16 August 2024
Navigating the Regulatory Landscape: The Evolving Challenges for Asset Managers
In a 2018 survey of asset managers, 85% of those questioned predicted that their regulatory burden would increase over the next five years. More than a third of these asset managers believed that their firm’s compliance budget would account for more than 5% of revenues in the future. They were right.
While asset management regulation is nothing new, what is new is the quantity. As an example, the US, the world’s largest market for asset managers, has seen regulatory activity significantly increase since 2020. According to SIFMA, Securities and Exchange Commission (SEC) chairman Gary Gensler is currently on track to propose or finalise 63 new rules by the end of his first four years in office.
By contrast, the previous SEC Chairman, Jay Clayton, finalised 43 rules between 2017 and 2020.
“The volume and pace of regulatory changes in the US and elsewhere are creating new exposures for asset management firms and their Senior Managers,” notes Jonathan Drinkwater, a Divisional Director with Gallagher Specialty.
The capitals of Asset Management
While asset management is a global industry, the US and the UK represent its two largest hubs, both in terms of assets under management and the number of firms whose primary business is asset management.
Within US financial markets, the SEC has worked to address inherent conflicts of interest, as the regulator seeks to rework market structure under its chairman Gensler. In fiscal year 2023, nearly 20% of the SEC’s actions involved either investment advisors or investment companies.
Off-channel communications
The proliferation of electronic communication channels and the remote workplace have contributed to the growth of off-channel communication as an exposure.
The first enforcement action related to off-channel communications, which occurred in 2021, was against a broker-dealer whose employees and supervisors were using personal texts, personal emails, and WhatsApp messages for business communications.
Each successive wave of off-channel communications enforcement actions has brought in an increasing number of investment advisors and investment companies.
In February 2024, the SEC announced that 16 financial services firms would pay combined civil penalties of USD81 million as a result of its latest sweep. In this instance, seven asset management firms were cited for violation of certain recordkeeping provisions of the Investment Advisors Act of 1940.
Asset managers and AML
Money laundering is a regulatory issue typically associated with banks rather than asset managers. However, the SEC has become interested in anti-money laundering (AML) compliance for asset managers.
In a 2023 enforcement action, the SEC found that an investment advisor had failed to have its mutual funds adopt and implement policies and procedures reasonably designed to detect money laundering activity. It was also cited for failing to conduct AML trading specific to the mutual funds’ business.
The investment advisor agreed to comply with a cease-and-desist order and paid a USD6 million penalty.
An effective regulator
UK financial regulation is remodelling itself as it seeks to maintain its status as the largest European asset management market. The Financial Conduct Authority (FCA) has stated it wants to be a more effective regulator. It is emphasising an outcomes-based approach to regulation rather than a prescriptive one.
Since January 2020, the FCA has been working on a post-Brexit regulatory framework, sometimes referred to as Big Bang 2.0. The regulators have worked to modernise financial regulation while retaining some alignment with EU rules.
Regulatory priorities for 2024
In March 2024, the FCA sent a letter to asset management firms outlining the regulator’s priorities for the year. This communication warned that “a high volume of significant business and regulatory changes” would be delivered in 2024.
Areas the FCA is focusing on include authorised fund managers’ ability to deliver value to their investors (assessment of value) and the Consumer Duty, which addresses their ability to deliver positive outcomes for retail investors.
“Asset managers, particularly those who manage assets for the retail market, have to digest and adapt to a number of significant new regulations such as the SDR, which went into effect in December 2023. And the Consumer Duty has specifically stated that fund boards and senior managers are specifically responsible for the funds delivering good outcomes for retail investors.”
Alex Burton Brown Executive Director, Financial Lines, Gallagher Specialty
The long arm of the regulator
Asset management is one of many financial services sectors that operates in multiple markets around the world. The result is that firms are subject to a wide range of regulatory regimes, with the largest firms juggling multiple regulators.
Asset management firms that take an integrated approach to regulatory challenges will typically fare better than those that approach each country’s regulator in silo.
Globally, regulators have some common agenda items that they are addressing, such as:
· Strengthening investor protections,
· Defining sustainable finance,
· Promoting operational resiliency, and
· Reducing systemic risk.
Even when regulators agree on an issue's importance, they may diverge in how they approach it from a regulatory perspective. Sustainable finance, specifically environmental, social, and governance (ESG) investing, illustrates the challenges and exposures that this creates for asset managers. For example, the US takes a rules-based approach to ESG disclosure, while the EU’s approach is more principles-based. The UK’s SDR and the EU’s Sustainable Finance Disclosure Regulation (SFDR) differ in a number of ways, such as how they apply a sustainable asset threshold to a fund. The SFDR incorporates a do no significant harm principle, while the SDR does not.
To conclude, the increasing regulatory burden on asset managers is undeniable, with significant implications for compliance and operational strategies. As regulatory frameworks continue to evolve globally, asset managers must remain vigilant and proactive in their approach to compliance. Robust corporate governance and integrated regulatory strategies are essential not only for meeting compliance requirements but also for protecting the firm's reputation and financial stability. Insurance providers recognise the value of comprehensive governance and compliance frameworks, which can enhance insurability and result in more favourable coverage terms and premiums. Asset managers must prioritise these practices to navigate the complex regulatory landscape effectively.
A conflict of interest
The FCA fined a London-based investment manager for more than GBP9.1 million for failing to conduct its business with due care, skill, and diligence, as well as inadequately managing conflicts of interest.
In its March 29, 2022, final notice, the FCA noted that because the firm agreed to settle early in the investigation, the original financial penalty of GBP13 million was reduced by 30%.
How can insurance assist asset managers respond to regulatory investigations?
Both Directors’ and Officers’ Liability insurance (D&O) and Professional Indemnity insurance (PI) are designed to provide coverage for legal costs in responding to certain non-routine regulatory investigations and approaches. D&O primarily provides coverage for legal costs incurred by the directors and officers of asset management firms where an investigation relates to their conduct or actions, whereas PI primarily protects the asset management firm for the costs it incurs in relation to a regulatory investigation into its provision of professional services.
There are several factors to consider so that D&O and PI respond effectively to regulatory investigations. For example, some investigations may involve informal requests from regulators for interviews and information. Therefore, it is important that coverage incorporates specific references to interview and document requests and is not limited so that it only responds to formal regulatory actions. Gallagher has extensive experience in dealing with claims for asset managers in this area and has adapted the coverage provided under its policies accordingly, including:
· Coverage for both formal and informal regulatory investigations
· Broad definitions for key terms
· The removal of problematic exclusions, such as Money Laundering
· Specific coverage for certain regulatory approaches such as FCA Private Warnings
Finally, regulatory investigations can result in a fine or penalty being imposed on either the asset management firm or its directors or officers. Gallagher’s policies include coverage for civil fines and penalties where they are insurable by law. However, it’s worth noting that no insurance policy will respond to criminal fines or penalties or where it is not legally permissible for them to be insured. Indeed, in most jurisdictions, it is illegal to insure a fine or penalty that involves bad faith on the part of the party being fined and there are also prohibitions from certain financial regulators on the insuring fines and penalties they impose.
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