Impact of the credit crunch on Asset Managers
Speech by Hector Sants, Chief Executive, FSA
FSA Asset Management Conference
17 September 2008
Welcome to the FSA’s fifth annual Asset Management Conference. I am delighted to see so many of you here at this sell-out event. I would like to open today by giving my perspective on recent events before moving on to consider more specifically the impact on the Asset Management sector and some of the key issues you face.
I ought to, perhaps, begin by saying that I subscribe to the view that economic and market cycles are inevitable. Indeed, a downturn of some magnitude was largely expected by commentators and regulators. A correction of risk pricing was, thus, foreseeable. But what was not anticipated was the collapse of investor confidence and subsequent liquidity squeeze. The loss of confidence was, in many ways, due to a lack of transparency and understanding, with both sellers and buyers of products forgetting the golden rule of “don’t sell or buy a product you don’t understand”.
As I have said before, the FSA sees this as a three stage cycle, beginning with market confidence and liquidity issues, then moving to a recapitalisation of banks and finally where we are now - working through the implications of the impact of those first two stages on the real economy. This third stage has potentially severe implications for consumers and presents a credit management challenge for financial firms. But is relatively well trodden territory for regulators and, I would hope, for firms’ management. I now believe that market confidence can only return when investors know where the bottom is. We are not there yet, as the events of this weekend have shown, but we are getting closer.
Impact of the credit crunch on Asset Managers
On a more positive note, it appears that asset managers have fared relatively well during the credit crunch, compared with banks in particular and other financial services firms in general. While there have been a small number of high-profile hedge fund liquidations and periods of high volume outflows from pooled funds, most firms appear to be coping in this challenging period.
We appreciate that the segregation of client assets, which is core to the asset management business model, is a key reason for the limited balance sheet impact on the sector. Consequently, most of the problems experienced by asset managers during the credit crunch have, in our view, been related to how they conduct their business.
In our January 2008 Financial Risk Outlook we highlighted a number of issues as priority risks. Among these were:
- that existing business models of some financial institutions could come under strain as a result of adverse market conditions;
- that increased financial pressures could potentially lead to firms shifting their efforts away from focusing on conduct of business requirements and from maintaining and strengthening business as usual processes; and
- that tighter economic conditions could potentially increase the incidence or discovery of some types of financial crime, or that they could lead to firms’ resources being diverted away from tackling financial crime.
We have seen these risks crystallise in asset managers in various ways and would draw out three lessons for firms to consider. Firstly, senior management should take seriously their responsibility to establish and implement appropriate systems and controls. This is especially important when firms are running more complicated funds and products, as well as investing in more complex assets. Secondly, while I acknowledge that the current environment is causing many firms to look at cost controls, management needs to carefully consider any headcount reduction exercise that could compromise essential functions, especially those in roles such as operations, risk and compliance. And finally, as the events of the last year have highlighted, market shocks can emerge unexpectedly and bring large repercussions. Firms need to ensure these stresses are being built in to their capital adequacy assessments and we will be actively considering these in our current and future evaluation of ICAAPs. We hope that you take the opportunity to discuss this and similar issues in the ICAAP workshops later in today’s programme.
Turning briefly to hedge funds. Although, as I have said, there were some high profile losses and liquidations, we have seen limited systemic impact from these funds. Investment banks’ exposures to hedge funds were broadly contained and the liquidations were reported to be orderly. What has been highlighted for individual funds is the importance of monitoring redemption risk profiles and managing mismatches between funding/notice periods and the underlying liquidity of funds.
Outcome based regulation
Many of these issues are risks that would arise during the normal course of business. They simply have become more evident due to the turbulent events in the markets. I continue to believe that these volatile times reinforce rather than detract from our view that a principle and an outcome-based philosophy of regulation is the way forward. I believe that analysis of events supports an approach to regulation which has a greater emphasis on the consequences of firms' actions rather than on rigid adherence to specific rules. Principles assume more importance and relevance in turbulent times when the environment that firms face can change quickly. Considered review of questions such as whether customers are continuing to be treated fairly, whether conflicts of interest are being managed appropriately and, critically, whether the business risks are being managed, should be the norm in a more outcome focussed world.
One of our key principle based conduct initiatives from an asset management point of view is treating customers fairly. Our main message on TCF is that we expect firms to be able to demonstrate that they are treating customers fairly by the end of the year using appropriate Management Information. We will be proactively assessing this during the first half of next year.
At last year’s conference, the industry highlighted that we needed to clarify what TCF meant for UK Authorised Collective Investment Scheme Managers. We subsequently engaged in productive dialogue with firms and trade bodies and published a set of good practice guidelines in January. These clarify what we mean by target market for retail fund manager and what measures we might expect retail fund managers to use in determining whether the actual distribution of a product matches up to their initial intentions for the product. We hope that all firms for whom these guidelines are relevant have had sufficient opportunity to reflect on these and implement the good practice measures proposed. From summer 2009, as part of our revamp of our overall supervisory procedures, we will embed our TCF strategy within our normal supervisory framework. TCF will then become part of our ongoing conduct regime.
We also remain committed to driving forward our key initiatives to tackle financial crime in the sector. We will continue to use all the powers at our disposal – civil, criminal and administrative – to combat market abuse and insider dealing. This is part of a concerted effort to ensure all market participants take this issue seriously. This year we have brought three criminal prosecutions for insider dealing, and anticipate there will be more to come.
Quality of Markets
Continuing the theme of conduct issues, there are also lessons to be learned from recent events beyond the supervisory regime. They also raise questions about how regulators address the issue of ensuring the quality of markets. This will be a subject we will continue to consider going forward. We have already looked at the efficiency of capital raising in markets and are considering further transparency in terms of the disclosure regime for general insurance firms.
To give two recent examples, we have made regulatory interventions in relation to contracts for difference and short positions in stocks where the issuer is undertaking a rights issue. On CfDs, we believe that the enhanced disclosure is required to address market failures around access to voting rights, corporate influence and undisclosed stakebuilding. We will be publishing our final rules on this shortly. In terms of short selling, we believe that it has a legitimate role to play in the markets. But, as with long strategies, it can be used for abusive and manipulative purposes. As you will know, in June we introduced a short selling disclosure regime designed to mitigate the risks of this type of abusive behaviour occurring in thye trading of shares in firms undertaking rights issues. It is important the rights issue mechanism is able to facilitate the raising of capital at a correct economic price, without distortion. We have implemented the regime on a one-off disclosure basis to minimise the burden on market participants and are currently reviewing this approach.
In closing, I would like to acknowledge the importance of the FSA helping the market adapt to the changing conditions we have seen over the past year. We also are committed to enabling the European market to deliver more efficiencies for all participants. We welcome the EU Commission’s recent proposals to revise the UCITS Directive to further enhance the efficiency of Europe’s fund management industry. We are also very supportive of CESR’s work on the management company passport and look forward to seeing a positive resolution of this issue. We remain focused on delivering a quality market place: a market place where borrowers and savers can make long-term financial commitments and a market place which works for everybody.
Thank you for your attention. Before the panel session commences I would be happy to take any questions you have.