy-and-hold to transaction-based attribution, thanks largely to the rising interest in fixed income asset classes. From a performance angle it makes the data quality from the portfolio side much better, and it assists in discovering where true active return is coming from.
These moves add even more pressure on the data requirement for Gips compliance. When you take into account the costs and resources required from building and securing an appropriately comprehensive data warehouse through to manipulating data to turn it into useful information for the end user, this focus on data integrity will add significantly to the cost of Gips compliance.
This is the dilemma that firms must weigh up. There is no denying the value of Gips validation, particularly when risk-averse investors have to navigate markets that have yet to return to stability. At the same time those volatile markets make the provision of accurate, verified benchmark data more costly than ever, but without which there is no hope of Gips compliance. Perhaps it is no surprise that more and more firms are turning to outsourced data management provision, and the economies of scale offered by third-party specialist providers, in their quest for Gips compliance.
Gips is a great example of what can be achieved through self-regulation. The new standards present an ideal opportunity for fund managers to revisit Gips, examine the benefits and look into the obligations. There is much to be gained – and thanks to the availability of benchmark data management providers – little to be lost. Any firm that is unnecessarily squeamish about outsourcing data management, and rejects Gips as a result, may discover that Gips compliance is in fact a far better option than handing performance management over to the tender mercies of external regulators.
• David Spaulding is the president of The Spaulding Group
©2010 funds europe