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Securities and Exchange Commission Asset Management Advisory Committee Meeting

Securities and Exchange Commission

Asset Management Advisory Committee Meeting

Tuesday, January 14, 2020

Discussion Panels

Opening Statements

Chairman Jay Clayton

In his opening statement, Clayton emphasized the importance of developing the Asset Management Advisory Committee (AMAC) in order to discuss emerging trends in the industry. He highlighted his ongoing discussions in Europe regarding the mismatch of liquidity in equity and fixed income markets, as well as the transition from the London Inter-bank Offered Rate (LIBOR). Clayton stated that the AMAC brings together experienced and thoughtful leaders in the asset management space to help the Securities and Exchange Commission (SEC) make informed policy and rulemaking decisions to promote main street investor access and choice while ensuring appropriate investor protections. He added that he looks forward to the AMAC discussing diversity and inclusion (DNI) in this industry.

Commissioner Elad Roisman

In his statement, Roisman expressed his gratitude for the creation of the AMAC and added his desire for the committee to consider the discussion of regulatory compliance and the impact of technology. He recommended that the AMAC consider limitations of products and services for small firms relative to large firms. Roisman stated that he would like to eliminate or consolidate barriers to entry as well as regulations and rules that ultimately interfere with investor benefits.

Commissioner Hester M. Peirce, Securities and Exchange Commission

In her statement, Peirce stated her desire for the AMAC to consider data privacy and protections surrounding asset managers. She emphasized the importance of these discussions given the implementation of the General Data Protection Regulation (GDPR), the California Consumer Protection Act (CCPA), and the potential of other U.S. state privacy laws.

Commissioner Allison Herren Lee, Securities and Exchange Commission

In her statement, Lee echoed the importance of the creation of the AMAC, particularly on asset management voting and investing. She highlighted her desire for the AMAC to consider environment, social and governance (ESG) disclosure discussions. Lee suggested that the SEC work to ensure that asset managers are best servicing clients by addressing ESG pricing risks, defining and identifying ESG funds, and ensuring client goals and voting are aligned.

Commissioner Robert J. Jackson Jr., Securities and Exchange Commission

In his statement, Jackson echoed the comments of the other Commissioners and recommended the AMAC consider closed and mutual funds in their discussions.

Dalia Blass, Director, Division of Investment Management

In her statement, Blass said that the AMAC would focus on engaging and better regulating the constantly evolving asset management industry. She believes that the AMAC will bring forward pressing issues in the industry, ultimately benefiting the SEC and main street investors. Blass highlighted that areas of discussion would include the rise of indexing, increased scale, and increased retirement savings. Blass emphasized that the AMAC consists of members from different backgrounds, sectors and geographies within asset management, which will help the SEC address trends and risks.

Ed Bernard, Chair, Asset Management Advisory Committee

In his statement, Bernard echoed his gratitude to the SEC and members for the formation of the AMAC. He said that the AMAC would prioritize strong dialogue and make recommendations where and when they are needed. Bernard outlined his priorities as chair, which is to serve and protect investors, embrace diverse thought and practices, and to prevent the violation of trust in asset management. He said that this conversation would provide the foundation for future conversations within the subcommittees. Bernard also suggested that members avoid linking every trend or issue back to regulation and would rather prefer them to offer context for solutions.

Discussion I: Evolution of Asset Management and Value Proposition

Panel Presentation

Michael Goldstein, Empirical Research Partners, spoke about the asset management industry holistically, highlighting key trends over the past decade, including the rise of indexing, investor price sensitivity and what constitutes as advice. Goldstein stated that institutional business is a quarter of the industry, having decreased from one-third of asset management. He continued that the industry has transitioned to retirement savings, while retail shares have largely remained flat. Goldstein added that the rise of exchange-traded funds (ETF’s) and private equity have been the largest “booms” in funds, increasing from three to nine percent of all assets over the last decade. Goldstein noted that Treasury bonds have been more favorable than stocks over the last 20 years.

