Nickerson: Conflicting Rule Changes are Causing Uncertainty for Advisers

As asset managers contend with the continuing onslaught of regulatory requirements one of the great uncertainties with which they must deal is conflict. Not with the regulators themselves but with contradictory rule changes between jurisdictions, which adds to the cost and compliance burden of dealing with new requirements. Such conflicts also create great uncertainty for advisers.

UK asset managers obviously must deal with FSA regulations but are also impacted by European directives as well as US rules, all of which are creating regulations based on local concerns. This results in disjointed and at times, contradictory, regulations.

Before stepping down at the end of last year, the IMA’s former chief executive Richard Saunders noted: “We are seeing a rise in more aggressive extraterritorial regulation which is adding cost and complexity to the industry and breeding protectionism in different jurisdictions. The litmus test for new regulation should be whether it brings real benefits to end investors. Too often this seems not to be applied.”

Philip Warland, head of public policy at Fidelity, agrees regulations from different jurisdictions based on their own issues creates problems for global asset managers and for investors, for whom the regulations are supposed to help. “The dividing line between investor protection and protectionism is a thin one,” he says.

Even within the same territory there can be contradictory actions. For instance while the UK’s HMRC seems keen on venture capital trusts, allowing substantial tax incentives to encourage investors, the FSA’s recent Ucis consultation seems to challenge such sentiment. If included in Ucis, VCTs could be dealt a severe blow and it could lead to the collapse of many products.

“The litmus test for new regulation should be whether it brings real benefits to end investors”

David Kaye, the chief executive officer of Puma Investments, says: “VCTs do a small but important job in supporting SMEs (small and medium sized enterprises). This is particularly important in the current economic environment. The UK government wants us to continue in this capacity as we are performing a vital role, funding the creation of jobs.”

In the 2011 budget, the investment limits and company size thresholds for VCTs were increased. However, more recently, the FSA’s consultation on restricting the sale of Ucis products purports to include VCTs. If included advisers would be limited in whom they can advise to use such vehicles, Kaye says. He adds:“VCTs have seen some rule changes over the years but those have been around the edges and not near as seismic as this would be.”

While it would not spell the end of all VCT groups if IFAs could not promote such products to retail clients, Kaye says it would severely hamper growth in this industry.

Contradictory rules or intentions get worse when the governments or regulators of other nations are involved. While there are many past examples, one current issue involves the US’s approach to regulating over-the-counter derivatives and the EU’s take on the issue. Warland notes: “Both the US and Europe have potential regulations that are extra-territorial and as a consequence, many groups will caught by both.”

The US rules will lead to OTC derivatives to be overseen by regulators and for trading in swaps to be routed through a clearing house, which is expected to increase their cost. It also poses limits on the amount of positions a trader can hold in different commodities.

Meanwhile, the EU rgulation on OTC derivatives, central counterparties and trade repositories (EMIR) also seek to implement similar changes. In addition, further derivative reforms are expected to be included in Mifid II, which has a 2015 deadline for implementation.

With both the EU and the US tackling the same issues, overlap is inevitable. According to legal advisers Shearman & Sterling, the extraterritoriality of the derivative rules “has the potential to cause intractable and irreconcilable conflicts for the derivatives industry”. It notes the main areas of difference include: registration requirements for dealers, rules on margin and collateral, registration requirements for clearing houses, exchange trading and reporting requirements.

The full extent of how a UK investment house should deal with such conflicts is still up in the air as guidance for overseas firms on each side has been slow in coming. On 21 December the CFTC granted relief from its provisions for overseas firms until July 2013 and further cross-border guidance is expected prior to that date.

So there remains time to work out some of the issues as they may affect UK-based houses. However, Warland says without greater transatlantic co-operation, a resolution is unlikely. “This is a very political issue.”

Remuneration is another brewing area of inconsistent approach. Already we have been dealing with RDR but Mifid II is looking at incentives and there is also wording involving remuneration in Ucits V and the Alternative Investment Fund Managers directive.

Having the same issue tackled differently by several directives increases the chance of overlap and contradiction, Warland says. Which will UK asset managers and advisers have to conform with? While some overseas regulations can be altered to fit into national rules, others cannot – as has been the case with the AIFMD.

Warland says in the face of such challenges companies have to spend increasing money and resource to strengthen their regulatory teams. “We have to look for the linkages between the various regulations and work our way through them to see the overall impact. That can be quite complex.”

Especially as it is not always readily obvious the impact of an overseas initiative, for instance in the beginning Facta appeared to be a back office accounting issue and not the client-facing problem it really was, Warland notes..

As in most cases complexity pushes up costs and has the potential to make products more expensive. In some cases, distribution of certain products may be hampered while others may have to be fundamentally changed in order to suit multi-jurisdictional rules. The much anticipated RDR implementation may be behind us but another year of regulation, conflicts and deadlines is upon us and many could have as much, if not an even greater impact.

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