UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 20162019
or
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to
Commission file number 1-14818
FEDERATED INVESTORS,HERMES, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania | 25-1111467 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 1001 Liberty Avenue | 15222-3779 | |||
| Pittsburgh, | Pennsylvania | |||
(Address of principal executive offices) | ( Zip Code) | |||
412-288-1900
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Trading Symbol(s) | ||
| Class B common stock, no par value | FHI | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yesx☒ No o☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o☐Nox☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx ☒No o☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesx☒ No o☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or emerging growth company. See the definitions of "large accelerated filer," "accelerated filer"filer," "smaller reporting company," and "smaller reporting"emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | x | Accelerated filer | ||||||
Non-accelerated filer | ☐ | Smaller reporting company | ||||||
| Emerging growth company | ☐ | |||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o☐ No x☒
The aggregate market value of the Class B Common Stock held by non-affiliates of the registrant as of June 30, 20162019 was approximately $2.7$3.1 billion,, based on the last reported sales price of $28.78 as reported by the New York Stock Exchange as of such date.closing price. For purposes of this calculation, the registrant has deemed all of its executive officers and directors to be affiliates, but has made no determination as to whether any other persons are affiliates within the meaning of Rule 12b-2 under the Securities Exchange Act of 1934. The number of shares of Class A and Class B Common Stock outstanding on February 16, 2017,14, 2020, was 9,000 and 101,697,183,101,117,928, respectively.
Documents incorporated by reference:
Part III of this Form 10-K incorporates by reference certain information from the registrant's 20172020 Information Statement.
Table of Contents
| Page | ||
| Part I | ||
| Item 1 | ||
| Item 1A | ||
| Item 1B | ||
| Item 2 | ||
| Item 3 | ||
| Item 4 | ||
| Part II | ||
| Item 5 | ||
| Item 6 | ||
| Item 7 | ||
| Item 7A | ||
| Item 8 | ||
| Item 9 | ||
| Item 9A | ||
| Item 9B | ||
| Part III | ||
| Item 10 | ||
| Item 11 | ||
| Item 12 | ||
| Item 13 | ||
| Item 14 | ||
| Part IV | ||
| Item 15 | ||
FORWARD-LOOKING STATEMENTS
Certain statements in this report on Form 10-K constitute forward-looking statements, which involve known and unknown risks, uncertainties, and other factors that may cause the actual results, levels of activity, performance or achievements of Federated Investors,Hermes, Inc. and its consolidated subsidiaries, (Federated)including Hermes Fund Managers Limited (Hermes) (collectively, Federated), or industry results, to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements are typically identified by words or phrases such as "trend," "potential," "opportunity," "believe," "expect," "anticipate," "current," "intention," "estimate," "position," "projection," "assume," "continue," "remain," "maintain," "sustain," "seek," "achieve," and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may" and similar expressions. Among other forward-looking statements, such statements include certain statements relating to:to, or, as applicable, statements concerning management's assessments, beliefs, expectations, assumptions, judgments, projections or estimates regarding: asset flows, levels and mix; business mix; sources and levels of revenues, expenses, gains, losses, income and earnings; levels of sales staff, competitors and competing products and strategies; obligations to make additional contingent or other payments pursuant to employment agreements; business opportunities; future cash needs and cash flows; uses of treasury stock, legal proceedings; the timing and impact of continuing regulatory oversight, and increased or modified laws, regulations and rules, including potential, proposed and final rules, or possible deregulation, by U.S. and foreign regulators and other authorities; the components and level of, and prospect for distribution-related expenses; classification and consolidation of investments; the ability to raise additional capital; auditor independence requirements; management's assessments, beliefs, expectations, assumptions, projections or estimates, including regarding fee rates, the level, degree, continuance, recovery and impact of fee waivers and reimbursements or assumptions of expenses (fee waivers), the effect, and degree of impact, of changes in customer relationships, the level, timing, degree and impact of changes in interest rates, yields or asset levels or mix,mix; fee rates and sources and levels of revenues, expenses, gains, losses, income and earnings; the level and impact of reimbursements, rebates or assumptions of fund-related expenses (Consideration Payable to Customers) and fee waivers (collectively, Fee Waivers); when revenue is recognized; whether performance fees or carried interest will be earned; the components and level of, and prospect for, distribution-related expenses; guarantee and indemnification obligations; the timing of, and direct or contingent payment obligations and costs relating to acquisitions; payment obligations pursuant to employment or incentive arrangements; business and market expansion opportunities, including, anticipated, or acceleration of, growth outside of the United States (U.S.); interest and principal payments or expenses; taxes, tax rates, deferred tax assets and the impact of tax law changes; borrowing, debt, future cash needs and principal uses of cash, cash flows and liquidity; the ability to raise additional capital; type, classification and consolidation of investments; uses of treasury stock; Federated, product and market performance and Federated's performance indicators; investor preferences; product and strategy demand, distribution, development and restructuring initiatives and related planning and timing; the effect, and degree of impact, of changes in customer relationships; legal proceedings,proceedings; the pace, timing, impact, effects and other consequences of continuing regulatory oversight,Brexit, as well as potential, proposed and final laws, regulations and other rules, continuing regulatory oversight by U.S. and possible deregulation, borrowing, taxes, productforeign regulators and strategy demand, investor preferences, performance, product developmentother authorities; dedication of resources; the adoption and restructuring optionsimpact of accounting policies, new accounting pronouncements and initiatives, including the plans for and timing of such options and initiatives,accounting treatment determinations; compliance, and related legal, compliance and other professional services expenses, interest payments or expenses, dedication of resources, accounting policies, indebtedness and certain investments, and liquidity; future principal uses of cash; performance indicators; the adoption and impact of accounting policies and new accounting pronouncements;expenses; interest rate, concentration, market, price, foreign exchangecurrency and other risks; guaranteeauditor independence matters; and indemnification obligations; and various other items set forth under Item 1A - Risk Factors. Among other risks and uncertainties, market conditions may change significantly resulting in changes toand impact Federated's business and results, including by changing Federated's asset flows, asset levels, assetand mix, and business mix, which may cause a decline in revenues and net income, result in impairments and increase the amount of fee waiversFee Waivers incurred by Federated. The obligation to make purchase price payments in connection with acquisitions is subject to certain adjustments and conditions, and the obligation to make contingent payments is based on net revenue levels and will be affected by the achievement of such levels. The obligation to make additional payments pursuant to employment or incentive arrangements is based on satisfaction of certain conditions set forth in those arrangements. Future cash needs, cash flows and future uses of cash will be impacted by a variety of factors, including the number and size of any acquisitions, Federated's success in developing, structuring and distributing its products and strategies, potential changes in assets under management and/or changes in the terms of distribution and shareholder services contracts with intermediaries who offer Federated's products to customers, and potential increased legal, compliance and other professional services expenses stemming from additional or modified regulation or the dedication of such resources to other initiatives. Federated's risks and uncertainties also include liquidity and credit risks in Federated's money market funds and revenue risk, which will be affected by yield levels in money market fund products, changes in fair values of assets under management, investor preferences and confidence, and the ability of Federated to collect fees in connection with the management of such products. Many of these factors may be more likely to occur as a result of continued scrutiny of the mutual fund industry by domestic or foreign regulators, and any disruption in global financial markets. As a result, no assurance can be given as to future results, levels of activity, performance or achievements, and neither Federated nor any other person assumes responsibility for the accuracy and completeness of such statements in the future. For more information on these items and additional risks that may impact the forward-looking statements, see Item 1A - Risk Factors.Factors.
