The IMA has given its reponse to the FSA's discussion paper on 'wider-range retail investment products'. RealAdviser assesses the key points raised
This week the IMA gave its response to the FSA's discussion paper on 'wider-range retail investment products'. Central to its response was the call for a single regulatory regime to be established for all retail investment vehicles. It dismissed the FSA's proposals for the creation of a 'sophisticated products' category as unnecessary and said it should move away from the historic baggage associated with terms such as 'packaged products'. What is the potential impact of both the FSA's proposals and the IMA response?
One of the key points in the FSA proposals was the segregation of a 'complex' class of investment products. This would include any investment that displayed a high degree of volatility, illiquidity or complexity. This could include the non-Ucits retail schemes and a number of the funds launched under the new Ucits III legislation.
A number of investment management groups, including Credit Suisse, New Star and Cazenove have introduced products structured as non-Ucits retail schemes. The products have generally included alternative asset classes such as absolute return strategies, offshore funds and private equity. Firstly, is there a risk that these proposals will stifle creativity in the industry and - more importantly - close off diverse and effective means of managing risk for fund management groups and their clients? Secondly, if so, does the IMA response adequately address this?
Simon Ellis, head of retail at Axa Investment Managers, believes that the regulator should not try and regulate by product. It can never catch up, particularly as the current market is displaying considerable innovation. Any move to segregate according to complexity could stifle innovation or drive it offshore. He believes it is now generally accepted that the future of multi-manager lies with the inclusion of multiple asset classes - this is the approach that has been used for high net worth investors for many years and its appearance in the retail market marks significant progress. Any attempt to classify multi-manager products as 'complex' if they include alternative asset classes would distort the market.
He adds: "The real difficulty is if regulators try to get involved in managing the contents of products…We need to take a step back and ask what we are actually concerned about. Surely it is that consumers have enough information that a product can or will contain a wider variety of instruments such as derivatives? It should be disclosed that the fund manager will use other instruments that could change the risk profile of the fund. The intention of using those instruments should also be disclosed."
To this end, Ellis believes that the regulator should look to regulate at the point of distribution - the provider and the adviser. He believes it is the adviser who should be saying 'this fund will use derivatives'. Equally, the providers need to demonstrate sufficient competence that it can manage these products - this regulation is already in place. Product development is happening so fast that rules based around current product definitions will quickly be rendered obsolete.
This is largely in line with the IMA's stance, which is based on six considerations: ensuring access to alternative investments is properly regulated; the existing high level of investor protection on collective investment schemes; the inappropriateness of selling unregulated collective investment schemes to retail investors without advice; the ability to give retail investors indirect access to hedge funds; the need for a level playing field between all products and the value of a UK taxation regime that encourages product providers to domicile funds onshore.
Richard Pursglove, head of UK institutional marketing at Cazenove Capital Management, points out that just because a fund adopts Ucits III doesn't mean it will use all the powers available under the regulations. Would the regulator have to regulate the type of fund? It would seem impossible to categorise all Ucits III funds as 'sophisticated' as this will include all funds by June 2007. How would a regulator monitor those who were using Ucits III powers and those who weren't? And how would they keep track of changes?
It is possible that by putting funds that include 'alternative' investments into a 'sophisticated' category, the regulator would again be depriving the mass of investors of valuable risk management tools. Pursglove says that there is a misconception over attitude to risk for absolute strategies: "These should act as a diversifier away from the market. It can reduce risk. There have been some high profile blow-ups of absolute return funds, but the vast majority set out to reduce risk."
The IMA points out that Ucits III regulation sets out the requirement for a derivative risk management process. This ensures that managers disclose: "any specific risk arising from particular investment policies or strategies or associated with specific markets or assets". It also states that access to alternative investment strategies within a controlled and transparent environment is of benefit to investors.
It also supports a coherent promotional regime for all retail investment products that includes collective investment schemes, listed products, life insurance products and structured products linked to bank deposit accounts. As it stands the FSA has left the life insurance industry out of its deliberations - the IMA disputes this, believing that some of the more troublesome products, such as precipice bonds, have been structured through life insurance vehicles.
The IMA is fully in line with its members in its response to the FSA. The FSA risks stifling much of the innovation in the fund management industry and, rather than reducing risk (as is presumably its intention), may actually reduce the range of alternative asset classes that fund managers can use to improve the risk profile of their funds. Once again, alternative asset classes would be limited to high net worth investors. This would represent a significant step backwards for the fund management industry.
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