Our cross-industry panel debated the risks of regulation in the GCC. Could new rules lead to higher costs for the end investor? Chaired by George Mitton in Dubai.
Nigel Brill, head of sales and relationship management, direct securities services, Mena, Deutsche Bank
Shikkoh Malik, regional head of products, investors and intermediaries, Mena, Standard Chartered
Rob Morrison, markets and securities services product manager, Citi
Craig Roberts, senior executive officer (Dubai), group head of open ended fund services, Sanne Group
William Wells, director, Middle East, Schroders
Funds Global: Regulators in the Gulf are tightening rules for investment funds. What are the characteristics of these regulations and what role do you have to play in this process?
William Wells, Schroders: There have been significant changes in the investment fund regulations recently with the primary goal of regulators being to ensure they protect the interests of local investors. One of the key factors is the different approach that regulators in the Middle East have taken compared to other markets. In most markets where Schroders operates, it’s the responsibility of the asset manager to register funds. Here in the Middle East, the responsibility has largely been put on the shoulders of the distributors.
Craig Roberts, Sanne Group: Regulators have to address the distribution perspective to capture all the market. A lot of the products being distributed here are international, not just local or regional. Targeting the distributors is probably an effective way of doing things, given the relatively small investment management community here. I would also add that change is not a regional phenomenon, it’s global.
Shikkoh Malik, Standard Chartered: When it comes to service providers like us, we are in the unique position of being hooked up both with asset managers, as our clients, and with the regulators as our main stakeholders, for our day to day business. In the region generally and in the UAE specifically, we act as an absorbing entity, taking feedback from our clients and relaying them to the regulators either during our routine contacts or during consultative committee meetings. We also go back to the regulators and share our own view, how certain processes are conducted in other markets, and give first-hand information, based on our experience across our multiple footprint markets.
Funds Global: Are there risks of unintended consequences from any of the regulations coming into force in the Gulf? In which areas do you have concerns and what can the industry do to manage these risks?
Nigel Brill, Deutsche Bank: Whenever you have new regulations in any industry, you’re going to come up with a certain amount of unintended consequences. In the case of these rule changes, there has been an additional layer of unit costs for stakeholders. As an example, in the past, asset managers wouldn't have had to use a third party for services like calculating NAVs [net asset values] and custody.
These services don’t come for free, and although it was a clear and correct intention of the regulators to segregate these duties, that additional cost layer for asset managers may have been unintentional. The thing none of us want to see is a funds regime that makes the Gulf countries a less attractive place to launch new fund products.
It’s a market maturity issue. The cost of these services – and we can call it outsourcing because that’s what it will be – reduces from a unit cost perspective. So, we will see that actual costs are driven down, asset managers can reallocate the headcount saved within the entity and, eventually, the cost we as service providers charge will be lower than it was when providing services internally. But it will take time for the real cost benefit to filter down.
Rob Morrison, Citi: The primary objective of any regulator is investor protection, but they are also trying to deliver growth within the market, and identify ways to encourage this. It’s a tough balancing act that regulators are faced with, where the possibility of a perceived over-regulation within a market can actually be a disincentive to growth.
Regulators want to ensure the necessary protections exist for the investors, but also that they allow service providers to control costs, and operate within a commercially sustainable environment. As barriers to international markets are broken down, it becomes easier for an investor to switch between markets and fund jurisdictions. Similarly, it becomes advantageous for a fund house to look at each of the sets of regulations and select the jurisdiction with the most favourable regulations.
Roberts: One of the unintended consequences you mention is the use of service providers. This will bring the local industry in line with global standards and, for fund managers in the region, it means a more attractive product for international investors. You're right to say it’s a cost, but it’s not a significant cost, and if it results in a more robust environment for investors to come in and participate in the markets, that's
Wells: Some funds that are not necessarily based here or domiciled here, that have in the past been sold into this market, may not be structured well. One of the positives is that many funds, with sub-optimal structures or from less well regulated jurisdictions will no longer be able to be sold into this market. However, one of the potential unintended consequences is how the range of funds offered to the local investor is going to change. There may be fewer fund managers selling their products into the market, and hopefully those funds are of higher quality, however the cost of registering each fund could lead to a more restricted offering for clients here.
Where some companies might have previously worked on an open architecture basis, you are likely to see many distributors registering a small number of funds. Less well understood is the requirement for distributors to perform due diligence on each of these funds on an ongoing › basis. What happens when they decide that a fund is no longer fit for purpose, or the best fund available to their client? They then have to search for another fund, register that at a further cost, and where are these costs going to go? Are they going to sit with the distributor? Are they going to be passed on to the investment management company, or are they going to end up being passed on to the customer?
