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Country reportsOctober 1 2012

London retains asset management star billing

Ongoing economic and regulatory uncertainty is playing to the advantage of established international financial centres, particularly London, which, despite the recent Libor scandal, has been named the most attractive financial centre in The Banker’s 2012 global asset management survey.
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London retains asset management star billing

Six centuries after the legendary Dick Whittington arrived there to make his fortune, London is still the city where great fortunes are made. In a surprising sequel to the Libor scandal, the UK capital has been voted the most attractive financial centre in The Banker’s 2012 global asset management survey. The Banker’s survey, based on interviews with nearly 60 firms, which between them manage more than $19,000bn in assets, clearly shows that rather than losing ground to other financial centres, London is becoming more attractive as an operational centre for global asset management.

Despite the fact that the survey was conducted at a time when there was daily international media coverage of widespread irregularities in the calculation of Libor rates, the dominant view among the world’s asset management community is that the streets of London are still paved with gold. When asked why London is so attractive, its business environment, its human resources and its proximity to global financial markets were the three most cited responses.

A large number of respondents told The Banker that London’s dominance as a global financial capital is far from waning. Phil Langham, head of emerging markets at RBC Global Asset Management, which chose London as the base for managing its emerging market funds a few years ago, says: "As investors are increasingly looking for global emerging market funds as opposed to regional funds, so London has become more prominent as an emerging market centre."

London retains asset management star billing

London-centric

Whereas The Banker's 2011 survey was dominated by fast-growing Asian financial centres, the continued international financial market uncertainty seems to have played into the hands of long-established financial centres such as London and New York in 2012. The head of business development at one European fund management company told The Banker that London is becoming the gravitational centre for emerging markets. “We are seeing a trend towards [asset] managers being based in London. For our part, we have found we can manage all emerging market investments from London.”

Howard Marks, chairman of Los Angeles-based Oaktree Capital, is also confident in the continued ability of traditional financial centres to thrive in difficult times. “We have offices all over the world, but these are never going to take over from London or New York,” he says.

Some respondents were in the process of expanding their London-based operations. Mathieu Gilbert, head of quantitative management at La Compagnie Benjamin de Rothschild, which, through an entity of the Groupe Edmond de Rothschild, is expanding its operations in London due to regulatory changes, says: "London remains the main centre for the asset management industry, despite competition from emerging financial centres such as Singapore."

Dolores Ybarra, Santander Asset Management’s global chief investment officer, also highlights the importance of London to the asset management business. “London is very important for fixed-income operations. If you want to be a big player in European fixed-income [markets], you have to be in London,” she says. However, Ms Ybarra also sees drawbacks to London as an operational centre for European markets. “Although London is very important, the currency is an issue. I have few clients operating in pounds. Most are based in euros or Latin American currencies.”

The 2011 survey highlighted a widespread reallocation of assets away from developed markets towards emerging markets such as the BRIC economies (Brazil, Russia, India and China), and other Asian countries; this trend is less pronounced in 2012. Several CIOs told The Banker that much of the strategic refocusing of global funds towards emerging markets has now been done. Even so, interest in developing and frontier markets remains high, despite some firms seeing price-based opportunities in distressed developed markets such as western Europe.

Ewen Cameron Watt, managing director and chief investment strategist at the BlackRock Investment Institute, sees the current debate over emerging versus developed market investment in terms of asset price growth versus cash flow. “In the emerging [market] space, you can have more confidence in asset-based strategies," he says. "But in a deleveraging, deflationary environment, the real value of physical assets tends to decline. Therefore any investment policy based on the assumption that assets are going to inflate in price is less likely to work. More likely to work are cash-flow or income-based strategies in a world of slow debt deflation.”

Regulatory concerns

The second big theme of this year’s survey is the rising cost of compliance. "[Higher] regulatory costs are being borne by savers, as well as by investment managers," says Mr Cameron Watt. "They are being borne by everybody, directly and indirectly, in the form of wider spreads and declining market liquidity. We all have to understand and accept that the legacy of the financial crisis is that there is going to be a step change in regulation. I don’t think in the current political climate that financial services can expect anything other than tightening regulation.”

