LONDON - It is highly likely that new European Union capital adequacy requirements will require money managers to set funds aside to cover operational risks, despite protests from European and U.S.-based money managers, said Howard Davies, chairman of the U.K. Financial Services Authority.
Any money manager doing business through a company incorporated in an EU member state will be affected by the new rules.
"In the extreme, this could drive (the asset management) business out of Europe or make European fund managers uncompetitive compared with firms in the United States," said Lindsay Tomlinson, newly elected chairman of the Fund Managers Association and chief executive of BGI Europe Ltd., London.
The FSA's Mr. Davies said he thought it "perfectly reasonable" that money managers make provisions for operational risk, but warned "the one size fits all approach is not appropriate." He said money managers generally posed far fewer risks to the overall financial system than deposit-taking institutions such as banks.
"I think European member states will find that a simple application of the new accord to investment firms will have competitive disadvantages," he added.
Once the new EU rules are applied, starting in 2004, the FSA will regulate firms according to the level of risk they pose to the financial system, Mr. Davies said.
He said investment firms, particularly those not holding client money, likely will fall into the lowest risk category and will experience the least intense form of supervision, which would be known as "FSA-lite."
Lobbying European Commission
The FSA is lobbying the European Commission to require other member states to establish different levels of oversight, as well.
But it is unclear whether the European Commission or regulators in other member states will differentiate between banks and money managers when setting capital requirements for operational risk.
Michael Haag is secretary general of the European Asset Management Association and has been trying to persuade the European Commission that it would not be appropriate to apply the same operational risk charge to banks, money managers and brokers.
Recent research by the EAMA found that assets under management by money managers in France, Germany, Ireland, Italy, Netherlands, Spain and the United Kingdom totaled around e8 trillion ($7.2 trillion).
"The European Commission does seem to be alive to the consequences for international competitiveness of the capital adequacy provisions. But there is some lack of understanding of the distinction between the investment management industry and the rest of the financial industry in terms of its impact on the financial system," he said.
FMA members are calculating the capital requirement's impact on their firms in order to propose a formula to the FSA for setting operational risk costs for money managers.
"Given that it is likely there will be a capital requirement, we are looking at what formulae would best work," said Mr. Tomlinson.
Double capital
One FMA member, whom Mr. Tomlinson would not name, calculated the new proposal would more than double the amount of regulatory capital required.
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.
Mr. Tomlinson suggested the new calculation be based on a tiered approach according to the impact of each firm on the financial system, with capital calculated according to revenues. "A formula based on a proportion of assets under management would not be appropriate," he said. Managers responsible for large pools of assets would face a hefty capital requirement regardless of whether their operational risks were any higher than those of smaller money managers.
He said members of the FMA so far have had a "sensible dialogue" with the U.K. regulator.
Recent research by the FMA showed that setting aside capital to cover money managers' operational risks was not the most effective mechanism to protect the financial system.
The report proposed the U.S. model of information disclosure, auditing, insurance and enforcement might be a more effective way to limit the impact of operational risks.