Malik: The balance a regulator has to strike, in this region, is that you cannot come from an environment of close to nonexistent regulations to an extremely advanced and mature environment, in a single day. If you look at Saudi Arabia, it has been a gradual process and they have shown flexibility in terms of their treatment of funds. Countries that were the first movers, such as Bahrain, have relatively more maturity just because they started the process much earlier.
Markets should not try to shave off ten years of maturity by trying to be at par with mature markets from one day to another. They need to keep in mind that, for the changes being introduced, the local market infrastructure might not be ready, the investors might not be ready, the distribution platforms might not be ready, and guess what? One of the most important parts of the link i.e. the asset and fund managers, might not be ready.
The UAE did try to come up with regulations which were quite refined, but they showed the flexibility of listening to the market, re-aligning their thoughts across those regulations, and tweaked them even at a very later stage. For other markets like Qatar or Oman, regulators must make sure they don’t strangle the market by over-regulating, and build the framework gradually.
So, in short, our view is that the newly introduced regulations across different countries are for the good of all participants and shall bring more maturity thus resulting in enhanced investor confidence.
Brill: I agree that the additional costs aren't huge, but they are another layer of costs. On the plus side, fund managers will be working now with professional organisations on a contracted basis, and that’s helpful for them. One thing we haven't discussed is the badging of funds. As a fund manager, if you work with a leading fund administrator, that’s going to be helpful from a marketing perspective in giving international or local clients some comfort around the segregation of assets and some assurance around the NAVs.
Wells: One issue is that the mutual fund industry is relatively immature and the average size of a locally domiciled fund is very small. Additional costs, whatever they may be, from the use of custodians or from regulators' fees, are going to have a higher impact and potentially more negative consequences than in other regions.
The other thing to look at is the way the industry is changing globally. Derivatives may be a negative word to many regulators here, but a lot of international managers use derivatives actively manage risk in their portfolios. That’s something regulators may not have fully considered when imposing caps on the amount of derivatives that are used in a portfolio. Actually, those derivatives can be used to reduce the overall risk to the client.
Funds Global: Saudi Arabia is the largest economy in the Gulf by far. How significant are recent regulatory developments there, such as the draft rules for investment funds issued by the Capital Market Authority (CMA)?
Malik: The size of the regulations is intimidating, but the good news is that a majority of them are a re-write of the previous version. One can easily identify quite a few positive changes. One being the rule that any fund distributed in Saudi Arabia, irrespective of whether it’s a local or foreign fund, needs to be distributed through a CMA authorised distributor. By doing so the regulator wants to channelize all the instruments coming into the kingdom in a way that it can exercise efficient oversight.
The regulations also warrant that the fund's (that is being distributed in the kingdom) jurisdiction of incorporation must have a regulatory environment compatible with that of the Saudi CMA. It would be interesting to see if the CMA comes up with a list of all the jurisdictions they believe are deemed compatible.
Similarly the regulations also require all funds to appoint independent entities for fund accounting services that in turn means specialised entities like us could provide best of breed services along with bringing credibility and efficiencies to the market.
Wells: In this aspect, the rules are similar to what the Securities and Commodities Authority (SCA) have done in the UAE. There, the likes of Luxembourg have been approved and will be posted on the website as equivalent regulators. I think that’s positive, particularly for global organisations who domicile their funds in the well regulated international centres.
The most important thing about the development of Saudi regulations is that it potentially opens up the largest market in the Gulf region to international players. The Saudi population of 28 million dwarfs the size of the rest of the Gulf, yet the funds industry there is relatively narrow in terms of the focus of the assets that are invested, a relatively small proportion of which are in products with an international focus. These rules give the opportunity to complement what the existing funds offer and that that will give the Saudi population broader opportunities for investing their money. It’s not going to change overnight. It’s going to be a slow process, but it’s clearly a positive development.
Brill: From our perspective, it’s a significant step. With this investment regime, it’s the first time the Saudi market has defined the role of a custodian bank. That’s hugely important for us because we are one of only two international custodian banks in the region.
There has been a lot of positive noise coming out that potentially Saudi will open its doors to foreign investors. We don't know when that will happen, but I think it’s getting nearer. Along with what’s happening with MSCI and everything else in the other markets, it’s encouraging.
