LONDON - Money managers based in Europe will have to set aside more reserve capital if European Union regulations are changed to make firms earmark funds to cover operational risks.
Any money manager trying to win business in Europe and using a company incorporated in an EU member state is likely to be affected.
American parentage is no guarantee of avoiding the additional reserve requirements, even though the U.S. Securities and Exchange Commission imposes no such capital adequacy requirements.
Compliance officers and auditors in the United Kingdom warned money managers might be forced to move outside the European Union if additional capital requirements are too onerous or crudely applied.
Capital set aside to meet regulations is capital not making a profit.
"If an asset management business has to set aside capital, they will have to consider how profitable the overall business is," said Michael Haag, European and international director at the U.K. Fund Managers Association in London.
Over the next year, the EU will revise its Capital Adequacy Directive on how much reserve capital a bank, broker or asset manager needs in order to do business in Europe. Generally, any asset manager that wants to run money for EU-based clients has to abide by the rules of the directive.
Outdated
EU officials believe current rules are outdated and should be brought in line with proposals published last year by the Bank for International Settlements, Basle, Switzerland.
The BIS proposals, expected to be in force by the end of next year, are aimed at preventing a systemic global banking crisis and govern how banks manage risks on their balance sheet. One BIS proposal is that banks reserve capital to cover operational risks, a hotly debated category of risk covering anything from a mistake in settling a deal to losses incurred by a rogue trade.
These proposals will apply only to banks and will be in force across the world's major economies.
But the EU's Capital Adequacy Directive applies to asset managers and brokers as well as banks, and will be in force only in the EU.
The U.K. Fund Management Association and the European Asset Management Association have raised grave concerns about extending the EU directive to include operational risk.
"Serious consideration needs to be given as to whether fund management companies pose the same threat to the stability of financial markets as banks," said Donald Brydon, president of the FMA and the EAMA, in a speech to members of both organizations late last month.
Boutique and independent fund managers, as well as startups, may be at a disadvantage, depending on the level of capital required to cover operational risks.
Calculating conundrum
It is still not clear how the amount of capital to cover operational risks will be calculated. The BIS is expected to publish a draft law early next year. The banking industry has been debating whether the amount should be based on a percentage of turnover, assets under management or profits.
Mr. Brydon also was concerned the competitiveness of the European fund management industry could be undermined from competition outside the region, particularly as U.S. asset managers face no capital adequacy rules in their home market.
"We don't have an interest in disadvantaging our operators in relation to other people. We will be attentive to that point, but we believe it is time to update the legislation," said Sarah Lambert, a spokeswoman for the EU Internal Markets Commission, which is working on revising the European Capital Adequacy Directive.
Addressing risks
Nick Parkes, a partner at auditors Arthur Andersen, said there was a definite need for money managers to address their operational risks. Many money managers tended to have a relatively small capital base compared with their total assets under management.
"I sympathize with the regulators, but there is a fundamental difference between the capital requirements for investment banks and those for asset managers," he added.
At the moment, an asset manager incorporated in the United Kingdom and doing business in Europe has to reserve either six weeks or 13 weeks of operating expenses, depending on whether the firm holds client money or passes it to a custodian.
