The Evolution Of The 3rd Party Management Company Sector: Conflicted

This is the third in a series of 4 Articles from the DMS Client Solutions Team, bringing you their unique perspective on the challenges and opportunities presented to them as the European regulatory landscape shifts.

In last week’s article Padraic Durkan explored the evolving landscape in Ireland for Fund Management in his Article: Irish Fund Management Companies: Time to Get Serious About Substance & Oversight.

This week, David Morrissey, DMS Global Head of Client Solutions offers his unique personal perspective on the evolution of the 3rd party management company sector.

The Evolution Of The 3rd Party Management Company Sector: Conflicted

When I joined DMS almost five years ago I was backing my instinct that the 3rd 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 another opportunity.

As such SEI is a logical place to start in examining the evolution of management companies and where they should sit in the wider fund provider infrastructure. You see SEI have a depositary and a proprietary management company.

SEI took a decision whilst I was still there that we all thought logical at the time; let’s use our management company to oversee the SEI propitiatory funds and lets not offer it as a third party management company as we would be conflicted as the depositary.

Conflicted…

I was certain being conflicted would matter. That it would be the determining factor in the 3rd party management company joining the depositary and auditor as a triumvirate of protectors of investors.

But that separation of depositary and 3rd party management company oversight conflicts in other ways also. It conflicts with:

The profit of retaining all functions
The convenience of a ‘one stop shop’ for investment managers

As such there is a conflict that providers are making decisions on and they are breaking out into 2 distinct schools;

We will look to retain all conflicted functions to offer a ‘one stop shop’ and there will be enough investment managers who value that over independence of depositary and 3rd party management company.
We will maintain the separation of depositary and 3rd party management company and put the investor interest before the revenue retention of all business lines.

Let’s 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 judgment being applied to ‘one stop shops’ in this piece.

If there is a market then someone will service it and there is no denying the success of ‘one stop shops’ and they are frequently able to have investment managers value the convenience over the conflict and save a bp or 2 in the process.

In short, investment managers are voting for ‘one stop shops’ and some will do so in the absence of investors questioning that conflict, asking why they should accept it, explaining they won’t and putting their money with investment managers who value them over their convenience.

Ireland and Luxembourg are different in their acceptance of this type of conflict. When you look at Ireland the top three 3rd party management companies are independent of the depositary.

When you look at Luxembourg you need to go to the top 10 3rd party management companies to find 3 independents.

So how is such a situation emerging in these heavily regulated days?

Is this reflective of the industry and regulatory appetite in the two key domiciles for independence or simply a quirk of the consolidation of 3rd party management companies not being as developed in Ireland?

One suspects that both regulators interpret the ESMA guidance in relatively consistent manner, so are they waiting for further ESMA guidance in terms of this independence? There is a strong indication this is coming but will be 2 years out from now.

So, if some managers will 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 1bp 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 3rd party management companies achieving significant scale, on substance for Self-Managed Investment Companies (SMICs in Ireland) and while these are focuses that play to our strengths with over 250 people employed across our management company platform ………… are they the greatest threat?

Five people can separate functions and do a good job in a well ran small 3rd party management company. Yet this is not allowed or 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, to self-review and to 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.