3
Part I
ITEM 1 – BUSINESS
General
Federated Investors,Hermes, Inc., a Pennsylvania corporation, together with its consolidated subsidiaries, including Hermes Fund Managers Limited (Hermes) beginning July 1, 2018 (collectively, Federated), was formerly known as Federated Investors, Inc. Effective January 31, 2020, Federated Investors, Inc.'s name was changed to Federated Hermes, Inc.
Federated is a leading provider of investment management products and related financial services. Federated has been in the investment management business since 1955 and is one of the largest investment managers in the United States (U.S.) with $365.9$575.9 billion in assets under management (AUM or managed assets) at December 31, 2016.2019.
Federated operates in one operating segment, the investment management business. Federated sponsors, markets and provides investment-related services to various investment products, including mutualsponsored investment companies and other funds (Federated Funds) and Separate Accounts (which include separately managed accounts (SMAs), institutional accounts, sub-advised funds and other managed products) in both domestic and international markets.markets, as well as provides stewardship services to various companies. Federated's principal source of revenue is investment advisory fee income earned by various domestic and/or foreign subsidiaries of Federated pursuant to investment advisory contracts withand based primarily upon the AUM of the investment products. Theseproducts and strategies. Domestic advisory subsidiaries are registered as investment advisors under the Investment Advisers Act of 1940 (Advisers Act). Federated also has investment advisor, while foreign advisory subsidiaries which earn advisory fee income based primarily upon the AUM of investment products, that are located outside ofregistered in the U.S. and are registeredand/or with foreign regulators.
Federated providedprovides investment advisory services to 124 sponsored investment companies and other funds (Federated Funds)135 Federated Funds as of December 31, 2016.2019. Federated markets these funds to institutional customers and banks, broker/dealers and other financial intermediaries who use them to meet the needs of customers and/or clients (collectively, customers), including retail investors, corporations and retirement plans. The Federated Funds are domiciled in the U.S., with the exception of Federated International Funds Plc and Federated Unit Trust, both of which are domiciled inas well as Ireland, the Federated Cash Management Funds, which are domiciled in the United Kingdom the Federated Short-Term Daily U.S. Dollar Fund, Ltd.(UK), which is domiciled inLuxembourg, the Cayman Islands and the Federated Strategic Value U.S. Equity Dividend Fund, which is domiciled in Canada. Most of Federated's U.S.-domiciled funds are registered under the Investment Company Act of 1940 (1940 Act) and under other applicable federal laws. Each U.S.-domiciled registered fund enters into an advisory agreement that is subject to annual approval by the fund's board of directors or trustees, a majority of whom are not interested persons, of the funds or Federated as defined under the 1940 Act.Act, of either the funds or Federated. In general, material amendments to such advisory agreements must be approved by the funds' shareholders. These advisory agreements are generally terminable upon 60 daysdays' notice to the investment advisor. See Potential Adverse Effects of Termination or Failure to Renew Advisory Agreements in Item 1A - Risk Factors for additional information on Federated's advisory agreements.
Of the 124135 Federated Funds as of December 31, 2016,2019, Federated's investment advisory subsidiaries managed 3827 money market funds totaling $206.4$286.6 billion in AUM, 4849 fixed-income funds with $39.5$44.2 billion in AUM, 43 equity funds with $48.1 billion in AUM, 11 alternative/private markets funds with $11.4 billion in AUM and 38 equityfive multi-asset funds with $36.2$4.0 billion in AUM.
As of December 31, 2016,2019, Federated provided investment advisory services to $83.8$181.5 billion in Separate Account assets. These Separate Accounts represent assets of government entities, high-net-worth individuals, pension and other employee benefit plans, corporations, trusts, foundations, endowments, sub-advised mutual funds and other accounts or products owned or sponsored by third parties. Fees for Separate Accounts are typically based on AUM pursuant to investment advisory agreements that may be terminated at any time.are generally terminable upon notice to Federated (or, in certain cases, after a 30 day, 60 day or similar notice period).
Certain Federated Funds have adopted distribution plans that, subject to applicable law, provide for payment to Federated for distribution expenses, including sales commissions paid to broker/dealers.services. These distribution plans are implemented through a distribution agreementagreements between Federated and each respective fund.the Federated Funds. Although the specific terms of each such agreement vary, the basic terms of the agreements are similar. Pursuant to these agreements, Federated acts as underwriter for the funds and distributes shares of the funds primarily through unaffiliated dealers. Each distribution plan and agreement is initially approved by the directors or trustees of the respective fund and is reviewed for approval by such directors or trustees annually as required under applicable law.
Federated also provides a broad range of services to support the operation and administration of the Federated Funds. These services, for which Federated receives fees pursuant to agreements with the Federated Funds, include administrative services and shareholder servicing.
On July 2, 2018, Federated completed, effective as of July 1, 2018, the acquisition of a controlling interest in Hermes (Hermes Acquisition). As a result of the Hermes Acquisition, Federated provides stewardship services and environmental, social and governance (ESG) integrated investment strategies. Through the stewardship services, Federated offers customers a range of solutions for engagement, advocacy, active ownership and impact and delivers effective engagement with the companies in which they invest. Federated integrates ESG factors into, or considers ESG factors in connection with, certain of its investment strategies and processes to seek long-term performance for its customers and clients.
