Giles Elliott, Managing Director, AlfaSec Advisors

The global fund industry has almost USD 65 Trillion of assets under management and is predicted to grow to USD100 trillion within the next six years. The growth of the industry has been fueled by the development of personal investments and changes to global state pension systems amidst increasingly aging populations and state budget shortfalls.

In the past few years we have seen significant changes in regulation covering the asset management and fund sectors, and this article examines some of the implications of these changes on the custodian and investor services industry.

The origins of the mutual fund industry date back to 1774 in the Netherlands where Dutch merchants sought efficient investment vehicles, but this did not flow internationally until the establishment of the Foreign & Colonial Government Trust in the UK in 1868. Mutual funds landed in the USA in the early 1890s and rapidly took hold in the form of predominantly closed end funds, where the only way to exit the investment was through another shareholder.

The crash of 1929 exposed shortcomings in this market, where unwitting investors in closed end funds lacked avenues for exiting their investments during the bear market. The market crash drove a decade of regulatory dissection and definition, resulting in three main rafts of regulation and the creation of the SEC 1940 Act that has continued to regulate US mutual funds for the past 70 years, additionally introducing the concept of custodian banks as independent record-keepers.

The parallels with the post 2008 global financial crisis are obvious, and we have seen an even broader set of regulations emerge both to tighten the regulation of the financial services industry, including asset management.

The growth of retail consumer investment and reliance on mutual funds as pension vehicles has forced regulators to continue to examine ways to limit non-market related risks for investors. This has been coupled by trends set by retail investors seeking access to more sophisticated investment options—products that have traditionally been limited to the professional, institutional sectors. Private Banks and wealth management channels are grappling with the challenges of aligning their retail and institutional platforms amidst the most significant period of regulatory change in history.

The offshore mutual fund market has grown significantly in the past decade, allowing fund manufacturers to benefit from broader distribution channels in multiple markets. Europe houses the largest offshore fund hubs in Luxembourg and Dublin, and the new AIFMD (Alternative Investment Fund Manager Directive) that came into effect in July 2014 marks the most radical changes to fund industry regulation that has been seen in the past 70 years. Many principles from AIFMD have also been adopted by the new UCITS V regulations, and hence the impact of these changes is across the European fund industry. These regulations cover multiple areas of focus including transparency, risk management, valuations, delegation and business conduct.

Alternative Investment Funds were a priority due to the demand from retail sectors for access, but where the risks of such leveraged vehicles required greater transparency and structure. The Lehman crisis exposed poor practices around collateral and client money segregation leading to losses from this concentration of activities and comingling and rehypothecation of collateral pools. The reaction to this has been multi-pronged both in terms of moving OTC derivatives reporting, clearing and margining on-market under Dodd Frank and EMIR regulations, but also in terms of the new client money regulations requiring clearer and stronger identification and segregation of client monies.

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