The panel discusses at the impact of Ucits V on the asset servicing industry and the implications of blockchain for fund firms and their providers.
Barry McGloin (business development manager, Caceis Investor Services)
Mario Mantrisi (senior adviser to the chief executive officer, Kneip)
Georg Lasch (Head of client development, BNP Paribas Securities Services Luxembourg)
Brian McMahon (Business development executive, alternative investment services, BNY Mellon)
Funds Europe: Where are we with Ucits V and what needs to be done to transition the regulations into practice?
Georg Lasch, BNP Paribas: We are about two months [as of mid-January] from the real kick-off of the Ucits V regime. The Level II measures have now been published. There was a long discussion on whether they would be applicable immediately or whether the industry would get an additional six months to get ready.
We are working closely with our clients to aim for readiness from day one but the whole industry, including regulators, will certainly welcome the ‘interim’ period until Level II becomes effective, to sort out the tail of project activity. The charge on Ucits V is particularly strong on legals. We are currently reviewing all our contractual arrangements with our Ucits V clients and including new clauses on responsibilities and allocation of tasks in our prospectuses and in our contractual arrangements.
We are also reviewing our fee arrangements on the depositary banking side. So we will not rely on the accounting agents of our clients providing us with positions on those assets. That might be a distinguishing factor in the future.
This, alongside independent ownership verification, will give our depositaries more independence and enable us to challenge the administrator, if necessary. The CSSF [the Luxembourg regulator] has taken the opportunity to somehow gold-plate what, in the past, was outside of Ucits. So ‘part-two’ funds, which in Luxembourg used to be everything non-Ucits, were taken on by AIFMD [the Alternative Investment Fund Managers Directive].
However, now that the CSSF has confirmed that the supervision duties of Ucits V will also apply to part-two funds, this makes them a more protected environment than they were in the past.
Brian McMahon, BNY Mellon: If you think about Ucits, it’s very much aimed at the retail investor, even though the majority of cash in there is from institutional investors. And I think the CSSF has looked at the part-two funds in a very similar guise as Ucits. There are part-two funds that fall under the AIFMD regulations and the impact when they change to Ucits will have to be considered.
Mario Mantrisi, Kneip: ‘Part-one’ is the Ucits part. But as there are a number of funds that didn’t fit into the Ucits Directive, the part-two aspect of the law was created. For instance, at the beginning, money-market funds were not allowed to be Ucits – thought that was changed with Ucits III. When AIFMD came along, part-two, being non-Ucits, came under AIFMD, which means they have the AIFMD passport.
Lasch: The big impact Ucits V will have is that under AIFMD, you could delegate some restitution aspects. There are a lot of part-two funds that have prime brokerage agreements, under which the depositary had given that responsibility [or restitution] directly to the prime broker of the asset manager. Ucits V does not allow any delegation of that mechanism any more, so it remains, de facto, a restitution duty of the depositary.
McMahon: All custodians have had to look at this. I think the other aspect that people are looking at is securities lending because you need to make sure that the depositary has additional responsibilities around the quality of the assets coming in [as collateral], in order to make sure that they’re of a similar grade. When you consider all the ring-fencing rules and everything else that’s involved with Ucits V, there’s a stronger onus on the depositary here.
Barry McGloin, Caceis: Ucits V for Caceis has a number of implications that fall into various categories – operational, contractual and reporting, each with a direct or indirect impact.
First, as a mainstream provider, we have to transition the liability provision and ensure we assess and control the risk it brings. Having already adopted and enhanced our depositary controls and processes under AIFMD, we are able to largely replicate existing processes.
Second, we must finalise the contractual arrangements to ensure the agreements are adapted in line with the depositary requirements of Ucits V.
Finally, I believe there will be indirect requirements as a possible reaction to the sanctions Ucits V brings. It is likely that there will be a drive for additional reporting, such as at the request of management companies and investment managers and other actors with responsibilities towards the fund to ensure they maintain oversight and can also satisfy their own responsibilities.
Transparency will continue to drive additional and more comprehensive reports to the regulator and other parties. The frequency of such reports is more likely to increase to ensure oversight is maintained throughout the funds lifecycle.
Mantrisi: In terms of remuneration, obviously you need to disclose it, like for AIFMD in the annual report, so that’s an aspect they’re looking at. On the sanction side, where will this lead us to? Is it something the industry has to integrate much more into its processes?
McMahon: When you bring in other rules such as MiFID II, there is more regulation, and if you get it wrong, you potentially face sanctions. Quite simply, you are going to end up with fewer products that you can manage, and that you can prove that you can manage. The onus on being able to prove that you are in control of the fund, that you know the fund that you’re managing, and you’re selling to the right people in the right guise, is going to increase. The reputational risk of having a sanction applied is too high for many organisations.
Funds Europe: Is the constant creation of new share classes to support fund distribution in the retrocession-free age sustainable? What difficulties does the process pose?
Mantrisi: No, for me, it’s not sustainable. And the reason is related to cost. The number of share classes is exploding, so I don’t think it helps the industry.