Assets Under Management
Total AUM are composed of Federated Funds and Separate Accounts and represent the balance of AUM at a point in time. Total managed assets for the past two years were as follows:
| As of December 31, | 2016 vs. 2015 | ||||||||||
| dollars in millions | 2016 | 2015 | |||||||||
| Money market | $ | 252,213 | $ | 256,437 | (2 | )% | |||||
| Equity | 62,381 | 53,556 | 16 | ||||||||
| Fixed-income | 51,314 | 51,119 | 0 | ||||||||
| Total managed assets | $ | 365,908 | $ | 361,112 | 1 | % | |||||
| As of December 31, | 2019 vs. 2018 | ||||||||||
| dollars in millions | 2019 | 2018 | |||||||||
| Equity | $ | 89,011 | $ | 72,497 | 23 | % | |||||
| Fixed-Income | 69,023 | 63,158 | 9 | ||||||||
Alternative / Private Markets1 | 18,102 | 18,318 | (1 | ) | |||||||
| Multi-Asset | 4,199 | 4,093 | 3 | ||||||||
| Total Long-Term Assets | 180,335 | 158,066 | 14 | ||||||||
| Money Market | 395,539 | 301,794 | 31 | ||||||||
| Total Managed Assets | $ | 575,874 | $ | 459,860 | 25 | % | |||||
| 1 | Alternative/Private Markets at December 31, 2019 and 2018 includes $8.2 billion and $8.3 billion, respectively, of fund assets managed by a non-consolidated entity, Hermes GPE LLP, in which Hermes holds an equity method investment. |
Average managed assets represent the average balance of AUM during a period of time and, for 2014, includes a liquidation portfolio that completely liquidated in the fourth quarter of 2014.time. Because substantially all revenue and certain components of distribution expense are generally calculated daily based on AUM, changes in average managed assets are typically a key indicator of changes in revenue earned and asset-based expenses incurred during the same period. Average managed assets for the past three years were as follows:
| Year ended December 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||
| dollars in millions | 2016 | 2015 | 2014 | |||||||||||||||
| Money market | $ | 252,346 | $ | 246,539 | $ | 254,260 | 2 | % | (3 | )% | ||||||||
| Equity | 59,431 | 54,149 | 48,317 | 10 | 12 | |||||||||||||
| Fixed-income | 51,161 | 52,805 | 51,333 | (3 | ) | 3 | ||||||||||||
| Liquidation portfolio | 0 | 0 | 4,557 | NA | (100 | ) | ||||||||||||
| Total average managed assets | $ | 362,938 | $ | 353,493 | $ | 358,467 | 3 | % | (1 | )% | ||||||||
| Year Ended December 31, | 2019 vs. 2018 | 2018 vs. 2017 | ||||||||||||||||
| dollars in millions | 2019 | 2018 | 2017 | |||||||||||||||
| Equity | $ | 81,212 | $ | 70,680 | $ | 60,255 | 15 | % | 17 | % | ||||||||
| Fixed-Income | 65,375 | 63,454 | 55,204 | 3 | 15 | |||||||||||||
Alternative / Private Markets1 | 17,896 | 9,397 | 441 | 90 | NM | |||||||||||||
| Multi-Asset | 4,192 | 4,764 | 5,062 | (12 | ) | (6 | ) | |||||||||||
| Total Long-Term Assets | 168,675 | 148,295 | 120,962 | 14 | 23 | |||||||||||||
| Money Market | 340,505 | 267,093 | 245,459 | 27 | 9 | |||||||||||||
| Total Average Managed Assets | $ | 509,180 | $ | 415,388 | $ | 366,421 | 23 | % | 13 | % | ||||||||
| 1 | Alternative/Private Markets for the year ended December 31, 2019 and 2018 includes $8.2 billion and $4.1 billion, respectively, of average fund assets managed by a non-consolidated entity, Hermes GPE LLP, in which Hermes holds an equity method investment. |
Changes in Federated's average asset mix year-over-year across both asset classes and product/strategy types have a direct impact on Federated's operating income. Asset mix impacts Federated's total revenue due to the difference in the fee rates earned on each asset class and product/strategy type per invested dollar. Generally, management-fee rates charged for advisory services provided to equity and multi-asset products and strategies are higher than management-fee rates charged to fixed incomefixed-income and alternative/private markets products and strategies, which in turn are higher than management-fee rates charged to money market products and strategies. Likewise, fundsFederated Funds typically have a higher management-fee rate than Separate Accounts. Additionally, certain components of distribution expense can vary depending upon the asset class, distribution channel and/or the size or structure of the customer relationship. Federated generally pays out a larger portion of the revenue earned from managed assets in money market and multi-asset funds than the revenue earned from managed assets in equity, or fixed-income and alternative/private markets funds.
Revenue
Federated's revenues from investment advisory, administrative and other service fees provided under agreements with the Federated Funds, Separate Accounts and other entities over the last three years were as follows:
| Year ended December 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||
| dollars in thousands | 2016 | 2015 | 2014 | |||||||||||||||
| Investment advisory fees, net | $ | 766,825 | $ | 626,325 | $ | 557,318 | 22 | % | 12 | % | ||||||||
| Administrative service fees, net | 211,646 | 211,458 | 213,136 | 0 | (1 | ) | ||||||||||||
| Other service fees, net | 161,378 | 84,910 | 84,039 | 90 | 1 | |||||||||||||
| Other, net | 3,522 | 3,916 | 4,757 | (10 | ) | (18 | ) | |||||||||||
| Total revenue | $ | 1,143,371 | $ | 926,609 | $ | 859,250 | 23 | % | 8 | % | ||||||||
| Year ended December 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||
| dollars in thousands | 2016 | 2015 | 2014 | |||||||||||||||
| Domestic | $ | 1,116,136 | $ | 907,841 | $ | 841,429 | 23 | % | 8 | % | ||||||||
| Foreign | 27,235 | 18,768 | 17,821 | 45 | 5 | |||||||||||||
| Total revenue | $ | 1,143,371 | $ | 926,609 | $ | 859,250 | 23 | % | 8 | % | ||||||||
| Year Ended December 31, | 2019 vs. 2018 | 2018 vs. 2017 | ||||||||||||||||
| dollars in thousands | 2019 | 2018 | 2017 | |||||||||||||||
| Investment Advisory Fees, net | $ | 907,605 | $ | 773,418 | $ | 731,670 | 17 | % | 6 | % | ||||||||
| Administrative Service Fees, net | 245,887 | 199,269 | 188,814 | 23 | 6 | |||||||||||||
| Other Service Fees, net | 173,402 | 162,990 | 182,440 | 6 | (11 | ) | ||||||||||||
| Total Revenue | $ | 1,326,894 | $ | 1,135,677 | $ | 1,102,924 | 17 | % | 3 | % | ||||||||
Federated offers a wide range of products and strategies, including money market, equity, fixed-income, alternative/private markets and fixed-incomemulti-asset investments. Federated's mix includesofferings include products and strategies that Federated expects to be in demand under a variety of economic and market conditions. Federated has structured its investment process to meet the requirements of fiduciaries and others who use Federated's suitable products and strategies to meet the needs of their customers. Fiduciaries typically have stringent demands regarding portfolio composition, risk and investment performance.