While most fund management firms surveyed by The Banker welcomed regulatory initiatives designed to improve financial stability and transparency, concerns over cost remain widespread. “Transparency is something we would all like to see more of, but we also don’t want to see a huge increase in cost to the investors we represent," says Mr Cameron Watt.

Commenting on the impact of increased regulation, Ron Florance, Wells Fargo’s director of asset allocation, also expressed concerns. “Regulation has increased the cost of doing business. Large firms have had the resources to make this adjustment, but it has been hard for smaller firms to meet higher regulatory costs since they represent a far higher percentage of their turnover.”

Like many within the industry, Mr Florance is concerned about the far-reaching – and in many cases unintended – consequences of current regulatory initiatives in financial services. “After a crisis, there will always be increased regulation," he says. Regulators are pushing towards higher standards. This will shape our industry over the next five years and it will be expensive.” Wells Fargo, an early adopter of new regulatory standards, has already had several smaller regional players asking for advice.

The Banker’s 2012 survey results reflect the fact that smaller firms are suffering disproportionately from this increase in regulation. Of the 9% of respondents that described the operational impact of recent regulatory initiatives as “greatly negative”, all but one were smaller firms with less than $250bn under management. Smaller firms generally expressed a higher level of concern, particularly firms involved in niche markets where regulatory details have yet to be clarified by national regulators.

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Mergers to be expected

Many respondents to The Banker's survey expressed a belief that smaller firms will be more negatively affected as a result of increased regulatory burdens, and some predict consolidation as smaller firms struggle with rising regulatory costs and difficult financial market conditions. Zurich-based Philippe Bucher, CFO of private equity fund of funds Adveq, says: “An unintended consequence of new regulations is that small firms – maybe as many as 30% – could disappear, leaving those with the critical mass able to cope with the increased regulatory burdens.”

Ashok Shah, investment director at wealth management firm London & Capital, says: “Not only has the cost of staying in business gone up, it is going to get higher. Smaller players will need to merge or be taken over and this will create opportunities for some firms.”

Even so, some niche firms see opportunities arising from regulatory change. The founding director of a Hong Kong-based portfolio manager says: “New regulation is clearly increasing compliance costs, but as long-only investors, we are less affected than bank-owned competitors and this creates opportunities. The banks were dominant in asset management and tended to use a large volume of synthetic products. So although we don’t welcome the added compliance work, the long-term effects may not be entirely negative for firms such as ours.”

Many firms remain concerned by the dramatic rise in costs, however. Santander Asset Management’s Ms Ybarra says that regulatory initiatives are increasing pressure on fund managers, particularly in areas such as risk control and compliance. “Santander has always been concerned about these issues. We need to increase and reinforce teams, and be more aware of who is buying our funds and this will increase operational costs. For example, here in Spain we have 40 investment managers for mutual funds, and then we have 25 guys in the accounting department – so the ratio is high,” she says.

Dividing opinion

More than 50% of respondents believe that the overall impact of new regulations has been negative. Rising regulatory costs at a time when asset prices are generally depressed have left some firms struggling, but the survey results also show some acceptance of the need for greater regulation, particularly in pricing structures and transparency. Nearly one-third of respondents said that new regulations have already had a “positive” impact on business.

“Regulatory initiatives have improved transparency. For example, SRRI [synthetic risk and reward indicators, under the Undertakings for Collective Investment in Transferable Securities, or UCITs, IV regulations] and recent legal initiatives on structured funds in Belgium and Luxembourg will help to make risks more transparent," says Naïm Abou-Jaoudé, CEO and chairman of Dexia Asset Management.

Commenting on the impact of regulatory initiatives, Donnacha O'Connor, a Dublin-based partner at international law firm Dillon Eustace, says: "New rules will increase costs, but they could also increase allocation to alternative investment funds since these will now come under greater regulatory control. For example, we could see pension funds and other traditionally conservative investors allocating more capital to hedge funds once they are no longer associated with markets having no regulatory oversight."

Uncertain times

In addition to the list of national and regional regulatory initiatives aimed at the fund management industry – such as the Foreign Account Tax Compliance Act in the US, the Alternative Investment Fund Managers Directive in the EU and the Retail Distribution Review (RDR) in the UK – changes in banking regulation have also had a profound effect on the industry. One of the biggest upheavals for asset management firms has been the deleveraging of European banks and the recalibration of capital charges as a result of the EU’s Capital Requirements Directive IV.

