Category: Policy Papers

Liquidity is something that is often talked about in financial markets, usually when it is perceived to be absent. However, an exact and consistent definition is elusive and attempts to clarify matters are often forgotten and inherently difficult to isolate for analysis. What does seem to be agreed is that more liquidity is a good thing, although even that may not be the case if the liquidity comes from inflationary monetary policy. Where the risk of failures in liquidity lie and should lie is more contentious.

Historically, much liquidity risk was held within the banking sector: banks naturally take liquid deposits and make illiquid information-intensive loans. Recently, regulation has constrained banking activity and this has led to a transfer of liquidity risk to other sectors such as asset-management. This has unintended consequences, as discussed in this paper, and may not serve investors or the broader economy well: many asset management strategies explicitly rely upon liquidity transformation and the interconnectedness of different components of the financial services sectors means that regulation that affects one part has a corollary, perhaps unintended, consequence on another sector.

An intelligent and thoughtful approach to regulation and policy is in everyone’s interests. NCI acts as a catalyst for discussion and I am very pleased to introduce this paper, which takes a reflective and broad view of liquidity risk and the policy landscape that addresses it.

Jamie Carter

Chairman, New City Initiative Chief Executive, Oldfield Partners

As CEO of a boutique asset manager, I understand well the challenges that come from being a smaller business. However, these are not without counterbalancing benefits. NCI has previously talked about the unique culture that small and medium-sized asset managers have and how this leads to superior outcomes for clients; this current paper extends that work to benefits offered to the wider economy. Small and medium-sized enterprises (SMEs) provide a disproportionately large contribution to innovation in the economy, particularly broad-based innovation that drives deep-seated positive change. Financial services SMEs, like NCI’s members, innovate markedly and collaborate together in open innovation as a cluster, much like that commonly associated with Cambridge or other hubs of innovation.

NCI’s view is that this SME cluster of small and medium-sized asset managers should be recognized and nurtured, as should the SME sector generally. However, support from government in one area, such as IMS II, does not offset the resource and financing constraints that limit SME innovation. By way of example, financial services and asset management SMEs, like certain other sectors, are unable to avail themselves of innovation funding or tax advantages that accrue to early-stage backers in other industry segments. NCI argues that this should change and that the unique and vibrant voice of NCI’s members, acting as an SME cluster of innovation, should be recognized with representation on the Asset Management Taskforce and other bodies.

I am pleased to introduce this paper on SME clusters of boutique asset managers, proud to be partner and CEO of one of them, and honoured to be able to represent NCI’s members as chairman.

Jamie Carter

Chairman, New City Initiative Chief Executive, Oldfield Partners

The idea of capital controls being implemented in a major developed market economy such as the UK seems improbable, but there are two events on the horizon which could cause such action to be taken and encouraged us to think about these risks:

1. A cliff-edge Brexit. The recent agreement for a transition period was disappointing in that it is conditional on there being a full withdrawal agreement. This conditionality raises rather than reduces the chance of a cliff-edge. An unprecedented event such as this provides no historical comparison with which to guide us, but in the paper we explore the imposition of capital controls elsewhere.
2. A Labour government. NCI is apolitical, but an independent, objective assessment of some of the policies currently being suggested by the Labour Party increase the risk of capital flight. We discuss these policies and the potential ramifications.

NCI cannot predict the probability of either event, but good risk management requires assessment of all types of risks, even those perceived to have a low probability of occurring. This paper is intended to provide members with food for thought, a trigger for some contingency planning should we be faced with the imposition of capital controls in the UK (or elsewhere for that matter). We assess the impact on the asset management industry, its customers and suppliers, the clearing and settlement process and we’ve used the case study of a UK fund vehicle with a global investment mandate to outline some key operational issues and provide suggested remedies which members and their customers should consider.

Jamie Carter

Chairman, New City Initiative Chief Executive, Oldfield Partners

When I talk to NCI’s members, I am often struck by the commonalities. Notwithstanding different investment strategies and different fund sizes, there is always resonance when it comes to prioritising the client and acting in his or her best interests, building a symbiotic relationship that is prolonged and mutually beneficial.

These thoughts were the genesis of NCI and discussed at length in our earliest papers, laying the foundation for supporting a client-centric model of financial services that would help “fix a broken City” and herald the benefits of the

owner-managed model within boutique active asset management. NCI has kept true to that vision, and thrived upon it.

