Mon Apr 2, 2012 3:00am EDT
* Firms wrestle with barrage of rules on how they manage money
* Complying with changes is proving expensive
* European sector may shrink to handful of huge players
* EU is assessing impact but few expect slowdown or rethink
By Chris Vellacott and Sinead Cruise
LONDON, April 2 (Reuters) - A raft of un-coordinated reforms demanded by the United States, the European Union and Britain threatens to shrink Europe's investment industry to a handful of huge players, denting a campaign for lower fund fees and squeezing investor choice.
After surviving huge outflows triggered by the financial crisis, fund managers are wrestling with a barrage of new rules dictating how they attract, manage and earn money.
But complying with the changes is proving expensive, and those fund firms already struggling to put a floor under falling margins look likely to ask investors to pick up the tab.
"We're spending much more in areas like compliance, spending much more on technology to meet regulatory requirements. We're redesigning funds to meet new requirements so there's a real cost," said Michael Dobson, CEO of Britain's largest fund firm Schroders, in an interview with Reuters.
"The challenges may be much tougher for a small firm than for us. I think that's probably rather likely," he added.
The motley mix of regulation faced by fund managers includes FATCA - a U.S. initiative cracking down on international tax dodging, which will force non-U.S. institutions to root out clients who may be eligible for U.S. taxes from 2013.
After the Lehman and MF Global disasters, regulators also want to impose stricter liability on custodians who look after investor cash, making safekeeping more expensive in future.
The EU meanwhile is revising pension fund rules in its Institutions for Occupational Retirement Provision directive, and may compel funds to hold larger capital reserves, bumping costs up further.
And in Britain, reforms on retail product sales are coinciding with an overhaul of the entire regulatory infrastructure, with fund managers soon to answer to a new watchdog known as the Financial Conduct Authority.
LITTLE CHOICE
European Commission officials are carrying out an impact assessment of the combined effect of all the European rule changes, but few expect a slowdown or rethink, leaving managers little choice but to comply or face the consequences.
"The one thing no-one has ever suggested is that regulation is a burden on the good guys. It's not a burden on the bad guys. They won't complain anyway. Put more regulation on and they still won't comply," said Peter Hargreaves, founder of Hargreaves Lansdown.
The cost of running a fund manager has soared in recent years as the outlay on property, staffing and technology as well as compliance has risen faster than the volume of net new client assets, forcing top executives to rein in spending to keep margins intact and shareholders on side.
Executives who have built up large investment managers over decades say today's regulation costs would have stifled their budding enterprises, and could be discouraging entrepreneurs from emulating their experiences.
"The regulatory burden is definitely a barrier to entry ... I'm not sure anybody would set out on that journey today," said David Bellamy, CEO of St James's Place, founded 20 years ago and now running 30 billion pounds of funds.
Hargreaves, who co-founded FTSE 100-listed investment manager Hargreaves Lansdown in 1981 in the spare bedroom of his house in Bristol, says entry to the UK market is now limited to large firms prepared to take on years of losses.
"You would need to be a massive organisation with incredibly long pockets, prepared to run the business for many years before it turned profitable," he said.
RISING COSTS
Others warn that European fund management fees will take far longer to fall towards U.S. levels, where the investment market is more competitive and often cheaper, because progress in cutting fees will be offset by rising compliance costs.
"The likelihood that fees decrease as they should and as they are in the U.S. are very limited," said Jean-Baptiste de Franssu, ex-head of European funds industry association EFAMA, who now heads up asset management strategic consultant INCIPIT.
After a slew of mis-selling scandals, regulators are increasing oversight on how investment products are sold.
In Britain, financial services selling is being overhauled to replace a commission-based model, with a structure based on fees paid by the client for investment advice in a process known as the Retail Distribution Review (RDR).
But the recommended changes are likely to ramp up pressure on small fund firms and financial advisors, many of whom cannot afford to charge lower fees to hold on to clients.
A survey of UK wealth managers by analysts Compeer found the industry spent about 10 percent of income on compliance in 2010, a cost which swallowed up half of net profit for some firms.
In 2010, UK wealth managers were forced to up their spending on preparing for RDR by 50 percent, Compeer said.
Data gathered by Skandia UK, part of the wealth management business of Old Mutual, with 272.6 billion of funds under management, illustrated the dilemma faced by some financial advisors (FAs) as RDR nears.
The number of financial advisors intending to operate solely as independent advisory firms after RDR has dropped 24 percent since the first quarter of 2011, with more advisors leaning towards restricted advice - subject to less onerous regulation.
Skandia said firms were evaluating what business model would be most cost-effective for them and the majority of their clients, with 17 percent of the advisors surveyed still unsure how they will position their business in the future.
"There will undoubtedly be a material cost to being independent compared to restricted, and the transparency RDR brings means this cost will be even more visible to clients," Skandia said.
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