Federated, which began selling money market fund products to institutions in 1974, is one of the largest U.S. managers of money market assets, with $252.2$395.5 billion in such AUM at December 31, 2016.2019. Federated has developed expertise in managing cash for institutions, which typically have strict requirements for regulatory compliance, relative safety, liquidity and competitive yields. Federated began selling money market fund products to institutions in 1974. Federated also manages retail money market products that are typically distributed through broker/dealers. At December 31, 2016,2019, Federated managed money market assets in the following asset classes:across a wide range of categories: government ($190.3257.3 billion); prime ($46.8 billion); non-U.S. domiciled ($9.3126.8 billion); and tax-free ($5.811.4 billion).
Federated's equity assets totaled $62.4$89.0 billion at December 31, 20162019 and are managed across a wide range of stylescategories including: value and income ($40.334.7 billion); international/global ($31.4 billion); growth ($9.6 billion); international/global ($4.5 billion); blend ($2.717.8 billion); and alternativeblend ($0.55.1 billion). Federated also manages assets in balanced and asset allocation funds ($4.8 billion) which may also invest in fixed-income securities.
Federated's fixed-income assets totaled $51.3$69.0 billion at December 31, 20162019 and are managed inacross a wide range of categories including: multisector ($22.840.2 billion); high-yield ($10.212.4 billion); municipal ($5.85.6 billion); U.S. corporate ($5.05.1 billion); U.S. government ($4.63.3 billion); mortgage-backedinternational/global ($1.51.6 billion); and international/globalmortgage-backed ($1.40.8 billion).
Federated's alternative/private markets and multi-asset investments totaled $18.1 billion and $4.2 billion, respectively, at December 31, 2019. Federated's alternative/private markets assets are managed across a wide range of categories including: real estate ($8.1 billion); infrastructure ($4.3 billion); private equity ($3.9 billion); and other alternative ($1.8 billion).
Investment products are generally managed by a team of portfolio managers supported by fundamental and quantitative research analysts. Federated's proprietary, independent investment research process is centered on the integration of several
disciplines including: fundamental research and credit analysis; ESG integrated investment strategies; quantitative research models; style-consistent and disciplined portfolio construction and management; performance attribution; and trading.
See Note (5) to the Consolidated Financial Statements for information on revenue concentration risk.
Distribution Channels and Product Markets
Federated's distribution strategy is to provide investment management products and strategies geared toward financial intermediaries, primarily banks, broker/dealers and investment advisors and directly to institutions such as corporations and government entities. Federated provides comprehensive investment managementservices to more than 8,50011,000 institutions and intermediaries, including corporations,banks, broker/dealers, registered investment advisors, government entities, corporations, insurance companies, foundations endowments, banks and broker/dealers.endowments. Federated uses its trained sales force of over 200more than 225 representatives and managers backed by an experienced support staff to offer its products and strategies, add new customer relationships and strengthen and expand existing relationships.
Federated's investment products and strategies are distributed in fourthree markets. These markets and the relative percentage of managed assets at December 31, 20162019 attributable to such markets are as follows: wealth management and trust (40%U.S. financial intermediary (65%); broker/dealer (34%);U.S. institutional (22%(23%); and international (4%(12%).
U.S. Institutional. Federated maintains a dedicated sales staff to focus on the distribution ofoffers its products and strategies to a wide variety of domestic institutional customers including government entities, not-for-profit entities, corporations, corporate and public pension funds, government entities, foundations, endowments hospitals, and non-Federated investment companies.companies or other funds. As of December 31, 2016,2019, managed assets in the U.S. institutional market included $61.9$99.1 billion in money market assets, $15.2$27.7 billion in fixed-income assets, and $4.6$3.7 billion in equity assets, $1.0 billion in multi-asset and $0.2 billion in alternative/private markets assets.
International. Federated manages assets from institutional and financial intermediary customers outside the U.S. through subsidiaries focused on gathering assets in Europe, the Middle East, Canada, Latin America and the Middle East.Asia Pacific region. The 2018 Hermes Acquisition expanded the distribution footprint of Federated outside of the U.S. As of December 31, 2016, 2019,
managed assets in the international market included $8.9$30.2 billion in equity assets, $17.8 billion in alternative/private markets assets, $13.6 billion in money market assets $3.1and $5.9 billion in fixed-income assetsassets.
Competition
As of December 31, 2019, Federated had $394.3 billion of Federated Fund AUM and $2.4$181.5 billion in equity assets.
The investment management business is highly competitive across all types of investment products and strategies, including mutual funds, separately managed accounts (SMAs)exchange traded funds (ETFs), SMAs, institutional accounts, sub-advised funds and other managed products.products and strategies. Competition is particularly intense among mutual fund and ETF providers. According to the Investment Company Institute, at the end of 2016,2019, there were approximately 8,100over 7,900 open-end mutual funds and nearly 2,100 ETFs of varying sizes and investment objectives whose shares are currently being offered to the public both on a sales-load and no-sales-load basis.
In addition to competition from other mutual fund managers, ETF providers and investment advisors, Federated and the mutual fund industry competecompetes with investment alternatives offered by insurance companies, commercial banks, broker/dealers, deposit brokers, other financial institutions hedge funds and exchange tradedhedge funds.
