BoE etc

Many global fund managers have made fortunes by scooping up hundreds of billions of euros’ worth of investor capital from across Europe. Thanks to EU regulations known as Ucits, which allow retail funds to be domiciled in one member state and sold across the bloc with ease, fund managers can open an office in one domicile — most often Luxembourg and Ireland — and use this as a gateway to sell in markets such as France, Germany and Italy. But EU policymakers are concerned that this liberal passporting could expose investors to harm. The question in Brussels is: do we need additional oversight? Brexit has added fuel to the debate, with the EU alert to the risk of European investors buying funds managed in a so-called third country, which is what the UK will become once it leaves. Companies including M&G and Columbia Threadneedle have moved billions of euros of EU investor assets from UK structures to Luxembourg or Irish fund ranges ahead of Brexit but these are still predominantly managed in the UK. This shift warrants extra vigilance, some argue. There is also historical concern about consumer protection, with people looking back to scandals such as the cross-border sale of Luxembourg funds that were exposed to US fraudster Bernard Madoff’s $50bn Ponzi scheme in the mid-2000s. John Liver, financial services partner at EY, says the re-emergence of the passporting debate could threaten global asset managers’ cross-border activities. “Funds are now at the heart of what it is to be European because of the industry’s dispersed business model,” he says. “The topic of ‘what does it mean to be a European asset manager?’ has been opened up again.” A senior industry figure, speaking anonymously, fears that changes could lead to the fragmentation of the European fund industry. “What we’re seeing is effectively [a push to] renationalise financial services rules,” he says. “This is a dangerous development.” With the current system, funds are regulated by the member state in which they are based rather than the state where they are sold. The concern is that the host country’sregulators lack the power to thoroughly vet products sold in their jurisdiction, which creates significant investor protection risks. For example, the Autorité des Marchés Financiers, France’s market watchdog, estimated that French investors had about €500m invested in the Luxembourg-based Luxalpha fund that funnelled money to Madoff. Since the product was regulated in the grand duchy, AMF input was limited. Regulators are supposed to share information to combat such risks under the co-ordination of the European Securities and Markets Authority, the EU-wide market supervisor. A recent report by Esma revealed significant shortcomings, however. It warned that investors could fall between the cracks as regulators fail to communicate and co-operate. In response to the findings, Julie Patterson, asset management regulatory change leader at KPMG, said: “It is clear there have been gaps or a lack of effective communication and co-operation between regulators.” An oft-cited weakness is that the European fund industry is predominantly regulated by the Luxembourg and Irish watchdogs, which are mainly export-based fund centres. In an apparent snub to these regulators, the Esma report said countries that lack a large domestic fund investor base “might have little incentive to assign adequate resources to the supervision” of funds sold elsewhere. On top of this, there is worry over inconsistencies in how EU rules are implemented, which leads to differing levels of consumer protection. This has been compounded by a fear that Brexit has inspired EU countries to bend rules to lure fund business from the UK. David Doyle, EY’s senior European financial regulatory adviser, says: “With the departure of a prominent centre of funds from the EU, the question has arisen of should EU legislators and regulators review the EU passporting mechanism [and whether] host countries should have more of a say in assessing remote-based fund management institutions.” Paris has been prominent in the debate. AMF chairman Robert Ophèle told the Financial Times last month that EU member states should have greater freedom over how they applied EU rules. He has also called for a “rethinking of day-to-day relations between supervisors” and suggested that the EU consider strengthening the role of host country regulators. Many believe that what began as a legitimate debate about consumer protection is now politicised, pointing to the AMF’s attempts to strengthen national regulators’ powers as being commercially driven. By pushing for watchdogs to be able to veto products, France may hope to force fund managers to set up shop within its frontiers, so stealing business from Luxembourg and Ireland. The French are also believed to have been behind an EU push two years ago to alter the rules on delegation, which allow an asset manager to set up a fund in one EU country and outsource portfolio management to investment staff in another country, in an attempt to capture a slice of the UK’s £7.7tn asset management market. This failed after other EU countries resisted but many expect the AMF to try again. How successful Paris will be in influencing the direction taken by EU policymakers will become clear in time. Ms Patterson doubts that the European Commission will tolerate national barriers being re-erected because that goes against the concept of the single market and freedom of establishment. “The commission is the guarantor of the treaties. If they were to argue for more national powers, that goes against the fundamental tenet of the EU,” she says. Indeed, the commission aims to boost retail investment in funds across Europe with a capital markets union. This year, it launched a drive to eliminate cross-border distribution barriers — an effort that many observers say lacks ambition — after finding that just 37 per cent of Ucits funds are registered for sale in more than three EU countries. “The commission is concerned that we have a multipolar oversight approach in Europe,” says Mr Doyle. In 2017, the commission proposed centralising the supervision of certain investment funds at EU level and giving Esma a greater role but member governments rejected the proposal. Many expect the system of national regulators sharing responsibilities to remain but there will still be a question over the height of any new hurdles created by national regulators. Mr Doyle does not expect the latest debate to threaten passporting as a concept but says it could result in fund managers being accountable to more regulators and required to carry out additional reporting, which would add cost and complexity. The senior industry figure is pessimistic, though. “If the investor protection concerns win the debate and clashes with the commission’s single market objective, you could end up with the commission advocating more fragmentation.”