“We are finding it much harder to market new products to the banks, which until now have been our core market,” says the CEO of one mid-sized London-based fund. “So as an industry we are facing depressed asset prices, higher regulatory costs and a shrinking client base.”

Insurance companies, another key client base, are also under pressure. Philippe Mimran, chief investment officer of asset management firm LFP Groupe, says: “Solvency II is the biggest [regulatory change] as it affects the structure of our clients. For example, we have already started to see insurance companies reduce investment in hedge funds and equities in favour of lower fee fixed-income [funds] and this is a risk for us. On the other hand, we see the UCITs changes as relatively positive as they will allow us to sell our local funds in other EU countries.”

Mr Mimran says: “We also don’t know when the solvency requirements will begin for insurance companies. This was supposed to be 2013, [but now there are] rumours it could be much later. So on top of the economic uncertainty, we also have uncertainty over when new regulations will start,” he says.

Retail market shake-up

Regulatory changes in the insurance sector are also having an effect on the asset management industry. La Compagnie Benjamin de Rothschild's Mr Gilbert says: “We have already seen reduced investment by large institutional investors such as insurance companies, some of which are reducing their assets. This is a clear trend in the market and the reason is the capital requirements induced by Solvency II that lead to large strategic switches in asset allocations.”

Several respondents say that the UK’s RDR will be one of the most profound regulatory changes. According to one London-based fund manager: “The UK’s RDR is dramatic. Retail customers are pretty unaware how much they are paying and to whom, and the RDR is designed to lift the lid on that. The overall impact will be positive, although the industry may not be fully prepared for the full impact of the new regulation. From a customer perspective, seeing how much is paid and to whom has to be a good thing, but the risk is that consumers will be given less choice since the training involved for independent financial advisors is so high that we may well end up with less advisors, less choice and potentially more risk.”

Another UK-based fund manager gave a positive response to the RDR: “How people buy financial products is changing, particularly through internet platforms. Both platforms and product manufacturers will have to prove their worth as customers understand how much they are paying and to whom. So transparency will help level the playing field, so that it becomes more about selling the best product. We hope this will make it easier for smaller funds to get to the market, as long as they provide a good service.”

Home or away

Tough global conditions have seen some firms begin to bring operational management decisions closer to home. Even so, more than 80% of firms still prefer to locate investment managers close to the companies in which they are investing, rather than close to clients.

BlackRock's Mr Cameron Watt says: “We have seen US money market firms withdraw from lending in Europe in the past year and take on much more of a home bias, and of course the Asian banks have been financing their own world proportionally. I think there is clearly a lot of home bias coming into the way financial systems operate compared to a decade ago. It will be interesting to see if that develops further, for example, because of governments’ needs to ensure their own tax payers are protected."

Another London-based investor commented on the tendency for firms to focus on home markets. “Given so many unknowns, it is natural for firms to focus closer to home, particularly given so much international regulatory uncertainty.”

Eivind Lorgen, global head of alternatives and manager selection at Nordea Investment Management, also sees firms consolidating operations closer to home. “It is not so much that firms are considering relocating [as a result of regulatory initiatives], more that they are centralising to either to one or fewer locations,” he says.

Nevertheless, large companies told The Banker that they remain committed to locating managers in new markets and close to investments. Young Chin, chief investment officer at Pyramis Global Advisors, Fidelity’s institutional asset management business, says: “Locating investment managers close to the markets in which they invest is important, especially in this fast-moving, rapidly evolving environment. 

"Fundamental, bottom-up research is critical to finding the best investment opportunities and generating alpha – this is a hallmark of our investment management process. At the same time, it is equally important to be located close to clients. Being close can help you better understand a client’s needs, build deeper, more consultative relationships, and ensure you are tailoring solutions and support to meet each client’s distinct needs.”

Another head of global asset management at a leading mid-sized UK fund management company says: “Locating close to our investments makes it easier to monitor management performance, so we are still looking to open offices in new locations. We’re currently monitoring the growth of domestic fund management sectors in countries such as China, India and Brazil. But we’re also looking at the growth of Luxembourg as a financial hub for cross-border funds.”