Competition for sales of investment products and strategies is influenced by various factors, including investment performance, attainment of stated objectives, yields and total returns, fees and expenses, advertising and sales promotional efforts, investor confidence and preference, relationships with intermediaries and type and quality of services.
Regulatory Matters
Federated and its investment management business are subject to extensive regulation both in and outside the U.S. and abroad. Federated and its products, such as the Federated Funds, and strategies are subject toto: federal securities laws, principally the Securities Act of 1933 (1933 Act), the Securities Exchange Act of 1934 (1934 Act), the 1940 Act and the Advisers Act,Act; state laws regarding securities fraud and registration, andregistration; regulations or other rules promulgated by various regulatory authorities, self-regulatory organizations or exchanges, as well asexchanges; and foreign laws, regulations or other rules promulgated by foreign regulatory or other authorities. See Item 1A - Risk Factors under the caption Potential Adverse Effects of Changes in Laws, Regulations and Other Rules on Federated's Investment Management Business for additional information.
Current Regulatory Environment - Domestic
While new regulations until March 21, 2017. On January 30, 2017, President Trump signed an Executive Order on reducing regulation and controlling regulatory costs, which, among other directives, (1) directs executive departments or agencies to identify at least two existing regulationscontinue to be repealed any time a new regulation is proposed or promulgated, (2) directs, with limited exceptions, the total incremental costs of all new (including repealed) regulations in 2017efforts also continue to be no greater than zero unless otherwise required by law, and (3) directs that any new incremental costs associated with new regulations be offset by the elimination of existing costs associated with at least two prior regulations. On February 3, 2017, President Trump signed an Executive Order on core principles of regulating the United States financial system, which, among other core principles, includes a policy to make regulations efficient, effective and appropriately tailored. On February 3, 2017, President Trump also issued a memorandum on the DOL's Final Fiduciary Rule directing the DOL to examine the Final Fiduciary Rule to determine whether it has or is likely to harm or adversely affect investors and, if the DOL determines that the Final Fiduciary Rule does result in harm to or adversely effects investors, to propose a rule rescinding or revising it. Specifically, the memorandum directed the DOL, as part of its examination of the Final Fiduciary Rule, to prepare an updated economic and legal analysis concerning the likely impact of the Final Fiduciary Rule, which must consider, among other things: (1) whether the anticipated applicability of the Final Fiduciary Rule has harmed or is likely to harm investors due to a reduction of Americans' access toeliminate certain retirement savings offerings, retirement product structures, retirement savings information or related financial advice; (2) whether the anticipated applicability of the Final Fiduciary Rule has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and (3) whether the Final Fiduciary Rule is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay to gain access to retirement services. That same day, acting U.S. Secretary of Labor Ed Hugler issued a statement indicating that the DOL "will now consider its legal options to delay the applicability date as we comply with the President's memorandum." On February 10, 2017, it was reported that the DOL filed with the Office of Management and Budget to seek to delay the April 10, 2017 effective date of the Final Fiduciary Rule for 180 days pursuant to a comment period as short as 15 days, and to seek to start another round of public comment on the Final Fiduciary Rule.
The current regulatory moratoriumenvironment has affected, and possibility for deregulation, additional regulation and oversight of the
In the fourth quarter of 2019, the SEC proposed or adopted new rules that impact U.S. investment management industry participants, including Federated. For example:
On December 30, 2019, the SEC proposed amendments to Rule 2-01 of Regulation S-X seeking to codify certain staff consultations and modernize certain aspects of its auditor independence framework. The amendments would limit the
scope of potential independence-impairing relationships that arise among funds in a mutual fund complex, shorten the look-back period for domestic first time filers in assessing compliance with the independence requirements, expand the number of de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships, further develop the concept of beneficial ownership, and introduce a transition framework to address inadvertent independence violations that only arise as a result of merger and acquisition transactions. Prior amendments to the auditor independence rules, which became effective on October 3, 2019, focused the analysis on beneficial ownership rather than on both record and beneficial ownership; replaced the ten percent bright-line shareholder ownership test with a significant influence test; added a known through reasonable inquiry standard with respect to identifying beneficial owners of the audit client's equity securities; and excluded from the definition of audit client, for a fund under audit, any other funds that otherwise would be considered affiliates of the audit client under the rules for certain lending relationships. The public comment period on the proposed amendments ends on March 16, 2020. Federated is assessing the most recent amendments to determine the extent to which they mitigate risk that Federated's or the Federated Funds' auditors will inadvertently implicate the auditor independence rules.
| On December 23, 2019, the SEC's newly adopted rule 6c-11 under the 1940 Act (Rule 6c-11) became effective, providing certain exemptions from the 1940 Act and specifically (1) permit ETFs that satisfy certain conditions to operate without the expense and delay of obtaining an exemptive order; (2) impose certain enhanced disclosure requirements regarding ETF trading costs; and (3) amend Form N-1A to provide more useful, ETF-specific information to investors who purchase ETF shares on an exchange (and amend Form N-8B-2 to provide the same information to investors in ETFs organized as Unit Investment Trusts). The Form amendments will have a transition period of one year following the effective date. Additionally, the SEC rescinded exemptive relief previously granted to ETFs as the ETFs will now be able to operate under Rule 6c-11. |
On November 25, 2019, the SEC re-proposed Rule 18f-4 under the 1940 Act (the "Derivatives Rule"), which regulates the use of derivatives by mutual funds, closed end funds, ETFs, and other investment companies. Among other requirements, the Derivatives Rule imposes a requirement for funds to adopt and implement a derivatives risk management program that meets certain criteria (including stress testing and back-testing) with board oversight and reporting by a dedicated administrator appointed by the board. The re-proposed Derivatives Rule also caps a fund's leverage at 150% based upon the value-at-risk (VaR) relative to a designated reference index. The VaR approach generally provides more flexibility and is an indication of a fund's risk attributable to using derivatives. There is an exception for funds that use derivatives only for limited purposes, such as if the fund's derivatives exposure is limited to 10% of fund net assets, or if the fund uses derivatives only for currency hedging purposes. The SEC has also proposed amendments to investment company reporting requirements to enhance the SEC's ability to oversee funds' use of, and compliance with, the Derivatives Rule, and for the SEC and the public to have greater insight into the impact that funds' use of derivatives would have on their portfolios. Finally, the SEC proposed to rescind its 1979 general statement of policy (Release 10666), which sets forth the parameters for funds to use derivatives in compliance with Section 18 of the 1940 Act. The public comment period on the proposed Derivatives Rule ends on March 24, 2020. Federated is assessing the potential impact of the Derivatives Rule, but does not expect the Derivatives Rule to have a significant impact on its business, results of operations, financial condition and/or cash flows or the Federated Funds.