Further, Goldstein said that the bond market yield is now about half of the spending rate, which has led to manufactured spending. Goldstein emphasized that demographics between the baby boomers and millennials have had a large effect on asset management. Specifically, that baby boomers hold 70-75 percent of household income. He added that assets are skewed to the top earners of the wealth distribution, leading to inertia among existing assets. Goldstein noted that companies are staying private longer than in the past and that mutual funds are becoming materialized within private markets. Goldstein warned against the potential consequences of the sectoral mix of leveraged lending and publicly held companies. He continued that indexing in equity markets has decreased, with ETF’s not making a decision as to the most viable option, notably due to active management being unable to meet benchmarks. Goldstein stated that in the real economy, cash flows for the largest companies have outpaced others at a rate never seen before. He noted that pricing has become a determinant for investor behavior compared to the past. Goldstein also cautioned against indexed equity vehicles, as narrowly defined liquid assets and fragmented ETF’s could cause a timing element problem. Goldstein concluded with explaining that the factors of advice in asset management have changed as a result of the fact that people believe that they are wealth managers or financial planners, not broker-dealers anymore. He added that these trends are largely a reflection of the global economy.

Ben Phillips, Casey Quirk – Deloitte Consulting, echoed many of Goldstein’s points and added his thoughts about what has led to the transition from the manufacturing paradigm to the service paradigm. He highlighted this is due to a variety of reasons, such as changing demand, supply, and the overall impact on asset management. Phillips echoed the impact baby boomers have had on the direction of the industry, adding that nearly half of retirement savings assets come from retirees. He noted that millennials tend to be more indebted, more risk-averse, and have different perceptions of capital markets, which leads to them investing in order to address specific questions rather than benchmarks. Phillips continued that technology and enterprise services have become a larger requirement for centralized economies of scale. He said this has led to platform and advice consolidation for holistic advice and customization. Phillips mentioned the effects of fees changing per annum, leading to a demand in asset management product discounts and slowing down fee sensitivity. Phillips echoed the impact of the decline of public companies and the increase in indexing. He added that fixed costs have increased on the supply side with self-evident economic impacts. He said the areas impacted had been valuing propositions, less registered products, different pricing methods, more direct-to-consumer distribution, more automation and focus on data culmination, and more listed-unlisted investing. Phillips recommended asset management consider the impacts of technology moving forward.

Question and Answer

Russ Wermers, AMAC member, asked about the impact of technology on the supply side. Goldstein said that technology has affected the longevity of indexing, making things cheaper at scale and creating competition for information gathering. He said money management has transformed for long term accuracy because of scalability. Phillips agreed and said there is a cost-sensitive environment and an investment quality component. He said that finding alternate data, faster date, and quality factors are becoming more difficult. Phillips added that tech companies leveraging their sunk costs into the industry could be disruptive.

Erik Sirri, AMAC member, asked about asset allocation related to outcome problems for American’s cash flow demands. Phillips answered that investors want specific investment questions answered for purposes of debt, liquidity, tax effectiveness and other direct allocations. He said that asset allocation models are built to bring that to them.

Gilbert Garcia, AMAC asked about the regulation of ESG. Phillips said Europe is finding it difficult to regulate standards, as there are questions of ESG definitions, how to enforce standards, how to audit investments and other questions of oversight. Goldstein echoed that no one is certain about what defines ESG.

Mark Tibergien, AMAC asked about the age demographics concern related to data and choice. Goldstein said that there are a variety of possibilities in advice-giving with technology. Phillips answered that with technology, it is more feasible to discuss consumer finance and debt and liquidity management. He added that this creates more competition and confusion.

Bernard asked about data evolution effects on the end investor. Phillips said it is difficult to correct advice given, and that asset management and intermediaries are not aware of who their clients are with no end-user data link exists. He said this ties in with the SEC Commissioner’s questions about data usage.

Bernard followed up about the current environment for small asset managers. Goldstein said that it matters for innovation, and the environment is less open for smaller firms to grow into large firms. Phillips said the question is about whether the tradeoffs for scaling can accommodate and cooperate with customer speculation.

Jeff Ptak, AMAC member, asked about disclosures for assessing asset managers and client data. Phillips said that India is the example, which has a system in place for reacting and resolving based on consumer data. He said their system is more about protecting the consumer and being granted the rights to how consumers want their data shared.

Rama Subramaniam, AMAC member, asked about the narrowing of choices on the supply side for 401(k) saving. Phillips said the biggest lever to bridge income gaps is for people to put money aside. He added that with Treasury yields, it would take longer in this industry. Goldstein recommended being cautious with declining interest rates.

Scot Draeger, AMAC member, asked about the impact of scale and consolidation and the decreasing utility for investors. Phillips said scale does create distance for client customization. He said managers are segmenting to maintain degree size to maintain client interactions. Goldstein said that it is common for big firms to remain the biggest because they are the cheapest.