Finding the optimum operational balance can be difficult. One London-based respondent, a partner in a global emerging market fund, says: “We are consolidating operations to fewer hub locations, but we still think placing fund managers on the ground in or near their markets is important. Speaking to company managers is even more important in emerging markets than it is in developed markets. We make more than 1000 company visits each year and that’s not easy to do unless you have a local presence.”

Emerging markets growth

Hopes for continued economic growth in developing markets are still driving strategic asset allocation as firms increase exposure to emerging and frontier markets. “I think it is inevitable that there is going to be an increase in the proportion of assets traded in Asia, relative to the rest of the world – that has been going on for a number of years," says BlackRock's Mr Cameron Watt.

Anthony Fasso, the Hong Kong-based chief executive of AMP Capital, says: “A lot of firms are overweight in investment expertise in mature markets and underweight in emerging markets. We cannot ignore developing country economic growth in the next five to 20 years, and the fact that growing populations are moving up the income spectrum. It is natural that firms want to base their businesses in high-growth markets such as north Asia, China, South Korea, Japan and to some extent in India.”

Although firms expected slightly more reallocation to south-east Asian countries than to the BRIC group of countries, more than one firm explained that this was because they had already built overweight positions in BRIC investments. “We already have a strategic long-term overweight investment position towards these countries, so for this reason we don’t expect much to change in the next 12 months,” says Mr Florance at Wells Fargo.

However, some responses to the BRIC countries were more measured than last year. One survey respondent told The Banker: “We are nervous about an increasingly negative current account in Brazil. It looks like what happened to Thailand in the late 1990s, and Brazilian growth has been weak for some months.”

Continued hopes for Asia

China and Asia remain the star markets on which hopes are pinned in the 2012 survey. Dr Martin Kühle, senior partner at Fisch Asset Management in Zurich, says: “The current easing policy in China is an early but important signal to be positive for Asia. We think Asian convertibles are mispriced by 3% to 4% and offer a smart way to build up equity exposure. We invest about 25% in Asia and we will remain overweight to this growth region.”

Meanwhile, Singapore pipped Hong Kong to the post as the most attractive financial centre for managing south-east Asian investment. Respondents repeatedly cited strong regulation, and a good business and legal environment as the reasons behind Singapore’s appeal as a regional asset management centre. But praise for Singapore was not universal. One London-based investment director complains: “Singapore’s inflexible [regulatory] discipline has stifled creativity.”

Even mighty Hong Kong has suffered setbacks in the current global financial climate. A London-based partner of a specialist emerging market fund says: “The industry is going through a cost-cutting and downsizing. For example, we have seen Renaissance Capital’s decision to close its Hong Kong office recently. But this doesn’t change the fundamental attractiveness of growth markets such as Asia, nor traditional markets such as London.”

Mixed reaction to Europe

Respondents were less keen on emerging Europe, however, when compared with the results of 2011’s survey, with fewer asset management firms intending to increase allocation to the region. One investor explained that his more bearish stance has been triggered by bank deleveraging and the knock-on effects on regional liquidity and asset prices. “We have reduced our allocation significantly to emerging Europe. Our view is that the region was overdependent on capital from foreign banks which are now, and will be, deleveraging for some time to come,” he says.

Even so, many investors are making long-term commitments to emerging Europe. Warsaw now ranks second after London as a centre for managing investment into the region and has built a solid reputation for support services such as IT. "We have seen some of the larger securities and fund-servicing firms such as State Street, BNY Mellon and Brown Brothers Harriman opening offices in Poland," says Mr O'Connor at Dillon Eustace. "Poland has an educated workforce with English as a second language."

Santander's Ms Ybarra is also positive about Poland’s development. “[Warsaw] is going to become a key hub for developing assets in emerging Europe. We now have the opportunity of having a large financial institution in Poland and want to reinforce our team and harness its growth.”

Meanwhile Wells Fargo’s Mr Florance favours the non-euro countries in emerging Europe. “We are most likely to commit to non-euro countries in this region at the moment – it’s somewhat ironic that they weren’t good enough to join!”