On November 5, 2019, the SEC proposed two amendments to its rules governing proxy solicitations. In addition to addressing changes to the procedure for submitting shareholder proposals, the proposed amendments largely seek to codify prior SEC guidance released on August 21, 2019 in several important respects. The amendments would codify the SEC's interpretation that proxy voting advice generally constitutes a solicitation within the meaning of the 1934 Act. The amendments would condition the availability of certain exemptions from the existing proxy information and filing requirements of the federal proxy rules used by proxy voting advice businesses on certain additional disclosure requirements, such as disclosing conflicts of interest. The amendments also would amend the proxy rules to clarify when the failure to disclose certain information in proxy voting advice may be considered misleading within the meaning of the rule, depending upon the particular facts and circumstances at issue. The public comment period on the proposed amendments ended on February 3, 2020. Federated is assessing the potential impact of the amendments on its business (including its Equity Ownership Services business), results of operations, financial condition and/or cash flows.
On November 4, 2019, the SEC proposed amendments to its investment adviser advertising and cash solicitation rules. In general the proposed amendments attempt to update and modernize the existing regulations. The amendments to the advertising rule introduce a new principles-based prohibition on certain advertising practices, and more tailored requirements for the presentation of performance results based on an advertisement's intended audience and permit the use of testimonials, endorsements, and third-party ratings. The amendments also would require that most advertisements be reviewed and approved internally by designated employees prior to use. The amendments to the cash solicitation rule
broaden its application considerably, including expanding its application to arrangements that involve compensation other than cash compensation. The public comment period on the proposed amendments ended on February 10, 2020. Federated is assessing the potential impact of the amendments on its business, results of operations, financial condition and/or cash flows.
On October 18, 2019 the SEC proposed amendments to Rule 0-5 under the 1940 Act to expedite the review process for exemptive relief applications that are "substantially identical" to recent precedent. While the relief provided by the amendments would be narrow, the amendments have the potential to streamline an important regulatory environmentprocess often utilized when bringing new products to market. The SEC has affected,indicated that firms may not "mix and match relief" from prior orders, and warned that "small changes to the terms and conditions of an application, compared to a precedent application, may either raise a novel issue, or require a significant amount of time for the Staff to consider whether it raises such an issue." The proposed amendments also establish an internal timeframe for review of applications outside of the proposed expedited procedure. The public comment period on the proposed amendments ended on November 29, 2019. Federated believes these amendments will benefit the investment management industry.
Investment management industry participants, such as Federated, also continued, and will continue, to monitor, plan for and implement certain changes in response to new proposed or adopted rules, such as the following (which Federated previously described in greater detail in its prior public filings):
On June 5, 2019, the SEC adopted a package of new rules (i.e. Regulation Best Interest) and amendments and interpretations intended to enhance the quality of retail investors' relationships with broker-dealers and investment advisers and to enhance investor protections while preserving retail investor access and choice in (1) the type of professional with whom they work; (2) the services they receive; and (3) how they pay for these services. The new rules are intended to enhance the standard of conduct that broker-dealers owe to their customers and align the standard of conduct with retail customers' reasonable expectations. The rules will also provide additional transparency and clarity for retail investors through enhanced disclosures on Form CRS designed to help them understand who they are dealing with, and why that matters. The interpretations reaffirm, and in some cases clarify, the standard of conduct that investment advisers owe to their clients and clarify the scope of the services a broker-dealer can provide consistent with the statutory definition of investment adviser. With the adoption of this package, regardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor. Regulation Best Interest and Form CRS became effective on September 10, 2019. Compliance with Regulation Best Interest and Form CRS reporting is required by June 30, 2020. The interpretation of an investment adviser's fiduciary duty became effective on July 12, 2019. On October 18, 2019, the SEC's Division of Investment Management issued Frequently Asked Questions which provide further guidance to investment advisers on disclosure requirements related to: (i) conflicts of interest regarding compensation that the adviser received in connection with recommended investments; (ii) investment adviser conflicts related to mutual fund share class recommendations; (iii) investment advisers' receipt of revenue sharing payments; and (iv) material amendments to Form ADV. The Department of Labor (DOL) is also considering regulatory options in light of its modified fiduciary standard for retirement plan advisors, promulgated in 2016 (DOL Fiduciary Rule), being vacated in its entirety in mid-2018, and is expected to issue a new fiduciary rule in the first quarter of 2020. In response to the DOL Fiduciary Rule, broker-dealer and other intermediaries implemented, or began implementing, changes to their business practices, including eliminating commission-based compensation arrangements, reducing the number of mutual funds offered on their platforms or requiring "clean shares" or other product fee structure changes based on SEC guidance. It remains uncertain whether, and to what degree, broker-dealers or other intermediaries will roll-back, modify or continue changes made prior to affect,the DOL Fiduciary Rule being vacated, or make new or additional changes in light of Regulation Best Interest, Form CRS, the SEC fiduciary duty interpretations, or any new fiduciary rule proposed by the DOL. Federated continues to varying degrees,analyze the potential impact of these Regulatory Developments on Federated's business, results of operations, financial condition and/or cash flows.
The implementationSEC proposed rules and amendments on March 20, 2019, to permit registered closed-end funds and business development companies to use the registration, offering and communications reforms the SEC had previously adopted for operating companies under the 1933 Act and to further harmonize the disclosure and regulatory framework for these funds with that of changes stemming fromoperating companies. The proposed rules and amendments implement provisions of the structural, operationalEconomic Growth, Regulatory Relief, and Consumer Protection Act (the "CEF Act") and Small Business Credit Availability Act (the "BDC Act"), and would generally provide eligible closed-end funds and business development companies with flexibility to follow more lenient securities offering rules currently available to traditional public operating companies. The proposed rules and amendments may benefit certain types of business development companies or closed-end funds, such as
exchange listed closed-end funds, but would impose additional regulatory requirements on other requirements imposed pursuant totypes of funds, such as continuously offered closed-end funds (including interval and tender offer closed-end funds). Federated offers exchange listed and continuously offered closed-end funds. The public comment period on the proposed rules and amendments to Rule 2a-7ended on June 9, 2019.
