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Excerpted from the Investment Management Association's written evidence:
IMA’s members are impacted by systemically important financial institutions (SIFIs) as investors in a SIFI’s own securities or securities a SIFI originates, such as asset-backed structures. As the “buy-side” our members interact with SIFIs as key constituents of the “sell-side” which are integral to many payment and clearing systems.
As asset managers do not give rise to systemic concerns, they should not be within the scope of the inquiry. A manager’s clients’ assets are segregated from the firms and the manager’s activities do not put them at risk, and as its fee is normally a percentage of assets managed, its interests are aligned with those of its clients.
The UK’s “comply or explain” regime under the Corporate Governance Code means that today the UK operates some of the best standards of governance. This framework remains sound, but it is now apparent that some of the causes of the crisis were around SIFIs’ governance. The risk that this poses to society, and ultimately the taxpayer, means that a distinctive approach needs to be taken to a SIFI's governance and that regulators have a role.
In this it is important that a balance is struck between the constraints of regulation and allowing boards to decide what is in shareholders’ best interests. Regulation may undermine the role played by shareholders who, as owners of companies and providers of risk capital, are best placed to hold boards to account.
IMA supports investors engaging with companies, which can include SIFIs, and over the last ten years, engagement has been transformed. But the market provides clients with a choice and it is not for authorities to be prescriptive as to whether a manager should engage or not. There are also limitations in what engagement can achieve – asset managers do not run companies; they do not set strategy nor are they insiders, in that they only have access to information that is available to the market as a whole.
Managers compensate for such information asymmetries by diversifying their portfolio construction.
The inquiry relates to SIFIs but the terms of reference refer to financial institutions generally. There are a wide variety of financial institutions and whilst the crisis showed that SIFIs can give rise to systemic issues, the same cannot be said for other types of institution.
An asset manager’s business model is very different to that of a bank. Its clients’ assets are segregated from the firms, and the manager’s activities do not put their security at risk. In a bank on the other hand, client funds are held on the balance sheet and used in the business. Asset managers, as agents for their clients, are rewarded a fee, normally a percentage of assets under management. Thus interests are aligned – the better companies perform, the better returns for a manager’s clients and the better a manager’s remuneration. If a manager overtrades, it adversely impacts performance because of the costs involved. Banks and brokers, on the other hand, earn revenue by trading with clients.
Asset managers do not give rise to systemic concerns and should not be within the scope of the inquiry. Unless otherwise stated, our comments focus on those, such as banks and brokers that do. In addition, many aspects of the inquiry are governed by EU legislation which covers a range of financial institutions.
Corporate governance is about behaviours and how a company in any sector, not just financial services, is directed and controlled. Good governance ensures a company is effectively managed, decisions are sound and success sustainable. It does not concern day-to-day operational management but what a board does.
It is widely accepted that today the UK operates some of the best standards of corporate governance. The UK Corporate Governance Code codifies principles, structure and processes for governance. Any SIFI with a Premium UK listing has to report on how it has complied with its provisions or explain where it has not – “comply or explain”. Whilst this framework remains sound, it is now apparent that some of the causes of the crisis were around banks’ corporate governance which failed to safeguard against excessive risk-taking.
A SIFI’s failure poses risks to society and the tax payer. Thus their governance involves a distinctive approach from the corporate sector generally and regulators have a role. It also continues to be high on the international and domestic agenda. The Basel Committee on Banking Supervision issued a set of principles in October 2010 for corporate governance practices in banks. Basel III is broadly being implemented by CRD IV which contains governance requirements for SIFIs, as well as other financial institutions such as MiFID asset managers.
Any SIFI headquartered in the UK should not be outwith European regulation and the scope for UK specific measures is limited. Even supervisory authorities are increasingly expected to follow harmonised approaches from European supervisory authorities.