Watchdog warns European regulations will hit returns

Tighter regulation within the European fund management industry will drive up the cost of funds and hit investors’ returns, the European Fund and Asset Management Association (Efama) warns.

Following the financial crisis, the industry has already seen a wave of new regulation, including the controversial Alternative Investment Fund Management (AIFM) directive and proposals for Ucits V.

Last week, the European Commission published two drafts of the AIFM, which drew more criticism. (article continues below)

While new regulation is intended to make the fund management industry more competitive and attractive to investors, industry leaders warn that this could have the opposite result.

“It is difficult to say by how much the cost of funds will go up [as a result of regulation] but the impact will be significant,” says Jarkko Syyrilä, the newly appointed deputy director general of Efama. As costs of funds are set to rise, Syyrilä (pictured) says asset managers will have to pass some of them on to investors.

Among the main cost drivers for Ucits funds are the Investor Compensation Schemes directive (ICSD) and revised requirements on depositary liability. Non-Ucits funds, on the other hand, are regulated under the AIFM directive. This includes more ­regulation on ­valuers’ liability, compliance, additional external reporting to regulators and depositary liability.

If the ICSD proposal goes through in its current form, all European member states have to build a compensation fund for their Ucits ranges. If, for example, the depositary of a Ucits fund loses assets or the custodian goes bankrupt, the scheme would have to cover the losses.

However, this means that Ucits funds would have to pay 0.5% of their assets over the course of 10 years into a pre-funded compensation fund. Together, all European Union countries would have to raise €27 billion (£24 billion) for their Ucits assets.

Depositary banks will also face a strict liability under the AIFM directive and Ucits V should they lose the assets a fund has deposited with them. This will drive up bank capital requirements, which raises costs of running funds for asset managers.

This will be particularly difficult for emerging market funds as it might not be possible for depositary banks to offer custody services in some emerging markets as the liability risk would be too great. Syyrilä says this regulation would be “crazy” given increased interest in emerging markets.

So far, it is not clear how revised regulation would affect custodian fees.

Chris Fletcher, the head of retail investments at Baillie Gifford, says the AIFM directive requires “silly” disclosures such as remuneration, which will increase administration and compliance costs. He predicts funds in general will become more expensive.

At the same time, asset managers may also become less profitable. Toby Hogbin, the head of product development at Martin Currie, expects that costs will be shared between investors and asset managers. “Regulation always comes with costs,” he says.

PricewaterhouseCoopers (PwC) warned earlier this year that regulation and its demands on asset managers have become a huge concern. PwC says the regulation will lead to radical changes in the framework but the full effect remains unclear.

The World Wealth Report 2010 published by Capgemini and Merrill Lynch Wealth Management also found that tighter regulation has become one of the biggest fears for asset managers and investors.

Although industry leaders agree that it was necessary to review the regulatory framework after the financial crisis, they say the fresh proposals have not been properly assessed by the commission.

The commission was unavailable for comment but has previously said insufficient regulation creates risks.