McMahon: My point is simple: operationally and generally the industry can cope; my issue is more on the investor side, because there’s now going to be a plethora of information that’s required – how many investors, for example, are tracking what share class they’re in? We’re trying to increase transparency and have better investor data, but are the new rules reducing or adding to the confusion?
Lasch: I’m not so sure about it being a problem. In the end, the share classes are there to adapt your portfolio to various types of clients. There is an evolution towards more share classes, but we’re still far away from having as many share classes as in the US.
McGloin: Share classes are mainly launched at the request of distribution and investor requirements. Ucits’ success is the ability to offer a product to an expanding number of investors in multiple jurisdictions. Part of this has been specifically due to offering multiple share classes which meet a wide variety of investors’ needs. Share classes support distribution by allowing flexibility such as hedged share classes, inducement-free, dividend, currency and differentiating fee share classes, etc. Furthermore, creating a new share class is far more cost-effective than the creation of a new sub-fund and reduces the time to market, so overall the creation of separate share classes is more economical.
Funds Europe: Are disruptive technologies at the point yet of impacting the fund services sector, and what does the future hold?
McMahon: Yes, but not the full chain. I think it’s a matter of time. The current investment in fintech is huge, evidently targeting specific areas of the value chain.
If you look at how people are interacting with the industry, this investment is likely to increase. Today there are something like 2.4 billion people that can potentially invest in the financial services market. In ten years, that number is going to be 4.2 billion, meaning another 1.8 billion people potentially accessing the market.
Lasch: But the thing is, it’s not fully automated, that’s why it’s creating complexity.
McMahon: The phrase ‘Big Data’ has been out there now for six or seven years. The question is, has anybody monetised Big Data? People are starting to monetise the investment in technology; there’s a plethora of information trends, analysis and decision-making. There are ways of redirecting how you’re investing in, or how you’re going after, investors. That’s available, but it hasn’t necessarily been tapped into. Is the disruption there today? Not as much as it’s going to be in 24 months.
Mantrisi: There are a certain number of topics in fintech which I think could be interesting to the funds industry. Blockchain, obviously, is one of those and another one is robo-advice, and maybe peer-to-peer lending.
McMahon: But people think differently. Look at Alibaba, which has one of the largest fund bases in the world with, I believe, 250 million investors, up from 150 million in a year – so an extra 100 million in a year!
Lasch: We are testing blockchain technology for several use cases, one of them being fund distribution. The biggest challenge for entering this way of handling a transaction that is not through a controlled, regulated infrastructure, or through an encrypted mechanism like Swift or a CSD [central securities depositary], would be if the regulator allowed a register to be held in the net.
Mantrisi: Do you think that these kinds of people are looking at the regulators?
Lasch: No, they’re not.
Mantrisi: They’re not, because look at Bitcoin. It’s completely outside of regulation, and therefore I agree with you, but the regulators, typically, always come later.
McMahon: Look at your operational chain: how much of that, ostensibly, could be replaced by artificial intelligence? So, by definition, it could have a dramatic impact on how we do business. As an industry, it’s going to change how we work. And then what does that mean in terms of a regulated market?
Lasch: I don’t believe in alternative currencies. I certainly believe in crypto currency, something like the virtual version of the existing currency, so a connection between the virtual and the real world in terms of how money is going to end up with asset managers, because eventually you have to invest it in the real world. We believe firmly that, in terms of distribution, a new sales channel will be through the entirely virtual world, through crypto currencies and blockchain.
Mantrisi: So no funds in Bitcoins?
Lasch: Well, the technology is the same so it’s not, in itself, an issue, but it does create some compliance issues.
McGloin: There are developments that the financial sector must anticipate in order to avoid having to play catch-up. This will require us to work with intermediaries and distributors, as the opportunity is complementary. Without the legacy impact or applying the traditional model, new developments may bring automation, reducing a wave of overheads from time, costs, to operational efficiency. Again, it’s distribution that remains a driving force and we are part of that collective service environment.
Lasch: How can we improve our way of working with the new technology? The fund administration process is a complicated process, which is already more or less automated.
We anticipate that in, probably, not too many years down the road, the NAV [net asset value] process could be fully automated.
Mantrisi: Big Data is another topic. One of the difficulties the industry has with Big Data – and I will make the link from Big Data to blockchain – is that we miss information on the end investor because of this whole intermediation we have in distribution. For the asset manager, it’s very difficult to know who, at the end, has bought the product. Now, if we combine this with blockchain, we would keep track of what’s going on in a transaction.
Lasch: But that is very dangerous. I think one of the strengths of blockchain today is that it’s a code that only tracks the transaction. The owner on the other side needs to be certified, but is in a different environment. As soon as you connect both, there is another place where you have both of the data which, in today’s environment you don’t necessarily want to be in the public domain, or in a secure domain but outside of the transfer agent.
Funds Europe: In light of the difficulties last year with Annex IV reporting under AIFMD, to what extent are the challenges of regulatory reporting being dealt with? Where do the main pressure points lie?