The SEC proposed rule 12d1-4 and amendments under the 1940 Act (Rule 2a-7)on December 19, 2018, which are designed to streamline and enhance the regulatory framework for funds that invest in other funds (or "fund of funds" arrangements). At the same time, the SEC rescinded rule 12d1-2 under the 1940 Act and most related exemptive orders granted by the SEC to provide relief from Sections 12(d)(1)(A), (B), (C) and (G) of the 1940 Act. The proposed rule would, under certain specified conditions, permit a fund to acquire shares of another fund in excess of the limits of section 12(d)(1) of the 1940 Act without obtaining an exemptive order from the SEC. Specifically, proposed rule 12d1-4 would: (1) prohibit an acquiring fund, except one that is part of the same group of investment companies as the acquired fund or one that has a sub-advisor that acts as advisor to the acquired fund, from controlling an acquired fund and requires an applicable acquiring fund that holds more than 3% of an acquired fund's outstanding voting securities to vote those securities in a prescribed manner in order to minimize influence over the acquired fund; (2) prohibit an acquiring fund that acquires more than 3% of an acquired fund's outstanding voting securities from redeeming more than 3% of the acquired fund's total outstanding securities in any 30-day period; (3) impose conditions designed to prevent duplicative and excessive fees in fund of funds arrangements by requiring an evaluation of aggregate fees associated with the investment in the acquired fund and the complexity of the fund of funds arrangement; and (4) prohibit funds from creating three-tier fund of fund structures, except in certain limited circumstances. Rule 12d1-2, which is proposed to be rescinded, currently permits funds that primarily invest in funds within the same group of investment companies to invest in unaffiliated funds and certain other regulations, adopted on July 23, 2014 (2014 Money Fund Rules), andnon-fund assets. The SEC also proposed related guidance (collectively, the 2014 Money Fund Rules and Guidance) was completed on or before October 14, 2016, the final compliance date for the 2014 Money Fund Rules. Subsequently, the SEC has announced that compliance with the structural, operational and other requirements imposedamendments to rule 12d1-1 under the 2014 Money Fund Rules1940 Act and Guidance will be an examination priorityForm N-CEN. The proposed amendments to rule 12d1-1 would allow funds that primarily invest in 2017.funds within the same group of investment companies to continue to invest in unaffiliated money market funds. Finally, the amendments to Form N-CEN would require funds to report whether they relied on rule 12d1-4 or the statutory exception in Section 12(d)(1)(G) of the 1940 Act during the applicable reporting period. The SECpublic comment period on the proposed rule ended on May 2, 2019. Federated continues to analyze the potential impact that the rule, if adopted as proposed, would have on Federated's fund of fund arrangements and DOL, among other regulatory authorities, self-regulatory organizations or exchanges, also have adopted orrelevant products and, as of December 31, 2019, given the uncertainty surrounding the scope and certain requirements of the proposed other rules and regulations, or taken or proposedrule once finalized, Federated is unable to take other actions, (collectively, both domestically and abroad, as applicable, Other Regulatory Developments) that have impacted, or willconclusively determine the impact Federated'son its business, results of operations, financial condition and/or cash flows. Given the regulatory moratorium and possibility for deregulation that exist in the current regulatory environment in the U.S., the degree of impact of the 2014 Money Fund Rules and Guidance, Final Fiduciary Rule and Other Regulatory Developments can vary and is uncertain.
Regulation or potential regulation by regulators other regulators, in addition tothan the SEC and DOL, also continued, and may continue, to affect investment management industry participants, including Federated. For example, the Financial Industry Regulatory Authority (FINRA) also has undertaken examinations, including, for example, a cyber-security sweep examination, and various state legislatures or regulators have adopted or are beginning to adopt state-specific cyber-security and/or privacy requirements that may apply, to varying degrees, in addition to federal regulation.
The activities of the Financial Stability Oversight Council (FSOC) also continue to be monitored by the investment management industry, including Federated. Since the FSOC indicated in 2014 that it intended to monitor the effectiveness of the 2014 Money Fund Rules. This promptedRules, concerns persisted that the FSOC may recommend new or heightened regulation for "non-bank financial companies" under Section 120 of the Dodd-Frank Act,companies," which the Board of Governors of the Federal Reserve System (Governors) have indicated can include open-end investment companies, such as money market funds and other mutual funds. Management continuesIn its past Annual Reports, the FSOC recommended that the SEC monitor the implementation of these rules and evaluate the extent to respectfully disagree with this position and does not believe that asset managers and management products, such as money market funds, create systemic risk. The FSOC has since moved away fromwhich they address potential systemically important financial institution designations of asset managers or investment products,risks in favor of studying and evaluating the financial stability implications of the asset management sector. On April 18, 2016,industry. In its 2019 Annual Report published on December 4, 2019, the FSOC releasedturned its Update on Reviewfocus to other types of Asset Management Products and Activities (Update), which reported its views on potential risks to financial stability arising from certain assetcash management products and activities, including mutual funds, other pooled investment vehicles and separately managed accounts. In the Update, the FSOC focused on potential risks arising from liquidity/redemptions and leverage, as well as securities lending, operational risks of service provider concentrations and resolvability and transition planning. The FSOC also indicated that among other additional analysis, it would continue to reviewuse amortized cost or have a stable NAV, and monitor the SEC's proposed rules on modernization, liquidity management and derivatives and their implications for financial stability. At several meetings from July 2016 through January 2017, the FSOC received updates on asset management products and activities, which included a discussion ofthat may be sponsored or advised by registered investment advisers, but are nevertheless not subject to SEC initiatives and data gaps, potential risks stemming from asset management products,oversight. These include entities such as hedge funds, the impact oflocal government investment pools and private liquidity funds. Noting that such entities are not subject to the 2014 Money Fund Rules, the FSOC recommended that financial regulators monitor developments concerning such short-term cash management vehicles for any financial stability risk implications. The FSOC also identified liquidity and Guidance,redemption risks, as well as the use of leverage, as an area of focus for investment funds and recommended that the SEC monitor the implementation and evaluate the effectiveness of rules intended to reduce such risks (e.g. the 2016 Liquidity Rule, and the process for non-bank financial company designations underre-proposed Derivatives Rule).