Neesha Hathi, AMAC member, about if there is a catalyst that could drive in different fee models. Phillips said it is not widely prevalent. He said clients do like the idea that asset managers get paid based on client benefits, but there is no enforceable model yet and it is not an overnight transition.

Discussion II: Evolution of Public and Private Securities Offerings

Panel Presentation

Stephanie Drescher, Apollo Global Management, focused on her firm’s expertise in private equity to illustrate the broader industry over the last decade. She explained the various asset class offerings, the transition of banks away from them due to liquidity concerns, and the increase of private equity, credit and real estate investment. Drescher touched on the breakdown of third part institutional investing relative to wealth management partnerships. She added that the shift from public to private investment includes trends of action to passive and alternative investing, with the additional incremental exposure to risk. Drescher opined that public market trends have experienced a 40 percent decline over the last 20 years, which pales in comparison to private market growth. She added that private markets provide companies more access to capital, as well as experienced management structures. Drescher highlighted the performance of private funds via the AUM and returns for pensions. She concluded that the desire to invest in the different asset classes seems to show continued upward trends over the next five years.

John Finley, Blackstone Group, focused on the shrinking public markers and the “terrific” returns from private markets, with the tradeoff of market access. He continued that volatility in private markets is lower, noting the potential intervention in passive investing and fewer risks associated with private markets. Finley stated that according to data, global retail investor demand, especially for wealthy investors, has increased in private U.S. markets, with a decline in mutual funds and money markets. He echoed previous points about the high returns for pension plans compared to 401(k)’s. Finley suggested that private markets provide investors more opportunities related to liquidity and lower fees. He emphasized that this transition is not a temporary shift and that more companies are delaying going public due to the opportunities of private markets. Finley suggested that private markets provide income-oriented investment, perpetual capital structure, periodic liquidity, and offer products upfront. He recommended adjusting accredited investor thresholds, easing of liquidity restraints for target-date funds, and allowing carry-like compensation for retail funds. Finley added that these recommendations could potentially mitigate risks in private markets for retail investors.

Colby Penzone, Fidelity Investments, stated that Fidelity generally holds less than 10 to 15 percent of investor allocations in a pre-initial public offering (IPO) and private equity investments. He suggested that there is not a great demand from non-high net worth investors in private markets. Penzone stated that mutual funds provide investors valuable daily liquidity and are effective vehicles for investors, specifically in the retirement savings space. He noted that retail investors have access to over 100 various liquid alternative funds managed through third parties. Penzone suggested the AMAC consider optimal allocation amounts for investors in private equity, diversification of private equity portfolios, geographic diversification, fee and pricing transparency, pooled vehicle governance, and broader access and streamlining for investors.

Question and Answer

Joe Savage, AMAC member, asked what private equity means and what the thresholds are for private equity. Finley stated that private equity is a segment of the private market, stating that the range is virtual across all firms. He recommended using target-date funds as an intermediary and as an advantage. Penzone said that companies are staying private longer to get access to later-stage funding when historically they would have become public.

Garcia asked about the SEC’s role in standardized documents. Finley said the SEC needs to look at changes need to preserve transparency, choice and innovation while allowing private equity strong institutional component rights and target-date fund flexibilities. He said target-date funds provide investors an extra layer of protection.

Michael Durbin, AMAC member, asked about intermediary financial exposures to a portfolio. Drescher answered that the base of education is quite strong and there can be an expansion of wealth experience for investors. She said intermediaries have a learning curve, and there would be a natural evolution of exposure as conversations evolve as there is one framework for allocation and diversification. Finley added that the role of the intermediary is critical and would help channel expansion to the framework.

Beck asked about volatility and avoiding misleading portfolio metrics. Drescher said that the context she discussed is reflective of the broad data set of underlying investors taking advantage of the asset class state. She recommended work be done to achieve the right percentages for portfolio investment.

Rich Hall, AMAC member, asked Finley why he is strongly in support of intermediaries. Finley echoed many of his earlier comments about target-date funds adding an extra layer of protection and providing investors cost and choice effectiveness. Penzone said from his experience large institutional clients have occasionally requested exposure to alternative funds. He said there must be a balance and practical implementation for costs and perceptions.

Hathi asked Penzone about the demand for clients in mutual funds. Penzone said Fidelity looks at all opportunities in the marketplace for driving alpha and would make changes based on demand. He added that he wants to ensure meeting appropriate liquidity levels and that Fidelity is meeting client benchmarks.

Subramaniam asked about the transparency of pricing and lack of liquidity. Finley said that private markets offer better returns with more liquidity. He said this is not different than a bank putting out funds and managing daily liquidity requirements.