Bond investors weigh merits of ETFs Vehicles can be used to complement active products or reweight portfolios © Bloomberg Share on Twitter (opens new window) Share on Facebook (opens new window) Share on LinkedIn (opens new window) Share Save Billy Nauman OCTOBER 7 2019Print this page0 Fixed income exchange traded funds have been having a bumper year with sky high inflows, but still face questions as some investors try to determine if passive bond strategies can perform well enough to merit a spot in their ­portfolios. Money has poured into bond ETFs every month so far this year. The inflows hit a new record high in June and have attracted a total of $135bn from January to August, according to EPFR data. More than 90 per cent of that has gone into passive funds. This mirrors the long-term trend in equity funds, where active managers’ market share has eroded year after year — especially in more efficient large-cap markets where outperformance is scarce and investors have turned to low-cost benchmark ­tracking products. Fixed income has been generally popular this year after volatility in equity markets in late 2018 sent people looking for safety and income, said Jerome Schneider, a portfolio manager at Pimco who runs actively traded ETFs. There was also “renewed fear with where global growth has been headed” which also heightened bonds’ attractions. However, bond markets operate differently from equity markets, and index tracking is not as easy to do. Pimco, the bond investor that specialises in active management, has argued that the weighting methods used in equity funds do not work for fixed income. Whereas most passive equity strategies allocate more money to larger companies, using a similar “market cap weighting” system with bonds results in more exposure to the most indebted companies. Bond indices also see much more turnover than their equities counterparts as there are a significantly higher number of new issuances coming to market at any given time. This gives active managers a strong advantage, Pimco argues, because they can pick and choose the best of these securities. Additionally the way that bonds are traded is not conducive to success for passive funds. “Most bond trading occurs via over-the-counter transactions and not on exchanges. Therefore, the majority of bond purchases and sales are not simple orders, but negotiations,” Pimco analysts explained in a 2017 paper. So given the limitations of a passive approach for fixed-income investors, what is behind the inflows into bond ETFs? In some cases, asset owners are buying bond ETFs as a tactical play to reweight their portfolio when they want to cut or gain risk. “When you want quick exposure to the beta [volatility] — an ETF is a great tool to get that exposure,” said Antoine Lesne, head of an ETF division at State Street. “You don’t have to take a lot of time picking a manager. You may just want it for a short time and you can leave very easily.” Other investors are choosing passive ETFs because they complement the active products in their portfolio, most likely because they want to put some of their holdings into a less risky asset, while they use the rest to pursue market-beating gains. For some core exposures, investors are not necessarily looking for alpha, or outperformance, said Paul Syms, head of ETF fixed income product management for Emea at Invesco. “If you’re looking at relatively simple benchmarks such as UK gilts or US Treasuries, active managers have a limited set of tools to add alpha,” he said. “They are different animals and you have to treat them differently but that’s not to say you can’t do well in the passive world.” The growth of ETFs was not necessarily purely a story of active versus passive approaches, Mr Schneider noted. “The growing market in fixed income ETFs has been a common theme over the past 12-24 months. But within that context active ETFs have grown at a higher trajectory,” said Mr Schneider. In addition to pure active and pure benchmark funds, there are also a growing number of quasi-active “smart beta” funds that track indices but do not simply assign weights according to market cap. While Mr Schneider believes there is a strong case for ETFs — especially in the US where they carry tax benefits — he stands by his group’s dedication to active management. “In a passive benchmarked index you are assuming risks that are not ideal for the current economic environment,” he said. Nevertheless, not all active managers outperform, Mr Syms noted, and investors’ decisions to pay for alpha is directly related to how much risk they want to take. “Ten years on from the financial crisis we are still in a low-yield world, or negative-yield world in Europe . . . Investors are much more fee-conscious,” Mr Syms said. “If you don’t believe a manager can add alpha then why not go to the low cost solution?”
