An increasing influence of the Markets in Financial Instruments Directive II is another risk for money managers in 2020.
MiFID II, which took effect on Jan. 3, 2018, was aimed at delivering data on equity trade flows, volumes and prices to a range of investors in an easily accessible and non-discriminatory way, boosting transparency of execution fees and transaction charges. But sources said the unintended effects of MiFID II haven't fully played out yet.
Glenn Poulter, head of brokerage, Europe, Middle East and Africa at Northern Trust Corp. in London, said money managers have had to rethink their operating models, as costs continue to rise and revenues come under pressure.
Post MiFID II, global commissions paid by money managers to brokers have continued to decline, having fallen to $17.3 billion in 2019 from $26 billion in 2008, according to McLagan, a London-based provider of compensation data and consulting to the financial services sector. Noting an analysis by Boston Consulting Group, Boston, Mr. Poulter said profit margins for the money management industry could fall to the mid-20% range in some regions from about 35% by 2021. "This in turn will put continued pressure on sell-side firms, as banks and brokers look to merge, consolidate or shut down unprofitable business units," he said.
Another issue under MiFID II for managers is cost calculation that buy-side firms need to conduct to disclose execution expenses to their investors. "While it is not uncommon for a new regulation such as MiFID II to be complex to implement, it's becoming increasingly clear there are areas which are not workable," said WTW's Ms. Nikulina. "The review of the regulation (in March 2020) by the European Commission will better specify the definition of costs and how they need to be calculated," she said.
The U.K.'s exit from the European Union might also spell a need to develop a third iteration of the directive to clarify standards around the delegation of portfolio management by money management firms to their parent entities or headquarters in countries outside of the European Union, including the U.K., noted Mike Booth, partner at advisory firm MJ Hudson LLP's regulatory solutions unit in London.
MiFID II does not distinguish what "business substance" is authorized in Europe, he said, adding that the regulation in its current form does not flesh out the standards for delegated services such as portfolio management when firms delegate a function to London, which after Brexit will be based outside of the European Union.
Sources also said there are more regulation-driven risks in store for managers in 2020.
Similarly to MiFID II's cost disclosure requirements, the U.K. Financial Conduct's Authority's newest regulation — Senior Managers and Certification Regime, effective Dec. 9, 2019 — requires individuals at money management firms to inform investors about fees to prevent overcharging.
In the first/second quarter of this year, the FCA is expected to release a report that will outline to investors how to compare services that managers are offering to determine which strategies could be considered value for money. Money management firms also must under this regulation assign responsibilities across their businesses, with individual senior executives assuming responsibility for potential losses to investors.
"Managers will start to worry about it when the FCA will start to reference individual people," Mr. Booth said.
Senior managers should reflect on the FCA's Nov. 19 £1.9 million fine to Janus Henderson Group and consider a course of action in those circumstances now the SMCR is in force, Mr Booth said.
"Janus Henderson (which ceased to utilize an active overlay in its fund) should have reduced management fees to reflect the value its investors were receiving," he said.
Across Europe, money managers are also preparing to help investors integrate carbon disclosures of the companies held in their portfolios under the European Union's disclosures regulation, which is expected to take effect in July 2020.
Noting the forthcoming changes under which managers must tell investors how their strategies relate to new pan-European standards, known as taxonomy, which was adopted on Dec. 18, Carlo M. Funk, head of environmental, social and governance investment strategy for EMEA at State Street Global Advisors in London, said his firm will be busy aligning investment products with taxonomy for the disclosures regulation in 2020.
Because the EU agreed to permit that investment strategies do not have to be aligned with the new standards, managers must at least spend time labeling investment solutions that are not compatible with the taxonomy. Mr. Funk said that any offering changes required to be made as a result of the regulation will be put to a vote by the board.