Impact of Dodd Frank on Asset Management Firms
This is a writing sample from Scripted writer Sudeep Mallya
Independent consultants, who perform studies on the readiness of FIs to adhere to DFA guidelines, are gung ho about sell-side firms but not overly optimistic about buy-side firms. Apart from these regulatory burdens that asset management firms must accede to, they will also have to comply with additional rules to function in European markets. The European Market Infrastructure Regulation (EMIR) introduces a new market entity in the form of central counter-party, which acts like an exchange between the two parties of an OTC trade. European regulators too have stamped their authority on the excessive compensation culture by introducing the Alternative Investment Fund Managers Directive (AIFMD). Along with DFA, further rules are being discussed extensively in the industry. Prominent among them is the Volcker Rule, which requires banks to substantially reduce the proprietary trades they undertake. As banks are important customers for asset management firms that deal in OTC derivative products it is presumed that they will take a huge hit on their trading volumes generated by banks. Seizing the Opportunity The DFA sets its core principles in financial stability and consumer protection. Modifications to the existing infrastructure will lead to a stronger competitive position. Post-subprime crisis, the asset management industry was in doldrums; the only way that the industry could redeem itself was through enhanced governance, risk management and operational transparency in asset management. Significant changes are required in the operating models to propel the industry towards unrelenting, long term performance, deliver investor returns and meet regulatory expectations. The advent of DFA may see the cropping up of new transparent derivatives exchanges. Some firms could garner benefits from re-organizing processes/systems, by exiting non-core businesses while concentrating their efforts on the core businesses on risk management strategies. Any pressure on banks to consider lending only to risk-worthy asset management firms would lead to only less risky funds surviving DFA. With the higher influence of technology-led solutions, the Act may lead to increased adoption of technologies like 'thin-client computing' or software applications that use web based interfaces. Although such technologies are already widely used an explosion of the use of these technologies in financial services would substantially further reduce the cost of these services. With the mushrooming of regulation organisations are faced with two options. Firstly, to pass on the costs to customers and face the risk of undermining confidence in the markets when it is still fragile. Secondly, to take the Act as an opportunity to shape strategy that improves firms while bolstering market confidence. Conclusion Is the Act a precise step or a step too far? Two highly divergent views emerge. For some DFA symbolizes the systemic response to excessive capitalism. For others, including the FIs themselves, it will stifle the future so much that market could stagnate for some time. The regulatory burden threatens to make the cost of doing business prohibitively expensive, while some grey areas in the Act still need clarification. The pace of the progress on DFA has been sluggish with only around 40.2% of the rules having been finalized as of 12 September 2013. Most of asset management firms' concerns about the Act will soon disappear once successful enactment kicks in, while systems and processes will be reinvigorated by the introduction of new set of reforms. While short-term concerns about additional collateral requirements act as a drag, the manner in which firms are able to rationalize their costs and sustain profitability - albeit it at lower levels for some time - will determine how they fare in future.
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