The evolution of the third party management company sector: Conflicted
This is the third in a series of four articles from the DMS Client Solutions Team, bringing you a unique perspective on the challenges and opportunities presented by the shifting European regulatory landscape. In last week’s article Daniel Forbes explored explored the evolving landscape in Ireland for Fund Management. This week, David Morrissey (pictured), DMS Global Head of Client Solutions, offers his unique personal perspective on the evolution of the third party management company sector.
When I joined DMS almost five years ago I was backing my instinct that the third-party management company sector was one that investors, and hence the industry, needed. I felt this so strongly that I left a company that I had enjoyed 18 successful years with and where I still count some of my best friends – SEI. I firmly believe that I would not have left for any other opportunity.
As such, SEI is a logical place to begin examining the evolution of management companies and where they should sit in the wider fund provider infrastructure. You see, SEI has both a European depositary and a European proprietary management company.
SEI took a decision whilst I was still there - that we all thought logical at the time – to use our management company to oversee the SEI proprietary funds and not to offer it as a third-party management company. The reason we took this decision is that we clearly saw that SEI would be conflicted were they to act as both third-party management company and as the depositary.
I was certain that, when it came to investor protection, conflict within the overall governance & oversight framework would not be tolerated by regulators or industry. In essence the third-party management company would become a key element of this framework of checks and balances alongside the depositary and auditor.
The combination of depositary and third-party management company oversight conflicts in other ways as well. It conflicts through:
- The profit derived from retaining all functions; and
- The lack of accountability inherent in the ‘one stop shop’ for investment managers
Within the industry there are two distinct approaches to building a governance & oversight framework for European Funds:
- We will retain all conflicted functions to offer a ‘one stop shop’ and there will be enough investment managers who value perceived convenience over independence of the depositary and third-party management company.
- We will maintain the separation of depositary and third-party management company and put the investor interest before the revenue retention of all business lines.
We’ll call these ‘one stop shops’ and ‘independents’ for comparison purposes.
Now, all companies in our sector should exist to make profit, so there is no moral judgement being applied to ‘one stop shops’ in this article.
If there is a market, then someone will service it and there is no denying the success of ‘one stop shops’, they are frequently able to make investment managers value the perception of convenience over the conflict and save a bp or two in the process.
In short, investment managers who utilise ‘one stop shops’ often do so without a great deal of consideration for the protection of their investors. As the focus on governance & oversight continues to intensify across Europe, institutional investors are beginning to ask why they should accept this risk and are putting their money with investment managers who value this investor protection over perceived convenience.
Ireland and Luxembourg are different in their acceptance of this type of conflict. When you look at Ireland, the top three third party management companies are all independent of the depositary. When you look at Luxembourg there are only three independents in the top ten third party management companies.
It seems odd that such a situation is able to persist in these heavily regulated times!
Is this divergence of approaches between Ireland and Luxembourg reflective of the industry and the regulatory appetite for independence in the two key domiciles? Perhaps it is reflective of the larger share of the Private Fund market, which historically has paid little heed to conflicts within structuring, being centred in Luxembourg? Or is it simply a quirk of the consolidation of third-party management companies not being as developed in Ireland?
One suspects that both CSSF & Central Bank of Ireland interpret the ESMA guidance in a relatively consistent manner, so are they waiting for further ESMA guidance in terms of this independence? There is a strong indication that this is coming but it will be two years out from now.
So, if some investment managers are going to choose the convenient ‘one stop shop’ with the inherent risk of internal escalation for group companies before external escalation to regulators, boards and investors - who puts the investors first?
Do investors know the industry is exposing them in this manner? Do they value the fees saved or the convenience for their investment manager over independence?
The industry seems to go through different phases; at the moment focus is on scale and third-party management companies achieving significant scale, on substance for Self-Managed Investment Companies (SMICs in Ireland) and while these are focuses that play to the strengths of DMS - with over 250 people employed across our management company platform - are they the greatest threat?
Five suitably qualified people can separate functions and do a good job in a well-run, small, third party management company, yet this is not allowed or is difficult to achieve.
However, a corporate group with multiple streams of revenue from one client can run a closed book and be trusted to self-report, self-review and put external parties before their own internal corporate goals. How is this not the real focus?
I would be very keen to engage with any other parties as concerned with this area as I am. Please do reach out to me so that we can take these discussions further.