Morrison: Everyone is very interested to see how the Saudi market will open up, and this is obviously a step in the right direction. Only time will tell how quickly these things move forward, but since it is such a critical market in the GCC, we will continue to monitor this progress closely.
Funds Global: The investment fund rules issued by the Securities and Commodities Association (SCA) in the UAE caused some concern when they were first released, but after dialogue with the industry, the rules have been amended into a state that is “palatable” for all market participants. Do you agree with this statement?
Wells: The adoption of the term qualified investors and how those investors can be approached has been a positive step that has been taken post-feedback and discussions with market participants. That is good for a lot of asset managers who operate in this segment of the market. Before, there were too many ifs and buts.
Malik: I was a part of the consultative committee which examined these regulations. In my view, as a service provider and as a part of the market consultative committee, we found the rules acceptable and heard a similar view from our clients.
Brill: We’d probably say there’s a general view that the rules are palatable. As we go around and talk to clients and prospects, we don’t hear of anybody yet saying they’re going to exit the market because of it.
Morrison: I think that’s a good point. We’ve seen a lot of interest over the course of the last six months from companies looking to launch new funds under the SCA regulations, this is a real positive. There is certainly a comprehensive set of regulations, and the SCA seems to be open to discussion where necessary.
Roberts: People have got some clarity. Some of the over-burdening restrictions that were in the first draft have been softened quite dramatically. Everyone says they want to work in a well regulated jurisdiction; they want to have a framework to work within. It’s got to start somewhere.
Funds Global: Is it fair to say that the relative stability of Bahrain's regulatory regime explains why Bahrain remains a popular domicile for funds investing in the GCC?
Morrison: Bahrain remains one of the success stories of the GCC funds industry, and has long been a domicile of choice within the region. What remains encouraging and one of the reasons Bahrain is such a popular destination for funds is the continued development and build-out of available structures, for example the recent development of Bahrain PIUs [private investment undertakings], which operate within a more open regulated framework than other fund structures. This model certainly provides an additional solution within the market, and we have seen quite a lot of interest in this structure recently.
Malik: If you look at the jurisdictions trying to place themselves as hubs for funds, the best global examples could be Luxembourg and Dublin. What did they do well in becoming what they are today? They created a progressive and evolving regulatory environment while simultaneously developing expertise and a talent pool. One cannot simply make a single set of regulatory guidelines and sit on them for ten years.
As the industry evolves constantly thus the regulatory environment needs to evolve accordingly. Bahrain has, to a certain extent, followed this model thus has been successful in attracting funds.
With the evolution of regulatory and market environment in other countries of the region, one also expects them to attract additional funds, in the future.
Wells: However, an interesting trend I've seen, because we’re talking here about funds investing into the Gulf, is the number of local asset managers, whether they are UAE based or Saudi based or anywhere else, who are setting up funds in well recognised financial centres, such as Luxembourg and Dublin. We talked earlier about the average small size of each of the funds, and clearly what they’re looking to do by domiciling them in some of these other jurisdictions is make them structurally more attractive to investors globally.
We have seen more and more of the local asset managers moving funds offshore, or creating mirror funds offshore, so they too can benefit from the potential scale of distributing into other markets. If you look at the number of locally domiciled funds that have been registered with the SCA, you can count them on the fingers of one hand. If you compare the number of international funds that have been registered, it’s 400 plus and these include many offshore funds managed by local asset managers and banks.
Funds Global: There has been talk of a GCC currency. Do you think this could be extended to a GCC fund platform (similar to Ucits in Europe) with common regulation and cross border passportability? If so, what advantages would this have for the industry?
Roberts: While it’s an ideal solution, it’s unlikely to happen in the near future. Each of the regions seems keen to develop their own hub. We've got Bahrain, Kuwait, the DIFC, the Abu Dhabi centre; even Oman is starting to become more visionary in its own way there.
It’s difficult to see how someone could unify this in some way. There are a lot of sovereign issues, KYC [know your client] type scenarios, regulatory questions about the equivalent standards and so on. It’s going to be difficult to see how a common funds platform could happen.
Malik: This proposal was put forward in the last ministerial meeting of the chairpersons of the boards of the regulators. It has been tabled and from the face of it there is a logical reason to do so. Does it make sense to bring all the markets together on one platform, where there is a bigger liquidity pool, there is more legitimacy in terms of the structure and the right talent pool? Yes, it makes a lot of sense. When would that happen? It’s anyone’s guess.
Brill: I think we’re agreed. It’s the Holy Grail, but it’s probably not on the horizon any time soon.
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