“When fund providers battle to bring down fees, investor’s win.” I came across this quote from Morningstar’s Ben Johnson while editing the most recent portfolio institutional. As we all know this is largely true, particularly if you are a DC scheme member or DB scheme trustee: lower fees = more return = happy investors.
Fee reduction is often driven by consolidation and increasing competition in a market place. We are seeing the beginnings of this in the exchange traded fund (ETF) space after Vanguard entered the European market last year and Blackrock announced it was buying Credit Suisse’s ETF business in January – boosting its share of the market to 48%.
The consequence of these industry developments is perhaps more aggressive pricing policy and competition among providers (more of which you can read about in March’s portfolio institutional out Wednesday).
Healthy competition is positive when it comes to funds and when it benefits investors, but is competition always positive? Well, elsewhere in the industry we are seeing managers announcing derivative clearing activity with Central Counterparties (CCPs) ahead of European Market Infrastructure Regulation (EMIR) coming into force. In November Royal London Asset Management (RLAM) said it had cleared its first significant trades at the London Clearing House, and this week Aviva Investors announced it had cleared OTC interest rate swap transactions with CME Clearing Europe – to name just two.
As this trend manifests, the volume flowing through the CCPs is likely to skyrocket. Indeed, when I spoke to RLAM’s CIO Robert Talbut a few months ago he estimated the amount of extra collateral required by the system would be a whopping $2.4trn.
This got me thinking about issues of competition and capacity because there are only a handful of CCPs to cope with these mammoth inflows. In a competitive market these CCPs will naturally seek to maximise flow through their own firm which could potentially result in a ‘race to the bottom’.
If CCPs go to war on competitive pricing and risk monitoring, the fear is because there are only a few they know they are in a strong bargaining position and can aggressively dictate pricing.
If competition between the houses becomes solely based on price this raises questions about whether these CCPs are going to be adequately resourced to provide the good quality service everyone wants. This is where the regulators will need to step in.
Consolidation and competition are not bad by any means, but as long as it does not compromise quality of service. In the case of central clearing of OTC derivatives, the regulators need to be on their game as we don’t want CCPs to cut corners in a race to the bottom and impact upon the quality of service being delivered to investors.
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