Geopolitics, global trends and the regulatory outlook for 2023

What can asset managers learn from a year fraught with geopolitics? And how can they be better prepared to respond to the challenges of 2023?

We started and ended 2022 in choppy waters due to a series of geopolitical and macroeconomic shocks, of which we are all too familiar. With this etched in our memory, asset managers have stepped cautiously into 2023. What are some of the geopolitical headwinds spilling over into 2023 and how can we use the EU regulatory agenda to prepare for the challenges that lie ahead?

Assets under management at the end of 2022

The asset management environment had a challenging 2022. According to ESMA¹, the euro area’s assets under management (AuM) experienced its greatest decline since the global financial crisis (GFC). EFAMA² has estimated that AuM for Europe dropped 11.8% during the first nine months of 2022, down from 2021’s EUR 32.2 trillion, while net assets of UCITS and AIFs fell 12.4% by the end of 2022³. Looking at the global situation, the 40 largest asset managers experienced a drop of almost one-quarter of their revenue from Q4 2021 to Q3 2022⁴, and the S&P500 was quoted as having lost just over 19% of its value, another low not seen since the GFC⁵. Amidst these lows, some characteristics remained unchanged in Europe: the majority of 2022’s asset management activity continued to be concentrated in six countries (the UK, France, Germany, Switzerland, the Netherlands and Italy), while investment fund activity market share was dominated by Luxembourg (27%) and Ireland (19%).

Geopolitical elements seeping into 2023

Weight of inflation

Economic activity has been weighed down by tightened monetary policy and inflation throughout 2022, and although inflation in the Eurozone seems to have peaked at 11.5%⁶ in October, it remains elevated and continues to be much higher than prevailing interest rates. Notably, the European Central Bank (ECB) raised the key interest rates in the Eurozone not once, but four times in 2022; the first increase in more than a decade⁷. Economic stagnation is still on the cards, as the ECB predicts annual GDP growth in the EU and EA in 2023 to be 0.8% and 0.9% respectively⁸, this compared to real GDP growth of +5.3% in 2021⁹. While a recession could cool inflation and cap interest rate hikes, this outcome may not be as likely as was believed a few months ago: the economic impact of persistent elevated inflation and high interest rates has been less severe than expected, and Europe appears set to avoid a contraction in 2023’s first quarter¹⁰.

Geopolitical conflict and continued sanctions

Dragging macroeconomic conditions have increased vulnerabilities for asset management. Should escalations occur related to the war in Ukraine, they have the possibility to lead to additional sanctions, broadening the impact on sectors, operations, products and services, and in so doing impacting the economies of sanctioning countries. This will continue to place strain on asset managers in terms of compliance, requiring a continuous assessment of investments and counterparties to determine whether they are subject to sanctions. Should secondary sanctions be imposed, compliance will be increasingly burdensome and the diversity of market access will be impacted¹¹.

Decoupling US/West-China

Aggravated by geopolitical tensions, efforts for the US to disengage from China (and vice versa) are ongoing. The result will likely be a steady decline in economic integration of the two countries. If further restrictions on and disincentives for economic connectivity are introduced by the US, we can anticipate knock-on effects for global financial institutions with cross-border interests, especially those in capital markets and payments networks. Western asset managers may need to revisit their investment strategies with China in this unfolding context. While decoupling is hot on the agenda for the US, the growing wealth generation and maturation of the Chinese market, combined with its fast-growing and sizeable bond market, make this emerging market a significant opportunity for international investors elsewhere in the world¹².

Multispeed ESG policies

The role of asset management in the green transition is becoming increasingly recognized. EY research shows that 54% of consumers will use ESG data for decision-making by 2027¹³. Yet, as companies push towards greater self-sufficiency, and look to reshore, onshore or friendshore elements of their supply chains in the wake of the war and energy crisis, companies may see short-term shifts in their emissions, thereby impacting current ESG strategies. Greenwashing in financial products will also continue to be scrutinized via the implementation of the Sustainable Finance Disclosure Regulation (SFDR), which kicked off this year on 1 January 2023. Application is, however, expected to be difficult. In a recent EY study¹⁴, 67% of firms highlighted data as the first or second challenge in building their sustainable investment frameworks, and only 45% of firms have cited their aim to disclose taxonomy alignment criteria by January 2023.

On the upside: global trends at play in 2023

While so many happenings are out of our control, asset managers can take decisive action on global trends to find opportunity amidst all the geopolitical disruptions. For one, fintech adoption is expected to continue to grow. Looking back at 2022, research has shown¹⁵ that Luxembourg has been ranked as the fourth best fintech ecosystem in Europe, displaying the highest number of fintech startups per capita in Europe in 2022. Those asset managers who recognize how their offerings can be enhanced via digital means, may find quick success in outsourcing or co-sourcing certain business elements to external vendors. Along similar lines to “digital”, Europe is quickly becoming a frontrunner for tokenization and decentralized finance. As a quick recap: “tokenization” allows for the creation of digital assets representing fiat currencies, financial products and instruments or property ownerships. In early 2022, the Luxembourg Stock Exchange announced that security tokens could officially be listed as securities, and two large players in the Grand Duchy – in real estate and financial services – have already taken advantage.

Private equity – with an abundance of dry powder – had its second-highest year for private equity activity since 2007 with USD 730 billion¹⁶ announced in transactions values. Transaction activity (generally speaking – not limited to private equity) is expected to grow in the next five years. Executives are cited as predicting that almost 30% of revenues will be generated by new products, services and businesses by 2027¹⁷. While some growth will be organic, the rest will be attributed to M&A when the timing is right. Also on the alternatives front, the review of the ELTIF Regulation, adopted in February 2023, promises to refuel interest of asset managers who seek to respond to investors’ growing appetite for alternative strategies and alternative asset classes.

When it comes to ESG, opportunities – and incentives – abound. We know that asset managers are in a position to fast-track the ESG agenda, by investing capital directly, and in a focused manner towards specific ESG goals. C-suite leaders are also becoming more prepared to pay a premium for companies with a positive ESG record, which is positive news for the almost 75% of private equity firms today, which expect to capture an ESG premium for businesses they are exiting, according to EY research¹⁸.

Diarize these important regulatory developments for 2023 and beyond

Knowing the regulatory landscape is a useful guide for being future ready. The regulatory agenda encompasses the global trends at work; being proactive in terms of compliance will set market leaders apart.

The main regulatory reforms expected for 2023 set to substantially impact asset managers are the AIFMD and ELTIF review. With the finalized text already approved by the European Parliament, the ELTIF review is expected to be published at the end of April and will apply nine months thereafter. Among the proposed changes, it is worth mentioning: the revision of the rules on portfolio composition which intends to enhance the attractiveness of the regime for promoters, the further flexibility granted to ELTIFs solely marketed to professional investors, and the possibility for the retail regime to offer a tailor-made product for alternatives, safeguarding key protection features and allowing for semi open-ended structures¹⁹. Still in the earlier stages, the trialogues for the AIFMD Review began in March 2023. This Review will, among others, introduce a loan origination regime and extend the list of ancillary services. The application of the new AIFMD is expected for Q4 2025.

To view the regulatory outlook for wealth and asset management in Luxembourg and Europe for 2023, as of 28 February 2023, please download our Market Pulse PDF publication.