Asset managers’ future shaped by increasing fiscal and regulatory pressures, says PwC

In describing the future of the asset management industry, PricewaterhouseCoopers’ (PwC) latest perspective in its “The Day After Tomorrow’’ series, highlights the profound and lingering effects caused by the financial crisis. The report offers a view on the key emerging themes on which the industry’s future will depend. These include: dealing effectively with the stresses placed on the current business model; the reaction of institutional investors in the post-crisis environment; fiscal pressure in a more adversarial environment; co-operation between the G8 and G20 countries and the expected raft of financial regulation as well as the thorny issue of compensation.

The key trends emerging are:

• The alternatives market will need to develop a more transparent, sustainable and correctly priced model;
• The squeeze on costs will force some institutions to consider if asset management is still a core business;
• New business models will need to be more investor-centric with a focus on rebuilding trust;
• New fee models providing more predictable revenue streams will provide opportunities going forward;
• Asset managers will need to consider how they should position and protect themselves from increasing and excessive tax burdens;
• Particular attention will need to be given to liquidity risks.

The alternatives sector will be at the heart of this turmoil. Its value proposition will need to become more transparent, sustainable and correctly priced as regulatory and tax scrutiny increases.

The report describes how business models have been hit hard by the combination of sharply falling markets and investor redemptions with a reduction in managed assets of 30-40%. A long period of market volatility, which is likely to remain unabated in the short term, is a primary factor in encouraging firms to seek new business models which can cope with difficult and less predictable market conditions. The squeeze on revenues and the chronic struggle of some players to manage their costs, especially compensation costs, will also force some institutions to consider if asset management is still a core business, especially in the case of banks.

These new business models will need to be more investor-centric. Both retail and institutional investors have lost trust in the industry and the magnitude of the crisis and its financial impacts means the industry will have to consider radical efforts, rather than counting on investors’ short memories. If not, the response may be additional and potentially cumbersome regulation which runs the risk of not keeping pace with financial innovations.

New fee models such as fixed service charges that break the link between assets under management and fees may provide an option that is not only more stable in the long term, but also means that charges would not be correlated to the market.

Launching the report, Damian Neylin, Partner and Leader, PwC Ireland Asset Management Practice said:

“Businesses are in full survival mode and continue to seek ways to reduce costs in the short term in order to maintain profitability or contain losses. There is a requirement for firms to fully evaluate what sustainable cost management means. Are cost-cutting measures sufficient and targeted, especially in the area of compliance and reporting infrastructure, to cope with new regulation?

“Firms may respond to market volatility by seeking new fee models that provide a more predictable revenue stream or aim to reduce costs in human resources. It isn’t all doom and gloom and there may be opportunities for independent asset managers and insurance companies to take advantage of banks seeking to raise capital through hiving off asset management firms. Thus, managers and insurers will be able to grow their own asset base and broaden their range. Those firms that are also able to invest in key areas such as compliance, risk management and reporting infrastructure will derive a direct benefit once regulation is in full swing.”

Asset management firms will also have to contend with an increased tax burden as governments begin to make more tax demands to compensate for the huge public debts they have accumulated over the last 18 months. Asset managers will need to consider how they should position themselves in this new environment while protecting their business from potentially unforgiving tax regimes.

Pat Wall, PwC Ireland Asset Management Tax Leader adds:

“Fiscal pressure will come in the shape of rigorous enforcement of tax rules, swifter closure of loopholes and a more adversarial environment. Asset managers will have no choice but to consider how they should position and protect themselves from excessive tax burdens. On top of this, the tax net will close in on wealthy investors and their advisors and there will be a renewed focus on privacy laws and tax evasion.

“I would expect asset managers to begin asking themselves whether they have the procedures and expertise in place to follow and implement any measures that will come down the regulatory pipe.”

Challenges may also occur with the ability of hedge funds with illiquid strategies to earn performance fees from unrealised profits. There could be market pressure to move to a private equity-style fee model that rewards only realised gains. Although the report highlights areas of concerns opportunities still exist for asset managers who are able to turn threats to business advantages.

Damian Neylin concluded:

“Transparency is a continuing motivator on both the asset management and investors’ side. Institutional investors will continue to increase their due diligence and asset managers will have to get better at articulating risk and reward to investors. This implies that managers will need a firm grasp of their own strategies, paying particular attention to counterparty and liquidity risks.”

Last but not least, Asia will become the top geographical focus of large asset managers. Spared by the financial crisis but impacted by the global economic slowdown, Asia will come back first and represents, as such, a major opportunity. Those asset managers which can continue investing in the deployment of their business in this part of the world will gain a significant competitive advantage.

According to the report, the nine key issues facing the asset management industry today and in the future are:

• Business models are under stress
• Investors: How will they react in the post-crisis environment?
• Fiscal pressures that will change shape of the industry
• G8, G20: A new spirit of co-operation (with consequences for asset management)
• How will the regulatory maelstrom impact the asset management sector?
• Is the “new model” in financial services under pressure?
• Deleveraging in the banking system will affect asset management
• Compensation: What’s good for banking….
• The re-awakening of Asia

ENDS

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