2022 was a particularly bruising year for asset managers, with many portfolios being adversely impacted by a combination of market volatility and soaring inflation. Experts already anticipate that 2023 will be tougher, as firms implement aggressive cost-cutting measures to stave off revenue decline and further fee compression.
Amid these difficult headwinds, the industry will need to deal with a plethora of incoming rule changes and potential regulatory developments.
So what awaits fund managers on the horizon?
Further scrutiny of ESG is inevitable
Allocations to ESG or sustainable funds remained relatively healthy in 2022, in contrast to the heavy withdrawals seen elsewhere. According to Morningstar data, sustainable funds drew in $22.5 billion in Q3, whereas the wider industry suffered outflows totalling $198 billion. [1] Despite the asset class’ resilience, regulatory scrutiny of ESG funds is expected to intensify in 2023 as the authorities look to root out greenwashing and product mis-selling.
This comes not long after a series of regulatory fines were levied against several high-profile managers for various ESG shortcomings. In 2022, the US Securities and Exchange Commission (SEC) fined the asset management arm of Goldman Sachs $4 million for policy and procedural failures around its ESG research. Prior to this, BNY Mellon was hit with a $1.5 million fine from the SEC for purportedly mis-stating and omitting information about ESG across some of its mutual funds. [2]
With regulators putting managers’ ESG credentials under the spotlight, boutique firms will need to exercise caution when making investment claims about ESG or sustainability. Conversely, this could also be an excellent opportunity for smaller firms – which are typically more specialised – to communicate clearly to prospective investors about what they are doing around ESG.
Expect some divergence between EU and UK regulations over time
Introduced in July 2022, the UK’s Financial Services and Markets Bill (FSMB) proposes a number of changes to existing UK financial services regulation, as the country attempts to usher in greater competition post-Brexit.
Among the provisions contained within the Bill include the revocation of retained EU law as it relates to financial services set out in Schedule 1, including the rules implementing the Alternative Investment Fund Managers Directive (AIFMD), the Markets in Financial Instruments Regulation (MIFIR) and UCITS. [3] Other upcoming differences include the regulation of sustainable finance, with different disclosure, marketing and naming standards emerging out of the UK and the EU.
This, however, does not mean the UK will jettison EU regulations overnight. Firstly, the government has stressed that there will be no revocation of existing EU rules unless there is a domestic law to replace it. Additionally, experts point out the government will be reluctant to deviate excessively from EU laws, preferring instead to tailor or finesse the rules.
Nonetheless, managers should brace themselves for the possibility of some regulatory divergences between the UK and EU moving forward, although the full impact of this is still yet to be determined.
Prepare for settlement compression
From March 2024, equities traded in the US and Canada will be settled on a T+1 basis instead of T+2, and other markets will likely follow suit (In fact, India began phasing in T+1 in 2022).
Although T+1 could help generate capital efficiencies, there are some unresolved issues, which need clarifying. Firstly, there are concerns about whether financial institutions based in different time zones to the US will need to pre-fund some of their trades. Under the existing T+2 model, financial institutions have two days after the trade date to settle their FX transactions, but under T+1 organisations would need to book FX trades on either the same day or T+1.
While this change will be felt most acutely by financial market infrastructures (i.e. CSDs) and custodians, asset managers could face challenges as well. A move to T+1 may lead to fund managers suffering from an increase in trade fails, resulting in additional costs. If these are to be avoided, it is vital that managers ensure their operational processes and in-house systems can handle the imminent T+1 transition.
Accordingly, asset managers should engage with providers this year about how best to prepare for the T+1 rollout in North America and beyond.
[1] Financial Times – January 3, 2023 – Robust inflows obscure a difficult year for ESG funds
[2] Financial Times – November 22, 2022 – Goldman Sachs to pay $4m penalty over ESG fund claims
[3] Simmons & Simmons (July 22, 2022) Financial Services ands Markets Bill Introduced to Parliament