Active Management Threatened By European Proposals

(January 26, 2012)  —  Proposed financial regulation in Europe could stymie active managers’ investment processes and hit investors’ returns, the UK’s largest trade association for fund managers has warned.

The Investment Management Association (IMA), whose members control €4.7 trillion in client assets, has asked the European Parliament to reconsider how inside information is defined under the Market Abuse Directive (MAD) and suggested an approach closer to that used in the UK.

Guy Sears, director of wholesale at the IMA, told a hearing arranged by the European Parliament’s Economic and Monetary Affairs Committee this week that the proposed legislation could prevent active managers carrying out much of their stock-picking practices.

Traditional, stock-picking fund managers that actively manage their portfolios claim to create outperformance by getting to know the companies they buy rather than just following an index. Although a debate on active versus passive management continues to rage, many believe only active management of securities can create true outperformance or alpha.

Sears at the IMA said: “The [current] wording in the [MAD] proposal on what is inside information could make it impossible for asset management companies to continue their active management practices, such as meeting with companies in which they invest to perform detailed interviews with senior management and with brokers who follow those companies.”

He said that under the Market Abuse Directive proposal made by the European Commission on 20 October 2011 any information made “available to a reasonable investor, who regularly deals on the market and in the financial instrument or a related spot commodity contract concerned”, would be considered as inside information.

Sears said: “They could never be sure that information disclosed to them during the course of these activities was not ‘relevant to an investor’, and if they traded following such meetings, they could be insider trading.”

Sears added that one way of resolving this discrepancy would be to use the UK’s relevant information not generally available (RINGA) test.

Under the RINGA test, inside information is regarded as that which is “likely to be regarded by a regular user of the market as a failure on the part of the person concerned to observe the standard of behaviour reasonably expected of a person in his position related to the market”.

This story initially appeared in aiCIO’s sister publication The Trade.