Introduction

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In an increasingly regulated and complex financial landscape, more players within the industry are turning to regulated asset managers to support both their day-to-day operations and ad hoc transactions. This article highlights some of these trends. While these developments are particularly significant in Luxembourg, there is a broader global movement towards enhanced governance. As a result, employing regulated asset managers is becoming the standard practice in many transactions.

A second key factor driving this shift is the rise in regulatory requirements, coupled with the automation of operational processes. The growing costs and responsibilities associated with compliance are prompting more companies to rely on regulated asset managers for effective management and oversight.

 

The services in scope

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This trend initially emerged within the realm of third-party investment fund managers (IFMs), such as management companies and alternative investment fund management companies (AIFMs), where overall responsibility remains with the managers. However, many operational tasks and processes are now being delegated to specialist partners. IFMs often delegate functions like administrative management, pricing, and custodian services to third-party providers. This delegation allows IFMs to concentrate on more strategic tasks while maintaining strict compliance with European regulations, such as the Alternative Investment Fund Managers Directive (AIFMD). To this end, many industry players are increasingly outsourcing certain functions to regulated asset managers while retaining ultimate responsibility.

Delegation offers several advantages. First, IFMs no longer need an in-house portfolio management team with specific expertise. Instead, they can develop an oversight team to monitor the performance and compliance of delegated asset managers. By outsourcing portfolio management to regulated asset managers, this oversight team ensures compliance with regulations and adherence to the specific investment strategy in place. This approach reshapes the organizational structure, requiring a shift from risk-taking to a more control-oriented focus. This model aligns well with the broader business approach of the Luxembourg fund industry.

Delegation is particularly beneficial for non-traditional or less liquid investment strategies. Even if an IFM retains a portfolio management team, managing a growing number of strategies would require either expanding the team's expertise or increasing its size, both of which could incur significant costs. Delegating portfolio management of specialized asset classes, such as private debt, to experts is more efficient. For example, private debt specialists differ significantly from U.S. equity or Chinese bond specialists. Historically, small teams managed diverse asset classes, but this practice is evolving.

As delegation becomes standard practice for investment funds, another trend is emerging: the increased reliance on regulated asset managers in direct transactions. With compliance and governance gaining importance in the financial sector, regulated asset managers are being enlisted to ensure smooth execution and adherence to high standards, providing reassurance to all parties involved in the transaction.

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The advantages of delegation: regulatory burden and  compliance responsibilities

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The Luxembourg financial sector is heavily burdened by regulation, and recent trends have not alleviated this pressure. In addition to the roles of IFM, custodian, and administrator, the asset manager plays a crucial part in this landscape.

 

Asset managers must adhere to strict standards and comply with stringent regulatory requirements. When portfolio management activities are delegated, the responsibility for managing investment funds is not transferred. Instead, the delegating entity is required to oversee the delegate, ensuring the policies, procedures, and operational standards are met. While oversight is a critical part of the process, it is often easier to review someone else's work than to perform the tasks in-house.

 

Managing portfolio activities internally requires compliance with increasingly demanding regulations, which comes with significant costs. The primary expense is staffing, but companies also need to invest in tools such as Bloomberg, a portfolio management system, and, depending on the investment strategy, potentially other specialized software. In addition, there must be robust policies, procedures, and controls in place, along with enhanced governance that includes specific committees to formalize the portfolio management process. If the investment strategy involves trading in Asian or American markets, the team may need to work outside of standard business hours. Furthermore, AML (anti-money laundering) checks on investments add another layer of responsibility and workload for the investment manager.

 

By delegating management to a separate regulated asset manager, the delegating entity benefits from comprehensive regulatory monitoring and compliance controls, including AML checks, all handled by specialized teams. This ensures that the required standards are met, and the associated responsibilities are effectively managed.

 

Advantage: efficient operational management

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Another critical aspect to consider is the significant operational risk inherent in portfolio management. Operational errors can occur at any stage of the process, from decision-making to implementation, and their impact can be immediate and substantial. These issues are distinct from poor investment performance; they refer specifically to operational mistakes. One of the most common types of errors occurs during trade execution. For less liquid assets, the consequences of such mistakes can be even more severe, with repercussions that may last for years.

 

By delegating the portfolio management activity, operational risk is transferred to the delegate. The delegate assumes responsibility for managing this risk, ensuring that adequate resources, processes, policies, and procedures are in place to implement the investment strategy effectively. Meanwhile, the delegating entity retains the responsibility for overseeing the delegate’s performance.

 

Asset managers must handle the complex operational requirements of executing investment strategies while complying with industry standards. This demands both material and human resources to ensure efficient trade execution and strategy implementation. Additionally, they must use sophisticated portfolio management software to facilitate precise monitoring and control, with systems like Bloomberg and other specialized tools being critical to this process.

 

Managing SWIFT flows adds another layer of complexity, requiring daily monitoring and rigorous oversight to ensure proper control. The challenge lies not only in maintaining continuous compliance with standards but also in responding quickly and collaborating with suppliers to propose operational improvements. By delegating portfolio management, asset managers enable clients to focus on market analysis and relationship management while ensuring smooth and professional execution of their investment strategies.

 

Conclusion

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An increasing number of players in the asset management industry are turning to regulated asset managers to support both their day-to-day operations and ad hoc transactions. This approach offers a range of advantages. This article explores this growing trend and summarizes the benefits of delegation.

The primary benefit is the ability to delegate the complex task of portfolio management to specialized companies with the necessary resources, tools, and processes. This helps reduce operational risk. By delegating, the workload at the delegator level is also simplified, as their main responsibility shifts to overseeing the delegate and ensuring compliance with the mandate and regulatory framework.

Another key advantage is cost efficiency. Delegation allows entities to lower internal expenses and achieve significant cost savings.

Overall, the delegation of portfolio management has gained traction in recent years, and this is likely just the beginning of a broader industry evolution. As a regulated asset manager with over a decade of experience, FARAD I.M. is ready to discuss how this opportunity could benefit your organization.