My ideas for this book had been milling around for several years, but there is nothing like having surgery during a pandemic to focus your mind. I was fortunate that Steven Gerrard at Agenda read the resulting outline and suggested that it could form the basis for an addition to Agenda's series on the Economics of Big Business – short, accessible introductions to the economics of major business sectors. I cannot thank him enough for giving me the chance to take this on. I am not an economist, so readers certainly do not need to be to gain an understanding of how the fund management industry functions and operates. The vast majority of literature relating to asset managers concerns how they invest, so there seems ample room to explore the array of other functions as well. There is even more room to explore asset management in Europe and the UK when so many books are focused on the United States, either intentionally or as a result of it being the world's largest market for mutual funds.

Writing this book has prompted me to reflect on what has changed, and what hasn’t, over the years since I entered the asset management industry in the late 1990s. This has made the process of writing particularly enjoyable as time for reflection of this kind is less easy when writing about what is new in the industry day-to-day as a journalist. Unusually, my earliest experience in asset management was analysing funds’ charges, which perhaps explains why I have found this part of the industry (how it makes money) just as interesting as its investment role (how it makes money for clients). I have been fortunate that over the intervening years I have been involved in researching and writing about funds’ performance, flows, regulations, distribution, as well as the impact of technology and the development of new products on fund businesses.

Working variously at a research firm, inside an asset manager and as a journalist has given me the chance to hear diverse perspectives on the industry, both from colleagues and from those at other firms across Europe, as well as in the United States and Asia. This has been made more interesting, and sometimes more lively, by often trying to explore issues that asset managers tend to prefer to be left unexplored.

High levels of profitability, rising markets that boost growth, and the prospect of increased demand as governments push individuals to take greater responsibility for their retirement savings, all point to the attractiveness of running an asset management business. And each of these is accentuated by the recurring revenues that mutual funds provide. So despite fund holding periods averaging just over three years, which might seem relatively short compared to changing home every 14 years, or changing car every 8 years, revenues are generated on fund assets every single day (IA 2021; Gibson 2021; SMMT 2021; Gillies 2017). And this holding period does not reflect that aggregate net inflows to mutual funds typically rise year-on-year, and certainly do so over any given three-year period. No wonder Bernie Cornfeld proclaimed, “If you want to make money, don't horse around with steel or light globes. Work directly with money.”

But the management of other people's money brings with it potential conflicts of interest that need to be managed when growing a business while staying aligned to the purpose of fund management. The main purpose of fund management is to grow clients’ wealth over the long term by prudently investing in companies and other assets. The main vehicle for doing this is the mutual fund, where clients’ assets are shared and the manager is obliged to act in their best interests. Inherent in this is a fiduciary duty that goes beyond managing the fund in the way set down in legal documents. While the exact nature of this duty remains contested in Europe, pressure is increasing from regulators for firms to justify their charges and demonstrate that consumers’ interests are at the centre of their businesses. Firms have so far largely resisted this pressure as it has the potential to threaten their profitability.

The shock of some in the funds industry to regulators’ efforts both to make firms put client interests first, and to define how far-reaching these interests might be, suggests that many asset managers struggle with groupthink in some areas of their business. In other words, they struggle to think beyond what is accepted industry practice (asking one of the highly paid mega consultancies to repackage existing thinking about how to succeed does not really count). Groupthink can even become a subconscious part of a company’s culture – “this is the way we do things”.

The United Nations (UN) opened the treaty entitled “International Convention for the Suppression of the Financing of Terrorism” for signature in 1999. Over a year later, on 10 September 2001, a grand total of four states had signed and ratified the treaty: Botswana, Sri Lanka, the United Kingdom and Uzbekistan. The events of 11 September 2001 and the response, individually and collectively, to the terrorist attacks on New York City and Washington, DC changed the need and utility for this particular UN Convention. Financial surveillance and the tracking of the economic activity of individuals and groups would be massively increased as a leading element of the new “war on terror”. Measures to combat the financing of terrorism (CFT) would be crafted and all countries would be expected to introduce them to their national legal systems.

