Moody's, the US credit-rating agency, has compiled a report that offers some tentative predictions for the world's asset management industry in the coming year. Regulatory considerations loom large.
Moody's expects asset managers to 'rationalise' their middle-and-back-office expenses (whatever that means) and thereby save money. This ought to protect their margins in the face of regulatory compliance costs, which include the fabulous amounts that most firms seem to be expending on IT.
Incidentally, the ratings agency expects global economic growth to be lacklustre in 2020 but does not expect a recession. It believes that mergers and acquisitions will go on at a brisk pace without 'overheating' (once again, a nebulous term). Debt ought to remain manageable and the outlook is stable.
What could change the outlook for the better?
Moody's is not looking forward to an increase in regulatory intervention because it knows that this is going to drive up costs and influence the behaviour of investors. It puts this prediction under a heading entitled "what could change outlook to negative," along with such factors as passive investing spreading even further into the fixed-income and non-US markets.
Under the heading of "what could change outlook to positive," Moody's lists synchronous global economic expansion (an unlikely prospect), a halting of the trend towards passive investing by way of better active performance (also unlikely), a re-acceleration of industry-wide organic growth in AuM, the digitisation of product/service delivery to create direct relationships with clients and make revenue grow faster, and the realisation of AUM market opportunities for foreign managers in China and emerging markets. Nowhere on this positive side of the ledger is the global increase in regulation as a stimulus to growth.
Asset managers under the regulatory spotlight
Regulators around the globe are doing a great deal to reduce conflicts of interests in financial advice (for example in the European Union's second Markets in Financial Instruments Directive or MiFID II and the US Securities and Exchange Commission’s Best Interest Standard Rules). With this in mind, the ratings agency urges asset managers to watch for 'fee compression' and a greater use of lower-cost products.
Liquidity mismatches in open-ended funds are going to be an obsession for regulators all over the world because of the collapse of the Woodford fund. With this in mind, Moody's is expecting more supervision of fund liquidity management in the EU, along with the inevitable rise in compliance.
The explosive growth of exchange-traded funds (ETFs) has raised questions among regulators and market participants about what all this growth means for the broader market. Moody's urges people to keep an eye on the market infrastructure that supports ETFs, fearing that it might not hold up in a prolonged period of market stress, particularly for ETFs that track less liquid (i.e. high yield) asset classes.
The General Data Protection Regulation (GDPR) is a new 'reality' for asset managers and Moody's is advising the market to keep an eye on the way asset managers deal with it as they become more digital and pursue more "direct-to-consumer distribution opportunities." It warns that non-compliance will be costly both in terms of reputations and profit-and-loss accounts.
Moody's also expects regulators to concentrate on the ways in which asset managers manage something that it calls 'technology risk' that pertains to model delivery, cyber-risk and artificial intelligence. It also expects regulators to want to know how asset managers are adding ESG screening (fixed-income investors apply ESG filters or 'screens' to their investments to avoid undesirable issuers or securities and fall in with their clients' tender social consciences) to their investment processes and ultimately to their decisions about where to invest.
Noting that "regulatory uncertainties present downside risks," Moody's moves on to the growing Chinese market, which it hopes will present Western asset managers with a 'gold rush.' In August, according to Reuters, JP Morgan acquired a majority stake in its Chinese asset management joint venture but it still needed regulatory approval to become the first foreign firm to take control of an onshore fund business in accordance with new Chinese rules. Moody's hopes that this approval, when it comes, will (it uses the non-committal word 'would') help to clear the path for other fund managers that want to enter this lucrative market. In the asset management business, evidently, regulators can take money away with one hand but can also give with the other.