This latest paper draws upon those core concepts, which we would summarize as ‘organizational culture’, and builds a foundation for the future, drawing upon NCI’s past work and interweaving it with academic and practical authorities to draw a compelling conclusion: that the boutique active management sector is especially amenable to the development of positive organizational culture and that this leads to superior outcomes for clients.

To draw another analogy (and perhaps an investment idea for the truly long term!), planets that support life must be in a particular orbit around a suitable star: too far away or too close and you cannot have liquid water, a narrow band known as the ‘Goldilocks Zone”. NCI members, as boutique asset managers, inhabit a similar optimal zone: not too big and not too small, this paper shows that they are just right to support positive organizational culture and can do so in a way that larger active managers and passive funds cannot.

NCI supports truly client-centric asset management and invites new members who share that vision and ‘culture’. I am pleased to be able to introduce this paper and hope that it acts as a catalyst for further work and discussion to advance the asset management and financial services industries that bring so much to the vibrancy of our economies.

Jamie Carter

Chairman, New City Initiative Chief Executive, Oldfield Partners

The active asset management industry has been under attack for a number of years from passive products, smart beta strategies, and latterly the press and the industry regulator. Although there has been a huge amount of coverage of the active versus passive debate, the tendency has been to group all active managers together, rather than to dig deeper and differentiate between types of active manager. In this paper we explore some of the risks of passive products and highlight some of the benefits of active management.

NCI members are specialist boutiques, with an owner-management ethos and strong alignment of interest with their clients. NCI believes these key traits provide structural advantages, particularly when compared to closet index trackers which charge high fees for index-like performance.

NCI recognises the attraction of passive products, which are another tool in the toolkit for investors. For some investors a purely passive approach, or a mixture of passive and active makes sense, but the majority of investors have the information and capacity to do better by selecting active managers.

This availability of information is key. Transparency is a core value of NCI. We believe value for money is in the eye of the beholder. By providing an investor with clarity about objectives and transparency of information, they are able to make an educated decision about whether a manager can add value to their portfolio. Large institutional investors have been able to obtain detailed information on the costs of running portfolios for years. Our message to all investors is to ask managers for detailed information on costs and charges. If the manager is unwilling to provide them, that probably tells you something.

The paper ends with what we hope are helpful conclusions to guide investors, and a call to the industry to consider working together to adopt technology to ease the investment process and reduce costs.

Jamie Carter

Chairman, New City Initiative Chief Executive, Oldfield Partners

New City Initiative (NCI) provides a collective voice for boutique asset managers, from the UK and the Continent, which share a strong common culture focused on alignment of interest with customers. NCI’s core values are independence, alignment of interest, transparency and responsibility. To that list I would add a fifth, which is competition. In order for the industry to continue to innovate and develop new products and solutions, and improved ways to deliver them to customers, there must be healthy competition and choice.

Since the financial crisis, the regulatory and capital burdens on asset managers have grown enormously, resulting in a much tougher hurdle for start-ups to overcome. Many of our own members, now successful, established firms, have said they could not start today as they had done ten or twenty years ago. That is a terrible indictment on the industry and should be a worry for the customers it serves.

The FCA’s Project Innovate and the joint FCA/PRA New Bank Start-up Unit have addressed similar issues for FinTech and challenger banks respectively, but as yet there is nothing similar in place for asset management. This paper proposes a framework for incubation of asset management, which NCI sees as a natural extension of existing initiatives. In fact, one of the proposals is that there is an approved suite of platform solutions provided by FinTech firms within Project Innovate which can then be used, or tested, by the incubating managers. Our proposal centres around three pillars: 1) supporting innovation, 2) provision of advice and 3) a regulatory sandbox.

Within the third pillar, we argue for a lighter touch regulatory regime until the manager or product reaches scale. In reality, new managers start with the backing of sophisticated institutions which do not require the same regulatory protection as a retail investor and the sandbox environment should apply proportionality. To give an example, it seems unnecessary for a start-up firm managing £50m of listed UK equities to report transactions which can be reported by stock exchanges or counterparties. A manager that is small presents no systemic risk and the trades are immaterial in comparison to the broader market.

The FCA has indicated it is considering this extension of their existing work, and NCI encourages them to proceed and welcomes the opportunity to discuss this proposal.

Jamie Carter

Chairman, New City Initiative Chief Executive, Oldfield Partners

It is no secret that the public despises bankers. Throughout history, the concept of banking and investing has always beentarnished with an image of individuals profiting from speculation or human misery – fund managers (especially hedge funds) ‘don’t make anything – don’t do anything’ and that ultimately our industry is one which exists solely to generate profits for ourselves with no benefit to our communities or mankind at large.

