Transparency Rules Could Hinder Fund Capacity, Moody’s Warns

New European trading rules could restrict the maximum size of investment funds, Moody’s has warned.

The credit rating agency predicted that spiraling regulatory compliance costs and reduced market liquidity would affect fund managers, following the publication of the final version of the second Markets in Financial Instruments Directive (MIFID II).

“The idea that post-trade transparency will promote greater liquidity in markets does not seem sensible.” —Andrew Balls, PIMCOThe new rules require bond traders to publish information on their trades before and after transactions, in a bid to improve market transparency in the wake of the financial crisis. But Moody’s said liquidity—and therefore fund size—could be adversely affected if traders were “less willing to commit capital to facilitate clients’ trades to avoid the risk of other market participants trading against them”.

With this negative effect on market liquidity, asset managers “would need to limit fund sizes and scale down their trading in order to trade in and out of positions quickly and efficiently”.

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“MIFID II’s new pre- and post-trade transparency requirements risk impairing market liquidity, limiting asset managers’ revenue potential by constraining the potential size of a fund,” Moody’s said in a research note.

Liquidity in some areas of fixed income has already declined dramatically since the peak of the financial crisis. Investors have previously warned about the capacity of the largest bond funds and their ability to trade in and out of positions quickly and efficiently.

Andrew Balls, CIO for fixed income at PIMCO, told Bloomberg that MIFID II’s transparency drive was “a mixed blessing”. “You may provide less liquidity to the market if every man and his dog is going to know what you are doing,” he said. “The idea that post-trade transparency will promote greater liquidity in markets does not seem sensible.”

In addition, the Investment Association—the UK’s fund management trade body—has argued that the proposed liquidity measure is “too unpredictable” and will make it harder for fund managers to make long-term investment decisions.

The European Securities and Markets Association (ESMA), which drafted the rules, has also proposed tighter rules on equities trading. The rules would restrict how much of a company’s stock could be traded away from regulated stock exchanges in so-called “dark pools”.

ESMA’s final report on MIFID II has been passed to the European Commission, which will decide whether or not to endorse it by the end of this year.

Blackstone has agreed to pay $39 million to settle charges that it failed to properly disclose fees to investors.

According to the US Securities and Exchange Commission (SEC), the private equity giant did not inform investors about gains from discounts on legal fees and accelerated monitoring fees collected from portfolio companies prior to their initial public offering.

“Full transparency of fees and conflicts of interest is critical in the private equity industry and we will continue taking action against advisers that do not adequately disclose their fees and expenses.”The practice of taking a lump sum for future consulting work “essentially reduced the value of the portfolio companies prior to sale, to the detriment of the funds and their investors,” the SEC said.

Furthermore, the SEC found Blackstone negotiated a legal fee deal that was more beneficial for the $333 billion firm than the funds it advised, “without properly disclosing the arrangement.”

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“Full transparency of fees and conflicts of interest is critical in the private equity industry and we will continue taking action against advisers that do not adequately disclose their fees and expenses, as Blackstone did here,” said Andrew Ceresney, director of the SEC’s division of enforcement.

The regulator also claimed that Blackstone breached its fiduciary duties through these fee disclosure irregularities.

Blackstone neither admitted nor denied the SEC’s allegations, and said in a statement that it had “voluntarily made changes to the applicable practices before this inquiry was begun.”

It also claimed the issues investigated by the SEC date back to more than 10 years ago when acceleration of monitoring fees was “a common industry practice.”

“Each accelerated fee was, however, as the SEC order acknowledges, disclosed when received and our limited partner advisory committee did not exercise its right to object,” Blackstone’s spokesperson added.

Blackstone’s settlement follows KKR’s $30 million agreement with the SEC in June.

The firm, charged with violating fiduciary duty by charging clients for its own expenses on failed buyout deals, was the first mega-private equity firm to face the SEC’s probe into fee disclosures.