Russia disappoints

Not all non-euro countries have benefited from the crisis, however. Liam Halligan, Moscow-based chief economist at Prosperity Capital Management, was particularly surprised by Moscow’s low ranking in the survey. “Moscow is superbly placed between European and Asian time zones, is endowed with excellent human resources and now has a central depository," he says.

"These factors, together with the size and importance of the Russian economy, mean Moscow will become more important, but building institutions takes time. Already, though, the improvements we have seen over the past 15 years of investing here have been spectacular. But they remain largely unreported by the mainstream media. The stereotypical Western view that there is no law and it is impossible to do business simply doesn’t chime with our experience.”

Dexia Asset Management’s Mr Abou-Jaoudé is also positive about the development of Russia’s financial markets. “After a long period of opaque regulations and difficult access, financial markets reform, especially in the equity markets [for example the merging of the country's two main exchanges], will make the Russian market more accessible to foreign investors and turn Moscow into a growing financial centre for the region,” he says.

However, Mr Abou-Jaoudé also warns that “more work” must be done on judicial and regulatory structures to protect the rights of international and minority equity holders.

London retains asset management star billing TABLES

Middle Eastern promise

Investor interest in the Middle East has remained stable compared to 2011. Dubai remains the number one regional financial centre for managing Middle Eastern investments, and some are still predicting that the emirate could be a frontrunner in the race to become the next global financial centre of the future.

Another Middle Eastern star performer in 2012’s ranking is Doha, which has leapt ahead in the rankings, moving into the top three locations for managing Middle Eastern investment behind Dubai and London. Doha now ranks in the global top six asset management centres of the future. Respondents from both Europe and the US praised Qatari authorities both for their clear strategy and their ambition to become a regional financial hub.

“Middle Eastern financial centres, particularly Qatar and Dubai, are set to become major regional financial locations as markets open up
and become less restrictive," says Mr Abou-Jaoudé. "Energy revenues are generating a positive effect in the region, but further reform and development are still needed to open up these markets to institutional investors.”

Another investor, based in London and specialising in emerging markets, says: “Qatar will win out in the long run. The authorities are taking a long-term view, slowly and gently building infrastructure and this seems like a good approach.”

Future focus

São Paulo comes top of the ranking of asset management centres of the future. Despite frustration with government policies, the consensus view from

respondents is that they would like to see the development of São Paulo as a regional financial hub for Latin America. Almost all respondents see São Paulo as the preferred hub for Latin investment.

Meanwhile, Shanghai has moved up to second place in this year’s ranking of emerging asset management centres, one place behind São Paulo. Shanghai is developing a clear lead over other mainland Chinese financial centres such as Beijing, Shenzhen and Tianjin. But while many firms are watching regulatory developments closely in mainland China, a number told The Banker that they still feel more comfortable operating out of Hong Kong.

Nevertheless, the potential development of China’s financial markets is likely to have profound longer-term effects on the global asset management industry. Mr Abou-Jaoudé says: “As the main financial centre of the world’s second largest economy, and one of the largest ports in the world, Shanghai will grow in importance as China is expected to open up its capital account and continue financial reforms.

"China’s gradual currency internationalisation and the increasing development of its financial markets – including equity, bonds, futures and commodities – will increase the focus on China’s financial centre. Also, the link with Hong Kong, already Asia’s leading financial market, will grow. For example, the government plans to start a pilot programme through the opening of a new service zone in Qiunhai, close to Hong Kong, in support of offshore renminbi business between Shenzhen and Hong Kong.”

George McKay, global chief operating officer of Allianz Global Investors says: “The positive growth outlook for China, coupled with the government’s intention to open up the market to foreign investors and internationalise the renminbi, makes Shanghai one of the obvious choices.”

About the survey

The Banker magazine’s global asset management survey is based on responses from nearly 60 international asset management professionals, together representing total funds under management of more than $19,000bn (at the highest level of consolidation). This represents roughly one-third of the total assets under management by the world’s 500 largest fund management firms. Responses were gathered by telephone interviews and written responses in June, July and August 2012. Where investors were not active in a region and did not expect to become active, or did not give a response, an entry of 'no change' was recorded.

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