Regulatory reform in the mutual fund and ETF industry has the fund world reeling as it seeks to address uncertain challenges, such as proposed rules on brokers and advisors, to adapt to a changing environment.

Money Management Executive's annual regulatory survey noted participants seem to be taking a wait and see approach going forward when it comes to spending on compliance.

Leading the pack in this year's Regulatory Issues Survey, compiled by Princeton, N.J.-based Lodestar Research, is worry among decision makers that are possibly facing fiduciary rules for advisors and brokers. In 2012, 44% listed fiduciary rules as their top concern, bringing it to the second most worrisome point.

SEC Chairwoman Mary Jo White said during the Oct. 9 Securities Enforcement Forum that investor protections from advisors and brokers is possibly next on the docket, which could indicate why approximately 54% of this year's respondents are watching this key market reform.

"Retail investors, in particular, need to be protected from unscrupulous advisors and brokers, whatever their size and the size of the violation that victimizes the investor," White said at the annual Washington conference. Because the SEC and the Department of Labor have yet to issue a fiduciary rule, Investment Company Institute General Counsel Karrie McMillan said "it's difficult to predict the impact."

"Funds are sold through multiple channels with a variety of share classes designed to accommodate the ways investors choose to compensate their broker-dealers and advisors," McMillan said. "Regardless of the approach ultimately taken by the regulators, we expect that fund sponsors will continue to design share classes to meet the needs of their various distribution partners and to make adjustments as those needs evolve."

Next, 53% of the survey group, which is made up of more than 200 vice president and C-Level executives from the investment management, advisory, broker-dealer and mutual fund industry, said they are glued to the Dodd-Frank Wall Street Reform Act provision to add additional capital surcharges for mutual funds or fund companies. These additional fees would be directed to financial services companies' "deemed systematically important." In 2012, approximately 42% of participants quoted this same concern, indicating an 11 percentage point increase.

Elimination or restructuring of the use of 12b-1 fees, now at 48% or the top three concern, has risen by 11 percentage points from the 37% marker posted in 2012. The SEC voted on the elimination of categorized mutual fund distribution fees in July 2010; these surcharges amounted to about $9.5 billion in 2009, the regulator said previously.

Then, coming in at number four is the lauded measure to impose stricter regulation on money market funds that seek to block any future episodes like the horror show that played in September 2008 when the Federal Reserve Primary Fund "broke the buck."

The SEC proposed rule, which sought to stop runs on money market funds by imposing two alternatives; a floating net asset value for prime institutional money market funds and the other would allow for the use of liquidity fees and redemption gates when times get tough.

Introduced in June, MMF reform closed its public comment period Sept. 17, according to an SEC spokesperson, which stated that Commission staff was still reviewing comments as of press time.

This year, approximately 43% reported floating the $1 net asset value of money market funds as a top concern. In 2012, there was a consensus among 37% of executives surveyed.

McMillan added that the ICI believes that the "narrowed scope of the floating NAV proposals reflects the SEC's understanding of the issue and focus on tailoring its response. However, she explained that the ICI is strongly opposed to the "imposition of both options in the proposal - requiring gates and liquidity fees on funds that have floating NAVs would only drive investors into products that are less regulated and potentially riskier, damaging both funds and their investors."

Also, while 45% heralded the SEC's review of the use of derivatives by mutual funds and derivatives as their top worry in 2012, the derivative rule fell to the fifth spot this year with 30% expressing apprehension.

Structure & Spending

However, as worry over how new regulation will hurt product innovation and competitiveness in the U.S. financial markets continues, 35% of this year's survey respondents said they were very concerned. A clearer picture can be painted when looking at concern at the firm and operations level. Thirty percent said they felt new and impending regulation will hurt their firm's ability to innovate, 28% noted that they expect an impact on growth and 30% said these restrictions will hurt their bottom line performance.

To help alleviate structural and operational tension, most firms said they had dedicated personnel to address these responsibilities. For the most part, 58% said that their firm has a dedicated chief compliance officer, 40% said their company's general counsel doubles as the compliance officer, and 35% listed chief risk officers as currently being on the roster as manpower to help with increased regulation. In 2012, nearly two-thirds or 65% listed having chief compliance officers and 36% said they had chief risk officers, showing movement along the employee chain towards integration of roles.

Integration in staffing structure could possibly mean more spending on technology infrastructure. While 44% said they didn't know if regulatory compliance spending would increase in 2014. Forty-one percent of this year's survey participants expect changes in promised compliance budgets to hardware, software, training, consulting staff and salaries.

Uncertain Future

There was no consensus on what spending budgets should be promised due to the increased and impending regulatory scrutiny. Forty percent said they expect shifts in regulatory compliance to increase by more than 10%, 36% of the survey participants said an increase between 6% and 10% was likely, and 21% reported an increase by 2% to 5%.

In 2013, despite 31% saying they spend under $1 million in regulatory compliance spending, 49% noted that they didn't know what sort of spend was promised to this sector of the business.

Additional uncertainty was seen in what these firm executives expect to spend on investment policy compliance in 2014; more than half of this year's respondents were unclear as to whether budgets would change.

In last year's survey, average spend for regulatory compliance and investment compliance was $9.6 million and $7.5 million, respectively. This year, mean spending amounts jumped to $18.2 million for regulatory efforts and $14.4 million for investment policy operations. However, the halfway point for both budget items was $500,000; the same as 2012's survey. 

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