Some of the City of London’s biggest names have attacked the financial system’s addiction to loose monetary policy and accused central banks of dicing with “moral hazards” — akin to the bailout of banks in 2008 — in their obsession with staving off a decline in equity and bond markets. “Markets have become conditioned — unhealthily in my view — to expect central banks to support risk sentiment, regardless of the potential moral hazards and creation of asset bubbles,” Anne Richards, chief executive of Fidelity International told the FT City Network. Ms Richards described central banks’ quantitative easing policies as a “groundhog-day” attempt to restore confidence in the markets. “We are in a circular pattern which is hard to see us getting out of right now,” she said. Win Bischoff, who chairs JPMorgan Securities, said the negative rate policies in the eurozone, Japan and elsewhere were taking the world into an “unknown abyss”. Countering suggestions that the inflation of equity and bond prices spurred by QE would be welcome to investors, Sir Win said: “That is not likely to be acceptable socially or to capital markets and providers of finance.” Anne Richards: 'Markets have become conditioned — unhealthily in my view — to expect central banks to support risk sentiment, regardless of the potential moral hazards and creation of asset bubbles' © Bloomberg The comments were among a lively clutch of responses in an online debate held by members of the FT City Network, a panel of more than 50 senior figures in the City of London. The debate was sparked by the ECB’s recent move further into negative interest rate territory. Shortly after last month’s policy announcement by ECB president Mario Draghi, Jean Pierre Mustier, the UniCredit chief executive who also heads the European Banking Federation, sought to offset a volley of criticism from mostly German hawks and present a more balanced assessment of the impact of negative rates on the financial system. Recommended The Big Read Interview: Draghi declares victory in battle over the euro “The net impact on banks of the monetary policy [is] positive,” Mr Mustier told the Financial Times in a recent interview. “[It is] negative on net interest income [but] positive for the lower [bad debt] provisions, so net net, positive.” Among the most aggressive critics of negative rates was Oliver Bäte, the chief executive of Europe’s biggest insurer Allianz, who accused Mr Draghi of politicising monetary policy. He rebutted the ECB president’s assertion that eurozone governments should already have implemented fiscal reforms rather than relying on monetary policy to fix Europe’s problems, in comments that appeared to directly address the outgoing ECB chief. “The reason why we’re not doing fiscal [reforms] is because you’re making it easy for people to spend money they don’t have,” he said. His colleague Andreas Utermann, chief executive of Allianz Global Investors and a member of the FT City Network, said: “Many are probably rightly asking the question as to whether QE has become counter-productive and might be signalling to investors and savers alike an uncertain environment which leads to even higher savings and [a] savings glut.” Michael Tory, who heads advisory firm Ondra, said: “We are all being progressively anaesthetised like a massive, global pot of slow-boiling frogs.” Some members of the network took an even bleaker view. Mike Rake, the former CBI president and BT chairman, said the combination of Brexit and the UK’s already rising fiscal deficit could well throw UK monetary policy dramatically into reverse, as the Bank of England sought to counter inflation on a par with runaway Latin American economies. “Sterling plummets,” he predicted. “We go into recession and interest rates have to rise significantly to finance the deficits and support sterling. Don’t cry for me Argentina.”

As the UK searches for a new governor of the Bank of England to succeed Mark Carney, there is a rare and much needed opportunity to rethink the country’s monetary framework. The last major overhaul, in 1997, made the BoE independent of government, sparking headlines such as, “The Old Lady is set free”. But in truth, it remains in chains, dominated by the same groupthink that causes smart executives to fail. The Monetary Policy Committee’s failure to anticipate the recession triggered by the collapses of Northern Rock, Royal Bank of Scotland and Lloyds Banking Group is a major black mark. So is what followed: the slowest peacetime recovery in 300 years. Some people argue that central banks cannot be expected to identify such turning points and that it wouldn’t have made any difference if they had. I strongly disagree: the recession was eminently foreseeable and early intervention would have helped. More than a decade after the 2008 financial crisis, it should be seen as absolutely essential for central bankers to assess and mitigate the risks of economic downturns. The MPC’s failure is directly attributable to groupthink, which my Dartmouth colleague Andrew Levin describes as “excessive insularity and consensus-oriented decisions that foster complacency and leave an organisation susceptible to catastrophic failure”. When I sat on the MPC, I was the only person who had not been to Oxbridge and did not live in London or South East England. I was a lone voice when I argued early on that the data showed that a recession was spreading to the UK from the US. I am concerned that the current MPC is similarly homogeneous and the tyranny of the consensus continues to reign. Since June 2014, Mr Carney has chaired 63 meetings. The three deputy governors and the chief economist are naturally deferential to their boss — only two of the eight people who have served as deputy governors ever dissented on interest rate decisions, and then only once each. Andy Haldane, the chief economist, has dissented just once. The four external MPC members who have few staff, no constituency, and no real accountability, also rarely dissent, especially on the dovish side. Just 33 of the total 252 votes cast on rates by the seven past and present external members during Mr Carney’s tenure were dissents — two for rate cuts and 31 for increases. Two current external members have never dissented and there hasn’t been a dissent this year, despite the Brexit-related uncertainty. There has only ever been a dissent on asset purchases at one meeting, in 2016. It is time to end this groupthink by revamping the MPC’s membership and selection procedures. The goal should be to increase accountability and transparency to try to encourage a broader range of views. To that end, we should remove all the deputy governors, the chief economist and the external members, and look to the US Federal Reserve as a model. There, 12 regional Fed bank presidents have their own offices and staffs that track what is going on in their own areas. Similarly, the MPC should be chaired as now by the governor and include six additional members who are provided with their own staff and represent a specific geographic constituency: London and the South, the Midlands, the North, Scotland, Wales and Northern Ireland. The MPC members do not have to be economists, and we should consider different selection methods. The Scottish, Welsh and Northern Irish representatives could be appointed by and answerable to their parliaments. This would make MPC members accountable to elected officials and the general public and has the added benefit of moving resources out of London. Why have a committee of nine if there is so little diversity of views? It is high time to fix that.