We sat down with Richard Withers, Head of Government Relations in Europe at Vanguard Asset Management, Ltd., to discuss the key issues and trends shaping the global regulatory landscape. Richard shares his policy expectations and what he believes to be the biggest regulatory priorities for asset managers in the year ahead.
As we enter 2018, what is the biggest regulatory challenge asset managers will face?
Outside of Brexit, I believe the biggest regulatory challenge facing asset managers right now is the ongoing policymaker focus on fund costs, charges, net returns, and the related question as to whether their products and services offer value for money. End-investor value for money is a focus at Vanguard, and we believe in ensuring there is effective price competition to help level the playing field, enable greater innovation, and improve investor choice. If regulators and the industry focus on addressing these issues, ultimately it will improve the financial well-being of millions.
MiFID 2 dominated headlines in 2017. What will be the top story of 2018?
I think we will still be talking about MiFID 2 in 2018 as its implementation beds down. Like the original directive, MiFID 2 will have a long-term impact for investment firms. The requirement that investors are provided with a “total cost of investing” figure will have a profound effect on investors’ awareness of costs incurred in purchasing a fund and their understanding of the impact of costs on net returns. As a result, we may see further scrutiny and pressure on costs, providing a tailwind to the recent trend towards lower cost funds and intermediary services.
While MiFID 2 will have many positive consequences in 2018, I also expect that we will start hearing noise about possible tweaks to the MiFID 2 regime in the coming years. I could envision pressure to:
- require that the total cost of investing is more simply displayed to end investors
- revisit how the transaction costs element of the total cost of investing is calculated
- close the gap between independent financial advisers and discretionary portfolio managers that are not permitted to accept and retain inducements from product providers and non-independent financial advisers that can
It will also be interesting to see whether MiFID 2 results in a comprehensive consolidated trading tape, or whether a MiFID 3 needs to be enacted to require this service to be provided on a public utility basis.
The transparency of ETF liquidity will be another important focus for 2018. The mandatory post-trade transparency within MiFID 2 is likely to increase the market’s awareness of the general depth of liquidity of EU ETFs, in particular. A significant amount of EU ETF trading still occurs over-the-counter in Europe, rather than on trading venues. A consequence of this increased transparency, is that this may result in further European investor-driven demand for the broad diversification and trading flexibility at low cost that ETFs offer.
What is the biggest open policy debate likely to advance or conclude in 2018?
I think there’s probably some crystal ball gazing required when it comes to thinking about what the post-Brexit environment looks like. There are obviously significant perils around predicting Brexit specifics, but even at a macro-level, we envisage it significantly impacting the nature of Vanguard’s policymaker engagement at an EU, UK and global level:
EU: There has not yet been any immediate, notable change to EU policymaking, because the UK remains an EU Member State for the time being (admittedly with reduced influence). Going forward, I would expect there to be an increasing focus on the development of a single/more harmonized EU capital market, which is able to compete with and have less dependence on the UK. I am hopeful this can be achieved through regulation that encourages cross-border competition, rather than through protectionist policies.
UK: In the short-term I believe we can expect the UK to retain EU rules, whether as an EU member state or in order to ensure a high degree of regulatory alignment between the UK and the EU on financial services matters. That said, clearly there is the scope for increased UK regulatory flexibility post-Brexit and I expect that we will increasingly see divergence between EU and UK policymaking. As such, I would expect that UK-based asset managers will see an ever-greater influence of UK policymakers going forward.
Global: Without the same influence at the EU policy table, it would appear critical that the UK maintains a strong influence at a global level, for example in the design of IOSCO global standards. This will be particularly important for asset managers with both UK and non-UK businesses so that they can operate these businesses with as minimal divergence as possible.
Regulators seem to have their eyes on ETFs. Will we see ETF specific regulation in 2018?
Although sometimes portrayed as unique instruments, ETFs are comparable to traditional mutual funds. As such, we believe it is important to allow them to continue to be categorised and regulated under the existing well-established regimes, such as the UCITS Directive. Alternative approaches could risk damaging existing regulatory brands and impose unnecessary complications for investors. So far, we haven’t seen that the increased volumes in ETFs have led to any strain in the ETF architecture. ETFs remain a small percentage of the overall funds market and stock market activity.
Given it represents the essential difference between mutual funds and ETFs, we expect policymakers to continue to focus on the role of authorised participants (APs) and liquidity providers in establishing the spreads at which ETFs trade and the connection between secondary ETF market activity and the underlying primary markets. We recognize the important role played by APs and liquidity providers, but our experience also suggests that the economic incentives available to these market participants means a robust arbitrage mechanism exists even in periods of stress.
Vanguard considers that whether a strategy or particular asset class is appropriate for an ETF should primarily remain a matter for asset managers to determine. Such determination should be based on transparency, liquidity and capacity management considerations in respect of the investment mandate in question.
At the same time, we recognize that there are increasing examples of more niche products, such as leveraged and inverse ETFs and ETFs of less liquid/illiquid asset classes. These products give rise to separate and distinct challenges than those posed by more diversified ETFs. We support regulators taking account of these differences in a risk based approach within their authorisation and supervision of ETFs.
Are regulators keeping up with technology’s disruption of asset management?
I think it’s fair to say that no matter the industry, the pace of technological change has outstripped regulatory reform and it’s no different in asset management. That said, we’ve seen positive steps by policymakers to understand the opportunities and challenges that FinTech can bring and, where relevant, to facilitate its positive disruption.
Unsurprisingly, one area that I see continued disruptive potential is in the case of technology-enabled investment advice. To maximise the full potential of robo-advisors, we believe it is important that regulators are convinced of the “alpha” – or added value of advice, the role that technology can play in making advice more affordable and accessible, and the need for consumers to have a sliding scale of advice and guidance options to match their wishes, needs, and disposable income.
The positions expressed are those of the author as of 1/14/18 and may or may not be consistent with the views of Brown Brothers Harriman & Co. and its subsidiaries and affiliates (“BBH”), and are intended for informational purposes only. Information contained herein is based upon various sources believed to be reliable and subject to change without notice. Furthermore, these positions are not intended to predict or guarantee the future performance of any currencies or markets. This material should not be construed as research or as investment, legal or tax advice, nor should it be considered information sufficient upon which to base an investment decision.
This article was originally published in the 2018 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.
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