We all know that regulatory zeal, as with so many things in life, has an arc—sometimes reaching high points and sometimes retreating. Personally, we were hoping for a bit of a pause—at least over the Memorial Day holiday in the U.S. To our surprise, the regulatory wheels continued to grind. Several breaking stories, during what would typically be a slow period, lead us to sound a note of caution: forces continue to push the pendulum further towards more detailed regulation. At times such as these it is important to focus on compliance with allpotential regulators—and there are many of them.
Over the past two weeks, the popular press once again highlighted efforts by major firms to manipulate interbank lending rates and reference currency rates, fueling a general perception that the “big guys” are not adequately scrutinized. Recent comments by Elizabeth Warren reflect the perception that the “game” is rigged. Expect ongoing developments in the U.S. and EU to fuel these flames for quite some time. Unfortunately public outrage often leads to irrational results, such as focusing regulatory attention on all aspects of the financial services industry—including asset managers. Regulators that do not regularly target asset managers may be attracted. For example, allegations that firms worked together to manipulate markets are likely to trigger enforcement by worldwide anti-trust regulators (who frequently operate independently from their colleagues in financial services).
The financial regulatory agencies themselves are not immune to these pressures. FINRA, for example, is calling for the SEC to license high frequency traders. Is this the beginning of a more general trend: licensing based on investment strategy? We detect a whiff of this as special control provisions are rolled out for private equity firms seeking to acquire insurance companies.
At the same time the lawyers are arriving on the scene with new ideas about how to garner fees. Do not underestimate how much private litigations could impact the future shape of the financial services industry. One recent example, City of Providence, Rhode Island v. BATS Global Markets, Inc. et al, involves high-frequency trading. Others are likely to focus on disclosure inadequacies concerning cybersecurity and these cases may particularly impact private equity firms. The litigations will shape industry behavior and regulatory perceptions.
At the same time, the alternative industry itself is rapidly changing. Press in the past few weeks highlighted that alternative managers are going into mutual (or “liquid”) funds and growing their direct lending businesses. The debate on the push into the retail market has largely been centered on whether performance will match the hype. That clearly is a challenge. An equally significant, but less discussed, challenge is whether compliance programs will match the new activities and their associated regulatory requirements. Most managers are new to retail regulatory requirements, which were onerous even before Dodd-Frank. Once again, compliance must include the SEC, but cannot be simply SEC-centric. As this environment continues to unfold, expect investors to pay more attention to the activities their managers are engaging in, even when those activities are outside of the investor’s account.
The arc of the compliance pendulum will swing a little higher before all these forces come to rest.