Mantrisi: We have over 2,000 AIFs [alternative investment funds] and several hundred AFMs [alternative fund managers]. The difficulty with Annex IV reporting is to set it up. I think once it has been set up, it’s running fine.
The next challenge which we are facing is related to what regulators will do with the data. It’s a quality issue. And if regulators start looking into the data, there might be some surprises.
McMahon: If you get the set-up wrong, if your interpretation of how something has to be reported is different. That’s the challenge.
Mantrisi: Yes, and you have to do some trade-offs because the regulation was not clear. So for me, the challenge is absolutely that, it’s the quality aspect. Regulators will be looking at the data, including ESMA [European Securities and Markets Authority], which is working on the consolidation of those. So therefore, as an industry, the quality is an issue to be solved.
McMahon: Where the funds aren’t regulated but the manager is, the Annex IV report increases in its importance. So, the CSSF will probably want to regulate the managers to protect the investor, and the first port of call is the data.
Mantrisi: I have done some analysis on the data. For instance, there is a section where you have to say who your investors are, and within that section you may use a category called ‘other’. Now, this is the most used category in terms of who your investors are. So it shows you how little, even in the alternative space, managers know about who their investors are, and I was quite surprised.
McGloin: Once you’ve set up the reports with consideration for the 40-plus forensic questions and accommodated the 2,000 data points, future reporting obligations are less intrusive. However, the reports evolve and with further regulatory reporting requirements, we can expect that the implementation of new reports will remain an ongoing concern for any bank.
Lasch: It’s important that the data contained in a database is really owned by people that are in charge of it. So we’re certainly getting there, but what we’re particularly worried about is the pace at which new reporting is being asked for or developed.
Funds Europe: Looking ahead to MiFID II, what are the considerations for fund management operations and fund services?
Mantrisi: My understanding is that ESMA is working on the definition of ‘target market’, and it’s a big challenge for the industry because before launching a product, we need to test the target market in terms of sustainability.
You need to make sure that your target market, as a product, matches perhaps the distributor’s own definition. So I think there’s a lot the industry needs to work on, and there’s a lot of energy and time which will go towards the ‘target market’ issue. This is one topic we’re looking at.
Another one is that of ‘ongoing charges’. Ongoing charges will be a challenge for the industry, especially if we need to include transaction costs within them.
McMahon: Fund managers have to look at their operating model to address all of the different concerns, the complexities and the rules around embedded derivatives. They are going to reduce the complexity, reduce the products, focus on platforms and how they can leverage what they have.
Lasch: And in the end, I’m not sure that the end investor will be able to read the report that they receive or see value in the report. So that’s another point, and one of the two or three aspects I want to look at is the role of the TA [transfer agent], particularly for funds where we have direct subscription through the TA, rather than through the distribution network.
McGloin: It is the portfolio manager, who is largely at the forefront under MiFID II, who encourages oversight, as sales and distribution channels are part of their responsibility. From our side, it also adds further analysis on compliance department pre- and post-onboarding.
Mantrisi: Yes, but in terms of KYD [know your distributor], what is reinforced within MiFID is the oversight responsibility. As the manufacturer, you need to oversee them on an ongoing basis. And what does that mean?
Lasch: All regulations are imposing far more due diligence than in the past. This obviously has an important cost element for asset management firms that have a more reduced staff, say, and for depositary service providers who have to do due diligence on their sub-custodian networks, transfer agents, investment managers and so on.
But it’s also a burden for those responding, so there’s a large category of people which is going to be fully busy with doing due diligence, which is an additional cost to the industry.
In the end, we’ll see what type of security it’s going to offer to the investor.
Funds Europe: What are some of the most important ‘next steps’ in fund management operations for the next 12 months?
McMahon: Embrace technology. It is going to change everything we’re doing, so early adoption is crucial.
Regulatory focus is obviously important because of the various rules that have come in. This is driving a lot of investment in technology. How we interface with our clients and their operations is going to increase because if you look at something like the Raif [Reserved Alternative Investment Fund], if a client wants to launch one of those, the speed between the decision to do it and actually launching it is going to be much shorter, so we have to set up our operations to allow for that in advance.
And the global economy. In January the oil price fell below $28 a barrel, China’s economic growth is slowing and interest rates are still either at, or close to, record lows in many developed countries. There are a lot of ingredients for uncertainty in the markets and we have to be alert to these challenges. We should look back to see what lessons we can learn and apply them now.
Lasch: Clearly, technology and regulatory change are already part of our daily lives. But the pace of change is clearly accelerating.
McGloin: I still see continued flow to allow innovation between the US and European markets. There remain some hurdles to distribution but it remains in our collective interest to innovate to do so. Therefore, our service will continue to adapt and support such channels.
Mantrisi: I would add tax. And there’s another one: Priips [packaged retail investment and insurance products]. I don’t want to go into all the aspects of Priips, but Priips will hit the industry even before the Ucits grandfather period ends.
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