Discussion III: Globalization of Asset Management

Panel Presentation

Alex D’Amico, McKinsey & Company, said that net flows are the best measure for money in markets and highlighted transitions in the global landscape. Most notably, he highlighted that the industry has recovered from 2008 and that reporting shows there to be pressure on performance and operating leverage. He continued that fee pressures for shared classes and rotation of passive are up to 80 percent.  There are upward trends for cost structures and that technology and operating leverages are global phenomena. D’Amico emphasized that the Asia Pacific region is 20 percent of the market, accounting for half of the net flows and outpacing the U.S. alongside Western Europe. He highlighted that there is a wide range of active versus passive investment across the globe, most notably there being pickups across regions. D’Amico highlighted that Japan’s markets tend to differ from the Asia Pacific as a whole, in that Japan tends to have less mature markets. He highlighted that global trends are the rotation of passive strategies, that fee pressures continue, technology disruptions, longevity, and the lack of retirement savings innovations. He concluded by recommending a focus on predominately passive investing, sustained alpha generators, and solutions to providers oriented toward outcomes.

Raquel Fox, SEC Office of International Affairs, said the SEC has focused on working with foreign securities regulators such as the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) to advance U.S. interests. She recommended that the AMAC and market participants communicate with the SEC to prioritize foreign engagement. Fox said this would assist in shaping the securities regulations to provide the U.S. perspective.

Dan Waters, Independent Director and Consultant, focused on key regulatory themes. He stated that the interest in mutual funds would have occurred even if 2008 did not happen. He recommended focusing on liquidity mismatch, retail investor outcomes, and ESG principles. Waters also recommended working alongside the FSB and IOSCO. He highlighted the difference between liquidity in banking versus individual funds and the attraction to low-cost funds by investors. Waters echoed points about the links between active and passive funding shifts.

Paul Roye, Capital Group, highlighted the shifts that the Markets in Financial Instruments Directive (MiFID) II had on information gathering and global complexities. He said the European Union aimed to increase price transparency and reduce asset management conflicts of interests. However, Roye pointed out that MiFID II led to a conflict of legal issues with providing research services for asset managers. He applauded the SEC’s no-action on the issue for U.S. firms and their work with EU regulators on this but recommended that this issue requires a fix as it effects firms P&L budgets. He also highlighted that this had had adverse effects on large versus small-cap firm’s ability to provide quality research to its clients.

Jason Vedder, Driehaus Capital Management, echoed Roy’s sentiment, adding that MiFID II has largely impacted small firms. He said that MiFID II could lead to draconian cuts for small firms. Vedder highlighted how research helps managers inform clients and avoid portfolios that would be harmful to investment.

Question & Answer

Garcia asked if there are statistics that show the stated trend that research cutbacks influence performance. Vedder said that there is research, and it is tough to pass on costs to clients. Roye said that the overuse and overcapacity of research led to MiFID and that language only allows for hard dollars to pay for research. He recommended that commissions for research payment be a possibility to help small and mid-size companies.

Bernard asked about the global context impact for research. D’Amico said that active management generates returns, and more research paid out of pocket. He recommended consideration of what is in the best interest of foreign vendors and getting funds flowing, as the hard cap is now over $250 billion in assets. Roye stated that it is tricky for investors to figure out asset manager performance, so they turn to lower costs for flows. He hopes Regulation Best Interest (Reg BI) can help and recommended looking at hard dollar caps.

Sirri asked about central banks’ engagement and context for effectiveness. Waters said he hopes for central banks and securities regulators to work closely together and is encouraged by the work with the FSB. Fox said the goal is to have a better understanding and collaboration between the SEC and FSB for capital markets.

Scot Drager, AMAC, asked about how MiFID affects small firms. Roye said that large firms could pay for research from their P&L budgets, while small firms have less room. Vedder said that currently, paying for research is a black and white issue, with no middle ground to work with for small firms.

Draeger also asked about the ongoing work with India. Fox said her office would continue to work to help emerging markets, as well as work on international enforcement cases and global securities investments.

Discussion IV: Discussion of the Committee

Bernard highlighted the members providing feedback on the day’s discussion and for any future points of discussion. The committee members concluded by introducing themselves and expressing themes they would like to continue discussing, most notably private versus public markets, ESG principles, emerging technology, MiFID impact, and globalization impact on U.S. managers. Blass stated her gratitude for the presentations and her encouragement moving forward.

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