How savvy asset managers can fend off the regulators

When US politicians wanted to court voters after the global financial crisis, they knew who to attack: the "fat-cat bankers" running the Wall Street banks in 2008.

This week, President Barack Obama visited Georgetown University to discuss social issues with students. But instead of railing against the financial sell side - the bankers - he took aim at the asset managers who make up the buy side; in particular, powerful hedge fund managers and private equity players. "The top 25 hedge fund managers made more money than all the kindergarten teachers in the country," he said, arguing that "society's lottery winners" should be forced to pay higher taxes on their operations. "There's a fairness issue here."

Investors should take note. For there are at least three reasons why Mr Obama's comments are important. First, it shows that the politics of anger has not died away. Never mind the fact that the economy is on a (moderately) healthy growth trajectory and that memories of the financial crisis are fading. US voters remain exercised by income inequality. Hence the continued appeal of firebrand politicians such as Democratic senator Elizabeth Warren.

Second, by focusing on the buy side of finance, Mr Obama has (perhaps unwittingly) highlighted a bigger power shift. Seven long years after the crisis, most mainstream banks (with the notable exception of JPMorgan Chase) have long since lost their colourful, swashbuckling chief executives, as well as the ability to churn out dazzling profits. Regulation has made them more utility-like.

But the buy side still has pockets of extraordinarily high profitability and an aura of excitement that sucks in smart brains. So when figures such as Timothy Geithner, former Treasury secretary, or Ben Bernanke, former US Federal Reserve chairman, have left government service in recent years, they have almost invariably headed in that direction. Christine Lagarde, head of the International Monetary Fund, recently said that 18th century French writer Voltaire would today advise us not to "follow the banker" in pursuit of money, but rather to "follow the financier".

The third reason Mr Obama's remarks must be noted is their timing. In the immediate aftermath of the crisis, the overwhelming priority of global regulators was to make banks much safer. But in the past couple of years, as regulatory reforms have been put into place, the emphasis has shifted to the buy side. The Financial Stability Board in Basel (which co-ordinates global regulators) and Financial Stability Oversight Council (which organises American bodies) have warned that they want to extend tighter controls over asset managers. In particular, last month the FSB issued a report calling for all institutions to face intensified oversight if they either have more than $100bn on their own balance sheets, or manage more than $1,000bn worth of assets that belong to others.

Big hedge funds, private equity firms and other asset managers are furiously trying to fight back. The moves have also dismayed Republican politicians: last month Daniel Gallagher of the Securities and Exchange Commission attacked what he calls an "assault on asset managers". But the FSB and FSOC moves are prompted by a concern that "even simple investment funds such as mutual funds can pose financial stability risks", as the IMF warned in a report last month, adding that "regulators need to know more about them through hands-on supervision".

It is possible to imagine a scenario where this sabre-rattling simply dies away, and regulators end up doing nothing more than demanding increased oversight - after all, levels of regulatory fatigue are high. But if the markets become dramatically more volatile this year and mainstream investors lose money - say, because the Fed increases interest rates - politicians might be looking for new scalps.

Either way, the one thing that is clear is that the asset management world is at a critical juncture. And that implies that investment groups of all stripes - especially those "lottery winners" - need to be politically smart and proactive; or at least a great deal savvier than the Wall Street bankers when the crisis hit.

Instead of just dismissing Mr Obama's comments as jealous sniping, or hoping the issue will go away, they should try to address them upfront. One place to start would be to recognise that some of the tax structures in the investment world - such as the "carried interest" rule that lightens the tax burden on private equity players - look peculiar, if not egregious, to most non-financiers. Better still, the buy side might float some proposals of its own.

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