2018 was a challenging year for asset managers from both an investment and operational perspective. On the investment side, managers had to navigate sporadic violent swings in the market, partly inspired by the so-called “Trump trade tariff tantrum,” an event which – for a while – turned Brexit into something of a sideshow. Simultaneously, the uncertainty surrounding Brexit itself continued, causing headaches for managers already focused on meeting the regulatory challenges of MIFID II, and the implementation of GDPR.
Regulation
AIFMD and Brexit: no change to depositary
Even though some UK managers had hoped that EU legislation such as the Alternative Investment Fund Managers Directive (AIFMD) would evaporate after Brexit, it is clear this will not happen. In fact, the UK government confirmed the regulation will not be weakened when it published a document – “Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018” – in October 2018 affirming that European law would be retained for domestic and EU managers operating inside the UK after Brexit.
The document effectively states that depositary will remain mandatory for UK based managers marketing to UK investors irrespective of what the final Brexit outcome may be. As the depositary performs such an integral governance role, this confirmation will be welcomed by some institutional investors, who are clearly supportive of the added protections that come with having an independent provider overseeing the activities of the funds in which they invest.
AIFMD: What comes next?
In the second half of 2017, the European Commission (EC) engaged KPMG to conduct a review of the AIFMD. The review sought to assess whether the AIFMD, introduced across Europe during 2013-14 , had achieved its general objective of providing an internal market for EU and non-EU alternative investment fund managers (AIFMs) along with a harmonised and stringent regulatory and supervisory framework.
KPMG’s final report was recently published and concluded that AIFMD’s objectives had largely been met. The report did not contain any major surprises but, as widely expected, highlighted weaknesses in the effective functioning of the EU’s marketing passport, burdensome regulatory reporting requirements, and inconsistencies around leverage calculation methodologies between operators of UCITS and AIFs.
It also noted that private placement regimes, the route which many managers use to market to EU investors, should be allowed to continue. The EC has already made some amendments to the AIFMD pre-marketing and asset segregation rules in 2018, and the industry will await possible further changes following the KPMG review.
SMCR reinforces the need for effective oversight
The Senior Managers & Certification Regime (SMCR) will be extended from banks to asset managers from December 2019. Governance is at the heart of SMCR, as the UK Financial Conduct Authority (FCA) seeks to create a stronger framework for accountability within the asset management industry by requiring senior managers to sign a statement of responsibility and certifying staff as being fit and proper.
Given the UK regulator’s decision to prioritise governance, asset managers need to make a concerted effort to demonstrate that their oversight processes are watertight. An independent depositary overseeing fund operations is one tool managers can leverage in this regard. The FCA will be scrutinising managers’ arrangements in detail and the regulator has already started to reach out to firms to discuss their preparations for SMCR ahead of its 2019 year-end deadline.
Investment strategies
Environmental, Social, Governance (ESG)
2018 was the year that ESG investing gathered momentum, both from a bottom-up (driven by investor demand) and a top down perspective (driven by regulation). On the latter, the EU’s proposed Sustainable Finance Action Plan (announced in March 2018) is still a work in progress, and the finer details are yet to be ironed out, something which is likely to happen in 2019.
In any case, asset managers will increasingly need to demonstrate to clients that they are implementing ESG in their investment processes, following concerns that some organisations are greenwashing their products. Independent oversight of ESG compliance will give investors comfort that their managers are doing what they say they are.
Digital assets
January 7 marked the 10-year anniversary of the introduction of Bitcoin. However, digital assets (including cryptocurrencies and tokens) remain a nascent market and they have yet to make a significant impact on the wealth management sector. Regulators globally have been gradually adapting their rule books to address digital assets, and the market is seeking to become more institutional over time.
Despite significant price drops during 2018, the digital asset market is expected to continue to develop in 2019. The provision of independent oversight and monitoring will help institutionalise and build trust in the sector. As more managers begin trading these instruments, they will need to engage with depositary providers who are conversant with and able to support this new asset class.
Conclusion
The depositary function, which forms one component of the AIFMD, was part of a series of proposals designed to protect investors and ensure good fund governance. Since the AIFMD first began to be implemented in 2013, this role is now seen as an important element of good fund governance. Furthermore, there is growing scope and demand for depositaries to engage with investment managers in different ways beyond its original AIFMD mandate.
