concerns that choice of product providers may be increasingly influenced by the strength of their balance sheets aPPEAR TO BE RECEDING
Concerns that Basel II proposals and related EU capital adequacy requirements may lead to intermediaries' choice of product provider being increasingly influenced by balance sheet strength appear to be receding.
The IMA is confident that the European Commission's inclusion of a waiver for fund management groups this July in its Capital Adequacy Directive III (CAD III) will pass through the consultation phase in the fourth quarter. Fund managers were exempt from the EU's Basel II regulations, which require amounts of capital based on companies' income be held on their balance sheets to offset operational risk, until amendments to the Ucits Directive removed this waiver last November.
If the waiver in CAD III is not passed through in its present form, fund management groups could be ranked by their risk management capabilities under the FSA's latest proposals for the implementation of the Basel II and EU Capital Adequacy Directive standards.
Although it is not yet clear how much of this data would be made public, it is believed it would take a similar form to the capital adequacy tables of life offices and would be another means for intermediaries and the public to judge the strength of particular product providers.
How this ranking would be worked out and whether it would lead to higher charges is still being debated by a working party of FSA and fund management professionals.
Moreover, the UK and European regulators' argument that its proposals will level the playing field between banks and fund managers is fundamentally flawed and will favour bancassurers, consensus suggests.
While fund management groups are typically highly cash generative businesses, this capital is efficiently allocated and if forced to keep it on their balance sheets, corporate activity would be more difficult to fund.
This would mean fund management groups would struggle to acquire other groups unless they can pay in cash. Given the industry is considered to be in need of further consolidation, such a move could be considered anti-competitive and as such contra to the FSA's remit.
Presently, fund groups are still only required to hold capital in reserve equivalent to three months expenditure. This is taken as the time in which any fund group facing difficulty should be able to transfer its assets under management to another fund group or encash and return these monies.
Julie Patterson, director of regulation and taxation at the IMA, said whatever shape the regulation does eventually take, fund groups are still being adversely affected by the lack of clarity over regulation in the near-term, in terms of future planning and systems development.
She is confident the picture will be a lot clearer by the end of the year, however, after all of these proposals are finally hammered out.
The IMA has been backed by numerous fund groups in its lobbying against these potentially more onerous capital adequacy requirements.
Memories of the Morgan Grenfell scandal back in 1996-1997, when European fund manager Peter Young was found to have misled investors over the value of certain holdings within his fund, remain fresh in the memories of many.
Deutsche Bank, the parent group of Morgan Grenfell, bailed investors out by injecting £400m into the fund to ensure liquidity and protect its image as best it could.
While Basel requirements were viewed by many as a response to these events, by ensuring fund groups can adequately support investors in case of another similar affair, fund groups stress the one-off nature of the event and the fact investors' assets are ring-fenced.
Stuart Cazier, joint managing director of operations at New Star Asset Management, said: 'These proposals threaten smaller independent houses. Our assets are separately held and the depository sees everything going on. Asset pricing is stringently controlled and the FSA has regulations on how much you can invest in unlisted assets.'
While most fund groups, other than the likes of Fidelity, UBS and Schroders, could never afford such a compensation package, Cazier stresses Deutsche was under no obligation to pay this amount. The Imro fine levied in April 1997 was actually £2m, although the regulator did take into account the swift response by the parent group. Patterson said consolidated supervision is covered by both the new and existing CAD and Basel II requirements are also implemented through CAD.
The complexity of the issue is compounded by the sheer volume of proposals emanating from the various EU and UK regulatory authorities involved and the at times seemingly conflicting nature of different bodies proposed requirements.
The FSA's Consultation Paper 173: 'Amendments to the Interim Prudential sourcebook for Investment Businesses chapter 5 rules on consolidated supervision', goes above and beyond the EU requirements, by proposing fund management groups ignore goodwill when calculating their asset base and hold positive amounts of capital on their balance sheets to offset any operational risk, CAD will ultimately supersede FSA legislation, Paterson said.
'CP 173 is super-equivalent to the EU requirements and has led to charges that rules are more strictly applied here than in other EU member states. The UK regulator is sometimes guilty of pre-empting European regulations when it is supposed to be interpreting them,' Patterson said.
'CAD III will take precedence in the end though, but additions to CAD are being made at the moment and both UK and individual EU member state regulators are seeking to influence policy direction.'
While the UK, France, Germany, Italy and Spain are all critical of the prospect of fund management groups being forced to implement Basel II requirements, other countries, including many in Eastern and Central Europe will vote for the proposal.
That said, the number of votes countries have is in direct proportion to the size of their financial services industries and the largest six in order of size, listed above, are tentatively in agreement.
'It does look certain that firms not holding client money will be okay and that those that do hold client money, but are not market makers will also get a waiver from the requirements,' Paterson said.
Sheila Nicholl, deputy chief executive at the IMA, said the fact that the waiver was reinstated into EU legislation in the Commission's recent pre-consultation stage was positive for the industry as it is typically easier to keep a clause in proposals rather than get one struck off.
'The hope is that the requirements for asset managers are not going to be much different from as they are now, but this has not even reached the form of a directive yet,' she said.
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