This book seeks to provide you with an understanding of why there were so few ratifications of the UN Convention on terrorist financing in September 2001 as compared to September 2002. The Convention entered into force on 10 April 2002 following the 22nd ratification of it. Further, you will gain an understanding of the development and evolution of the global regime to combat terrorist finan¬cing in the first two decades of the twenty-first century. This chapter prepares you with several background concepts to establish a foundation for the material covered in the remaining chapters. The next section begins with a definition of terrorism as a political act, a necessary prerequisite for defining terrorist finance. But first there is a section developing the concept of money that is implied in the activity of terrorist financing. Following the definition of terrorist financing, drawn from the UN Convention, the chapter offers some background on the Financial Action Task Force (FATF), the international organization created to address money laundering by illegal drugs traffickers. It would be drafted into international efforts against terrorism in 2001, and attempt to apply its existing expertise developed to counter money laundering to terrorist financing. The final section of this chapter points towards the topics covered in each of the remaining chapters of the book.

The 11 September 2001 attack on the World Trade Center in New York City was not the first attempt to bring the skyscrapers crashing to the ground. On 26 February 1993, Ramzi Yousef drove a Ryder Econoline (rental) van loaded with explosives into the parking garage of the World Trade Center. The deton¬ation of over 1,000 pounds of fertilizer supplemented by hydrogen cylinders left a blast crater of 130 feet by 150 feet with damage to seven levels of the building, killing six people and injuring a further 1,042 people (United States Fire Administration 1993: 1). There is a brief description of attempts to identify and track down those responsible for the attack on the website of the US State Department Diplomatic Security Service. The emphasis of this online article is to highlight the role of the Diplomatic Security Service in the identification and apprehension of Ramzi Yousef, and it contains this interesting statement: “This event was the first indication for the Diplomatic Security Service (DSS) that terrorism was evolving from a regional phenomenon outside of the United States to a transnational phenomenon” (Bureau of Diplomatic Security 2019: n.p.). The statement, to some extent, may be self-reflective, given that the page is dated 21 February 2019. At the same time, however, it reinforces widely held perceptions of terrorism in the twentieth century as fundamentally a local problem.

The case of the first terrorist attack on the World Trade Center is often used to emphasize the importance of money in terrorist groups achieving their object¬ives (Raphaeli 2003: 60; Biersteker & Eckert 2008: 1). The driver of the van soon made his way to Pakistan, where he was later arrested with the assistance of the Diplomatic Security Service and extradited to the US to stand trial. Meanwhile, soon after the bombing, another member of the group returned to the van rental company hoping to get back the $400 deposit. In testimony before a US Senate subcommittee in 1999, the Director of the Federal Bureau of Investigation (FBI) stated that the attempt made to recover the deposit was because the group had very little funding. It was a mistake that led to the arrest of this terrorist along with other members of the group.

Fund managers sit at the heart of an asset management company, providing an investment service that is then wrapped in a product and sold to clients. It is these investment products that form the building blocks on which an asset manager builds its business. A firm's investment management team undertakes a range of activities, with security selection – the decision to invest in a particular stock or other asset – representing the culmination of contributions from other members of the team. Linked to this are the decisions to disinvest from investments, reflecting that investing is an ongoing process. An investment management team broadly covers three other areas: economic analysis, asset allocation, and company research. Increasingly, data analysis represents a fourth, distinct contribution to the process. As with many other functions, these roles may overlap or be divided up in different ways, which will be partly dictated by the size of the company.

Economic analysis provides a macro view of the economic and political backdrop for individual countries or sectors, together with views on how the dynamics shaping these markets might change in future. This includes a mix of short-term perspectives, such as the impact of a particular political election or Bank of England's decision on interest rates, and longer-term strategic changes, such as the ripple effects through the economy of more people working from home.

Asset allocation is the strategy or tactics relating to which types of securities to invest in and when, as well as ensuring the portfolio of investments is appropriately diversified and in line with the fund manager's approach to investing. Most funds will use asset allocation insights as one of the inputs to decide how a fund should be invested. However, some funds’ primary focus is on getting judgements about the correct asset allocation across a wide range of potential assets. For these funds, the rest of the investment process is focused on how best to implement the fund manager's views on asset allocation, rather than focusing on individual companies. For example, the manager might implement his or her views by investing in a range of exchange-traded funds that replicate the returns of particular countries’ stock markets.

Investment analysts carry out research into individual companies, drawing on external research as well as their own analysis of a company's profile, past growth and future prospects.

By now the purpose of fund management might seem to be clear. But this is sometimes confused with the role and function of fund managers (and their colleagues). The distinction is worth considering to better understand the nature of the industry, and as a means to identify potential challenges for firms and resulting flaws in the way they behave.

