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Are regulatory costs stifling start-ups?

Are regulatory costs stifling start-ups?

The burden of regulatory compliance is holding back start-ups and stifling competition in asset management, warns think-tank New City Initiative (NCI).

Research indicates small and medium-sized investment management firms are being held back by regulatory costs and many individuals are reluctant to go it alone due to the complexities of compliance.

Milena Ivanova recently set up London-based investment boutique Monogram with former Wealth Manager cover star Paul Marson. She says increased regulatory costs not only act as a barrier to entry but also risk hurting clients by restricting choice beyond the largest players.

‘Good people in the industry need to be able to do business without the burden of infrastructure and be true competitors to big asset managers. So clients will have more opportunities as well,’ Ivanova said. 

Burden on new competitors

Ivanova said the costs and the time delay made the process of setting up the business more challenging.

‘I have been surprised by how long and how costly the process is. Regulation is to the advantage of big institutions. The entry of new competitors is becoming harder and harder,’ she said.

While big businesses have in-house lawyers, small firms facing the same cost of infrastructure need to hire external consultants, which can be very expensive.

Ivanova added that because it can often take the Financial Conduct Authority (FCA) six to nine months to process an application, the time delay puts an extra burden on firms as they are unable to earn revenues during that time, making it difficult to cover costs.

‘We eventually assume that businesses like ours will probably pass on increased costs to the clients. It is impacting clients negatively. This is not what we will do, but I assume other businesses will,’ she said.

Stephen Black, co-founder of Tier One Capital, said that the enhanced costs of setting up business risks stifling innovation, ultimately holding back the evolution of the asset management sector.

He said Tier One’s funding was sourced privately, with no bank involvement, but not all investment managers looking to set up themselves will be able to secure this backing. ‘If that is the new standard for market entry then a huge practical barrier is emerging, that is collectively bad for all of us,’ he said.

‘New market participants create a disproportionate amount of creativity and innovation, which is absolutely essential for a healthy sector.’

NCI’s report, How regulation is damaging competition in asset management found the number of small and medium-sized enterprises (SMEs) in the industry has been stagnating. FCA annual approvals for firms managing investments totalled 194 in 2012, 171 in 2013 and 160 in 2014.

However, Black suggests there may be other reasons that explain this trend.

‘There are other factors influencing any stagnation, including a relatively flat period of global economic growth, an extended period of low wage growth and the relative lack of wealth creation through SME exits.

‘This is partially the unavoidable effect coming through of a severe lack of SME funding since 2008 and a continued reduction in headcount across virtually all long-established asset managers.

‘We wouldn’t agree that there are no positive growth stories out there as general activity remains strong.’

Black contends it is still a difficult environment for SME funding and it therefore needs to be supported by government policy.

‘A veritable black hole exists of SMEs that otherwise should be coming through but weren’t funded by the banks from 2008 onwards,’ he said.

Though it is difficult for start-ups to support the financial costs resulting from increased regulation, some argue that a firm with quality, differentiated offerings should still thrive.

John Howard-Smith, chief executive of Psigma Investment Management, warns mediocre firms with mediocre offerings will struggle and are destined to failure. ‘Clients should only engage with firms that have sufficient resources to ensure their systems and compliance are properly resourced and have sufficient funding to see them through to profitability,’ he said.

A ‘new priesthood’ emerges

The research also highlights the emergence of a new ‘priesthood’ owing to the demand for compliance officers.

Since 2001, the number of UK compliance officers has more than doubled, while other asset management staff levels have declined by around 20% says the NCI.

‘I do feel that this area of compliance consultancy is a frustration because the added regulation has allowed a kind of mini industry to appear,’ said Richard Whitehead, chief executive of Dart Capital.

‘Historically they were paid a reasonable market rate but such are the demands to shore up compliance requests there is a shortage. These people command very high premiums. One of the unintended consequences of increasing financial regulation created by our industry is that those individuals are becoming incredibly expensive.’

Ivanova suggests one way around this could be to simplify the application process so individuals are comfortable completing it themselves.

She said this would negate the spiralling cost of hiring multiple compliance officers and by putting more of the responsibility on the individual rather than the firm. It would also help make regulation more effective as people would be duty bound to take responsibility.

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