Asset managers’ future shaped through a prism of fiscal pressure and regulation 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 of the financial crisis. The report offers a view on the key emerging themes on which the future of the industry  depends, including:

• 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;
• the expected raft of financial regulation; and
• the thorny issue of compensation.

The alternatives sector will be at the heart of this turmoil. Besides the increased regulatory and tax scrutiny underway as a result of the G8-G20 willingness to eradicate the shadow financial system, its value proposition will need to become more transparent, sustainable and correctly priced.

The report describes how business models have been knocked 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 is likely to remain unabated in the short-term and is a primary factor 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 to manage 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. The magnitude of the crisis and its financial implications means that the industry will need to consider radical efforts, rather than counting on investors’ short memories. If not, the response may be an additional and potentially cumbersome regulation which runs the risk of lagging behind 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.

Pierre de Villiers, Asset Management Industry Leader, PricewaterhouseCoopers, 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.”

De Villiers continues, “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. However, it isn’t all doom and gloom and there may be opportunities for independent asset managers and insurance companies to take advantage of the fact that banks are 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. Firms that are  able to invest in key areas such as compliance, risk management and reporting infrastructure will derive a direct benefit once the regulation is in full swing.”

Asset management firms will also have to contend with an increased tax burden as governments begin to make more taxing 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.

Bryan Ingram, Associate Director, PricewaterhouseCoopers, commented:“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.

Ingram continues, “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 regarding 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.

Hennie Jansen van Rensburg, PricewaterhouseCoopers, says, “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 be the first to recover and this represents 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.