At a basic level, there is a clear difference between the function of each role at an asset management company and the purpose of the industry as a whole. When defining an asset management company's role, elements of the former – the various functions – are often highlighted, rather than the objectives of the latter that should influence all roles within a fund company. This may appear to be more of a technical clarification rather than a broader comment on the industry. However, the distinction is a useful way to check whether a fund company actually considers the industry's purpose and its place within it. Most firms are focused on the way their business functions and the roles within it, and often they only fleetingly or obliquely appear to have a conception of their purpose and to use that understanding to influence the way their business is run.

The purpose of fund management is to grow clients’ wealth over the long term. This purpose may have beneficial by-products, but the industry's existence cannot be justified by such by-products because of the primacy of the relationship between fund manager and client. It may well be that some clients invest to make a positive impact on aspects such as the environment (which will be discussed later in this chapter), but even asset managers that manage money in this way are still focused on long-term returns for their investors – the primary purpose of the business remains the same. At the same time, an asset management company may offer products, such as short-term investment strategies, or services, such as an online investment platform, that help the growth of its business by attracting clients, but these do not change the industry's raison d’être. I would contend that the same is true for smaller parts of the overall funds industry, such as hedge funds, which often argue that their purpose is to offer differentiated returns from their more conventional rivals.

Many investors and fund management companies are united in their desire to find a particularly elusive individual: the star fund manager. So elusive is their quarry that a sub-industry of researchers and analysts has developed over the years to support this quest. Investors that choose actively managed funds want to find an individual who can generate better returns than the market over prolonged periods of time, while asset managers understand this desire and want to attract the money that follows it by promoting their fund managers and key members of their investment teams. “We are a people business” and “it is our people that sets us apart” are popular refrains from fund companies.

The desire to find a star fund manager is understandable, both commercially (it makes money for fund companies and, if one is found, investors) and philosophically (if active managers are able to consistently outperform the market, then this must involve skill). It is worth pointing out that, at a basic level, over any given time period some fund managers outperform the market average (either the average returns offered by replicating an index or the average returns across a range of fund managers with a similar investment focus). This is not just a theoretical view, it is reality. Some stocks will rise more than others over a certain period, and so some fund managers investing in companies listed in the same stock market will perform better than the average. The difficulty for fund investors is identifying if, and when, a particular fund manager (via a fund) will outperform the average. Star managers are those that are deemed to have the skill to be able to outperform over prolonged periods of time, or who have built up a following of clients in the belief that the manager can do this.

Client following is a particular feature supporting the status of star fund managers because their performance alone does not make their star shine, but instead it is their ability – and that of the sales and marketing team supporting them – to translate this into inflows and therefore to build increased scale in a fund that boosts their reputation. Crucially, a fund's scale also builds greater influence with the companies in which a fund manager invests.

The discussion around the definition of terrorism in Chapter 1 emphasized that it is a form of political violence undertaken with the goal of changing a govern¬ment policy, or even to change the government itself. And until the late twen¬tieth century terrorism was generally viewed as a problem of domestic politics with few cross-border aspects. This view shifted with the recognition of growing transnational terrorism with cross-border aspects, including the money used to fund the terrorist group. In addition to the Convention on terrorist finan¬cing, the UN Security Council has published numerous Resolutions imposing financial sanctions and targeting the money behind specific terrorist groups. But a pivotal Security Council Resolution regarding terrorism and “the inherent right of individual or collective self-defence” was issued on 12 September 2001. The first paragraph of Resolution 1368 reads that the Security Council, “Unequivocally condemns in the strongest terms the horrifying terrorist attacks which took place on 11 September 2001 in New York, Washington, D.C. and Pennsylvania and regards such acts, like any act of international terrorism, as a threat to international peace and security”. It continues by expressing sympathy and condolences, calling on all states to seek out not only the perpetrators of these attacks but also to increase efforts to prevent future attacks. Further, it asserts the readiness of the Security Council to combat terrorism in all its forms under the UN Charter. Later that day the Secretary-General of the UN was asked by a reporter what his personal feelings were at the time. The response of Kofi Annan was:

Before looking at the UN Security Council measures to combat terrorist financing it is helpful to understand the primary tool employed by the Security Council. The next section provides a short review of the evolution of targeted sanctions imposed by the UN.