However, in my mind, it is the fund managers – these allocators of capital – who make the whole system work. Without capitalism and the difficult task of putting money to work where it will generate the highest rate of risk adjusted return – we would have had far fewer inventions, human advances, and wealth creation for society as a whole.

This paper, written by Richard Turnbull, goes into great detail as to why this is true. Fund managers provide liquidity, expertise, risk reduction and are also better structured to create the right culture of service and long term thinking. This helps fund managers avoid exactly the accusations of short termist speculation that are often levelled against us. Ourability to retire with dignity or fund new technologies depend upon our industry flourishing in the right way.

The problem with capitalism, as we are seeing with current events such as the vote against the EU by Britain, is that it means in many cases, brutal changes for those areas of the economy which cannot deliver the efficient returns. This means people’s lives change and this can be both incredibly painful and has long term social and financial ramifications too. To respond to these valid issues, a more sympathetic approach to investing which understands the effects of these changes (such as ESG investing) is now being pioneered, by the investing community and we at the NCI welcome this. This does not negate the need to generate returns for investors – but an understanding as regards the effects of our decisions is a good thing.

Finally – there is a view that the people behind some of these firms carry less moral weight than someone in a more vocational profession. We would dispute this, believing that taking thoughtful and difficult decisions to allocate savers’ funds to generate the best possible returns, is in itself both a hard task and one with an enormous positive outcome for savers and therefore society. We all need to generate better cultures and the NCI has taken a strong lead on this – but at the end of the day I believe that fund management is a powerful force for good and it is time that we started to celebrate our contribution both to global finance and the world at large.

I would like to thank Richard Turnbull for his excellent work here and for the engagement he brought to our group through the interviews he undertook and the fresh perspectives he generated via his links with the Centre for Enterprise, Markets and Ethics. His Centre has an important task ahead of it and we welcome the partnership we have formed together.

Dominic Johnson
Chairman, New City Initiative and CEO, Somerset Capital Management

The last few years have been turbulent times for all those involved in the financial markets as they come to terms with all the changes in regulation, market behaviour and market practice. In the past, buy-side institutions such as institutional investors, pension funds, asset managers, wealth managers and private banks have tended to be immune from any turmoil. This time is completely different as the changes are more far-reaching and the upheaval is having a significant impact on all financial market participants, but it has come as a particularly major shock to the fund management industry.

Clearly there has been an increase in costs as a result of compliance with the new risk and regulatory regime. Frequently, additional resources are required to meet the extra administrative burdens associated with doing business in the current environment. Undoubtedly these do not fall fairly across the spectrum of institutions involved and become a barrier to entry for new specialist entrants.

One way institutional investors and asset managers can turn this new business environment to their advantage is in the area of FX. These new regulatory changes are a unique opportunity to upgrade their business model, their FX operational processes and improve efficiency to reduce investment costs and improve fund performance.

The New City Initiative was established to both promulgate our vision for better alignment between investors and money managers – but also to give positive steer to regulators and governments as to how to achieve this. This paper outlines clearly the issues confronting our industry over the coming years and where we would either draw our members’ attention to certain issues, or where we think the regulatory framework could be better structured. Wellington talked about ‘The Other Side of The Hill’ and I hope this document gives some clue as to what is in store for our firms in the near and medium term.

What we find, time and time again is that regulations designed to do one thing (make for a ‘safer world’) actually end up doing the exact opposite – normally destroying competition, making the larger firms larger and thus potentially reducing returns to investors, customer retention, and making the whole system more delicate. The powers that be have oftenmisunderstood what ‘risk’ is and how it is up to a market to price it properly. Much of their efforts to somehow ‘control’ risk, either force it into dark corners where it cannot be easily seen or reduce liquidity in a market, where the real and ultimate risk (as seen in 2008) is a liquidity crisis. We continue to argue that better structures and culture lead to better outcomes and we remain committed to the path of less regulation and more forcing of a change in how people ‘think and operate’ to achieve these same goals of managing risks and being more transparent.

Our view is to promote positive change and I hope that you will find in this paper not only a new set of worries but also a set of quite simple answers to help us make for a better environment in financial services.

Dominic Johnson

Chairman, New City Initiative
CEO and Founding Partner of Somerset Capital Management LLP