Each fund management company is divided broadly into three divisions: its investment management team, those involved in sales and marketing, and support functions including operations and administration. This does not mean that every firm will neatly divide up its business in this way, but the division provides a useful model by which to understand an asset manager’s organizational structure. In addition, various elements of this structure can be outsourced to external organizations (third parties). For example, many start-ups and smaller firms outsource operational and governance functions. This chapter provides an overview of these different functions and the roles within them, as well as areas where outsourcing is used.

Approximately 42,000 people are directly employed by asset managers in the UK (IA 2021). A breakdown of these figures shows that operational roles account for half of those employed in the industry, while investment roles account for roughly one quarter of the total (see Table 2.1). The figures provide a useful way to visualize the shape of an asset management business through its staff, despite the composition of larger firms inevitably impacting the overall figures and also bearing in mind that outsourced roles are not included.

The 2008 financial crisis hit employment at UK asset managers, with those directly employed falling from 25,500 in 2007 to 24,000 in 2009, according to surveys by the UK asset managers’ trade body, the Investment Association. Employment has risen each year since. The surveys also suggest that one of the most significant responses to the financial crisis was an increase in staff in compliance and oversight functions, which now stand at 8 per cent of the total, up from a low of 4 per cent in 2010, although the current level looks to be stable, having been reached five years ago. The rise in internal IT appointments continues, however, accounting for 11 per cent of the total five years ago and 14 per cent today (IA 2021).

The European Fund and Asset Management Association (EFAMA) uses the UK figures, together with equivalent information from France and Germany to extrapolate a European total of around 115,000 individuals directly employed by the asset management industry (EFAMA 2021). The European trade body then considers the indirect employment generated by the industry through related services, such as distribution and advice, auditing, custodianship, legal, marketing, research and technology, and estimates that together these firms help create 644,000 full-time jobs.

Among the enduring images of Islamic State's time controlling territory in Iraq and Syria are photographs and videos of the wanton destruction of the ancient ruins of Palmyra. From the perspective of its strict adherence to a Salafi-jihadist branch of Islam, these historic sites were idolatrous, justifying this massive act of iconoclasm. Other examples that were recorded and shared by the group included the destruction of items at the Mosul Cultural Museum, the Nineveh archaeological site and the Nimrud archaeological site (González Zarandona, Albarrán-Torres & Isakhan 2018). At the same time, this iconoclasm concealed a conscious material motivation to acquire portable relics and antiquities for sale on the black market, which provided a further source of income. The multi¬tude of income sources utilized by IS attracted the attention of the governments working to counter this new transnational terrorist threat. The UN Security Council directed the production of a report by the Analytical Support and Sanctions Monitoring Team specifically on IS in 2014. Subsequently, the FATF and a number of other organizations produced additional studies analysing IS finances and suggesting methods to prevent its fundraising as a way of defeating the group.

IS, also known as Islamic State of Iraq and Syria (ISIS) and Islamic State of Iraq and the Levant (ISIL), as well as by the Arabic acronym, Daesh, succeeded in controlling territory across Iraq and Syria for a period from 2014 to 2019 (Talley & Faucon 2020). As such, it offers a case study that is different from other twenty-first-century terrorist groups, with its capacity to exploit different sources of funding, including oil and taxation. Simultaneously, it provides a case study for assessing the effectiveness of the tools used to combat the financing of terrorism. The next section introduces IS, explaining its evolution out of a series of earlier jihadist groups in the region and the ways that it collected revenue before 2014. The second section explores the funding methods that controlling territory allowed IS, meaning they were able to gather revenue “like a state”. This is followed by a companion section covering the other methods used by an insurgent/terrorist group that also continued to be used by IS.

Our understanding of terrorist financing has changed over the past 70 years and that evolution of terrorist financing was presented across Chapters 1– 4. In addition, to place the parallel development of measures to combat the finan¬cing of terrorism in context, the introduction of money laundering as a crime was discussed, along with the establishment of the FATF. An international organization, the FATF was created to understand money laundering and it first produced guidance to help countries combat money laundering in 1990. In 2001 the organization's mandate was expanded to include terrorist finan¬cing, making the FATF the responsible organization for producing international guidance to combat terrorist financing as well. The historical development of both terrorist financing and the regime to counter it provided the background for understanding the contemporary issues impacting the CFT regime that were explored in Chapters 5– 7.

There are several key points to take away from this book regarding the measures used to combat the financing of terrorism. First, there was the initial focus placed on terrorist financing by the US government in 2001. As shown, their claim that terrorist financing is the “lifeblood” of terrorism was a justi¬fication for pre-emptive sanctions. The lifeblood image, however, is a flawed analogy. It implied that it would be possible to prevent future acts of terrorism by freezing assets, preventing fundraising and stopping the transfer of money. The diverse set of terrorist attacks in Europe between 2001 and 2021 demon¬strate that this is not the case. In those attacks the perpetrators variously used their own salaries and savings, took out small bank loans, engaged in petty crime and received contributions from foreign terrorist groups. The CFT measures operating in Europe did not provide advance warning of any of these attacks. Rather, the information gathered by these measures came into use only after the fact to trace the source of financing behind the attack. Following the attacks in Paris in November 2015, for example, the French government identified the use of anonymous prepaid cards by the terrorists and introduced a proposal to regulate them in the future.

To better understand how asset managers compete with one another, it is necessary to look at how firms sell funds and the development of new products. There are more than 4,580 fund management companies across Europe, although many of these manage tiny pools of money (EFAMA 2021a). This number fits with the industry narrative that there is intense competition and that a large number of firms are constantly vying with one another to show that their funds are better than others.

However, taking Europe as a whole, many of these firms will not compete against one another. This is either because any given international firm is not necessarily active in every European market, or because a firm is a part of a larger group (such as a bank or insurer) and primarily provide funds to be used internally rather than competing with independent asset managers for a client's business. Having said this, even when individual countries are singled out, the number of competitors is still large, with approximately 1,100 asset managers in the UK, 680 in France and 386 in Germany (EFAMA 2021a). In addition, there are 417 companies in Ireland and 268 in Luxembourg. And even if these latter two partly overlap with the lists for the three largest European fund markets, they still swell the numbers of competitors.

These numbers also show that barriers to entry for establishing an asset management business in Europe are low. Getting a business off the ground has been made easier over recent years as service providers have made better use of technology, giving small investment management firms the ability to outsource more of their operations. The robustness of these small operations relying on large third-party providers was proven over the recent past as asset managers were forced to work from home through the pandemic. The regulatory burden in Europe has clearly increased over the past ten years, but this has not stopped the launch of fund management businesses, even if it has added to the cost burden, albeit for larger firms in particular.

But establishing a firm is different from making it a successful business. The biggest challenge for a fund management company is to attract sufficient assets early on to keep the business going. Gaining seed investors is crucial for this process, not just for making the business viable, but also for attracting more clients.

Fund managers play an important role in free market economies around the world, controlling more than $100 trillion of financial assets globally, with the ability to invest that capital into companies and to influence the way in which they are managed. Most research and literature on asset management focuses on investing – how fund managers do it, who does it well, the ways in which it has changed, as well as advice on how others can invest too. This leaves a largely unfilled gap looking at the rest of an asset manager's business, ranging across sales, operations, governance, marketing, risk management, finance and compliance. It is these functions that are needed to turn a solo stock picker into a successful business. They are integral to making investment management commercially viable. And it was these aspects that moved from the periphery to centre stage when Neil Woodford, the UK's best-known fund manager, was forced to close Woodford Investment Management in 2019 amid an acrimonious split with the firm overseeing its operations. Around 300,000 investors are still trapped in Woodford's former flagship fund (Martin 2019).

This is not just a British story. Fund manager scandals have broken in recent years at Swiss asset manager GAM, French firm H2O Asset Management, and German Union Investment. Unlike Woodford, these asset managers are backed by large financial institutions. H2O was owned by Natixis Investment Managers (part of French banking group BPCE) and got into difficulties because of its relationship with controversial German financier Lars Windhorst, while GAM was caught up with disgraced Australian financier Lex Greensill. The chief executives of Natixis IM and GAM have both stepped down since these revelations broke.

Understanding how such problems can arise is part of how these businesses make money, the nature of their business models, the role of their compliance and oversight functions and how they incorporate investors’ interests. Each of these will be examined throughout this book. It will also look at fund managers’ increasing focus on sustainable investing – investing with the long-term good of wider society and the planet in mind, not just focusing on shorter-term financial interests. As the large sums of money that fund managers earn are more prominent in the popular imagination than what fund managers do, it is no small task for firms to demonstrate that they are focused on social and environmental issues.