On December 4, 2019, the Dodd-Frank Act (including six quantitative thresholds appliedFSOC voted unanimously to a broad groupadopt amendments to its interpretive guidance regarding the designation of non-bank financial companies during stage oneas systemically important financial institutions. The adopted amendments are substantially similar to those that were proposed on March 6, 2019. Under the amended guidance, the FSOC changes its designation approach from an entity-based approach to an activities-based approach under which an individual firm would only be so designated if it determined that efforts to address the financial stability risks of that firm's activities by its primary federal and state regulators have been insufficient. Under the amended guidance, among other things, the FSOC is required first to focus on regulating activities that pose systemic risk, through actions by primary regulators. This differs from the FSOC's historical focus on designating individual firms as systemically important. Under the proposed guidance, the FSOC also would make its designation process more efficient by reducing it from three stages to two, and make the designation process more transparent by inviting participation and engagement by firms under consideration for designation. The FSOC also would be required to conduct a cost benefit analysis (to the U.S. financial system, the U.S. economy, and the nonbank financial company) prior to making a designation, which must include an analysis of the process).likelihood of the potential systemic impact actually occurring, and to assess the likelihood of a non-bank financial company's material financial distress by considering "not only the impact of an identified risk, but also the likelihood that the risk will be realized."
Certain Democratic candidates for the 2020 Presidential election have expressed support for a financial transactions tax (FTT) that would impose a 0.1% or 0.2% tax on securities transactions. On March 5, 2019, legislation was introduced in both the House of Representatives and Senate that, if passed and signed into law, would impose a 0.1% tax on stock, bond and derivative transactions. The possibility of deregulationtax would apply to sales made in the U.S. or by U.S. persons, and initial securities issuances and short-term debt would be exempt. A later proposal would tax stock trades at 0.5%, bond trades at 0.1%, and derivatives transactions at 0.005% coupled with an income tax credit for individuals with income of less than $50,000 ($75,000 for married couples), which is intended to offset the efforts underway to improve the transparency and to seek to curtail certain authorityaverage burden of the FSOC, and the degree to which actions by the FSOC can impact the investment management industry, including Federated, is uncertain.
tax for such individuals. Management does not believe this legislation will be enacted under President Trump's administration.
The current regulatory environment including the SEC's 2014 Money Market Fund Rules and Guidance and the SEC's Final Fiduciary Rule, has impacted, and will continue to impact, Federated's business, results of operations, financial condition and/or cash flows. For example, the floating NAV for institutional and municipal (or tax-exempt) money market funds, and redemption fees and liquidity gates, required from and after October 14, 2016 underregulatory changes, such as the 2014 Money Fund Rules and Guidance, resultedcan result in a shiftshifts in asset mix from institutional primemixes and municipal (or tax-exempt) money market funds to stable NAV government money market funds across the investment management industry and at Federated, which impacted itsflows. These shifts impact Federated's AUM, revenues and operating income. While management believesManagement continues to believe that, as and to the extent interest rates rise,remain at higher levels and do not return to near zero, money market funds will benefit generally from increased yields, particularly as compared to deposit account alternatives, and that as spreads widen, investors who exitedassets will continue to flow back into money market funds. While 2018 and 2019 did see a shift in asset mix back toward institutional prime and municipal (tax-exempt) money market funds, there is no guarantee such shift will likely reconsider their investment options over time, including Federated'scontinue and return the asset mix between institutional prime, privatemunicipal (or tax-exempt) and government money market fund and prime collective fund,funds to pre-October 2016 levels; therefore, the degree of improvement to Federated's prime money market business can vary and is uncertain.
The DOL's Finalchanges made in response to the DOL Fiduciary Rule once effective, also willimpacted, and any modifications or additional changes that may be made in response to Regulation Best Interest, Form CRS, the SEC fiduciary duty interpretations, or any new fiduciary rule proposed by the DOL likely may impact, Federated's AUM, revenues and operating income. For example, while management believes that Federated's separately managed account/wrap-fee strategies work wellit remains
uncertain whether, and to what degree, broker-dealers or other intermediaries will roll-back, modify or continue changes made prior to the DOL Fiduciary Rule being vacated, or to make new or additional changes in level wrap fee account structures and can provide transparency and potential tax advantages to clients, and that Federated's experience with bank trust departments andlight of Regulation Best Interest, Form CRS, the SEC fiduciary experience and resources presents an opportunity to add value for clients,duty interpretations, or any new fiduciary rule proposed by the DOL, if intermediaries are likelycontinue to reduce the number of Federated Funds offered on their platforms, and mutual fund-related sales and distribution fees earned by Federated may decrease. In that case, similar to other investment management industry participants, Federated could experience a further shift in asset mix and AUM, and a further impact on revenues and operating income. On the other hand, management continues to believe that Federated's business may be positively affected because separately managed account/wrap-fee strategies work well in level wrap fee account structures and can provide transparency and potential tax advantages to clients, while Federated's experience with bank trust departments and fiduciary experience and resources presents an opportunity to add value for clients.
Federated has dedicated, and continues to dedicate, significant internal and external resources to analyze and address the 2014 Money Fund RulesRegulatory Developments, and Guidance and the Final Fiduciary Rule, includingtheir effect on Federated's business, results of operations, financial condition and/or cash flows. This effort includes considering and/or effecting legislation, regulation,affecting legislative, regulatory, product structure and development, information system development, reporting capability, business and other options that have been or may be available in an effort to minimize the potential impact of any adverse consequences. For example, Federated took steps to adjust its money market fund product line to offer a broad menu of institutional, municipal, prime, government, 60-day maximum maturity, 7-day maximum maturity and private and collective money market funds. Given the uncertainty of a possible delay or replacement of the Final Fiduciary Rule, Federated continues to prepare for its April 10, 2017 effective date. Federated’s preparation includesFederated's efforts include having conversations with intermediary customers regarding the Final Fiduciary Rule and SEC guidance relating to the Final Fiduciary Rule,Regulatory Developments, and analyzing product offering and structure adjustments, regulatory alternatives and other means to comply, and to assist its clientscustomers to comply, with the Final Fiduciary Rule,new fiduciary rules or interpretations, the 1940 Act and other applicable laws and regulations. Among other actions,As appropriate, Federated developed an educational website to assist clients with compliance with the Final Fiduciary Rule, increased the number of Federated Funds that offer "clean shares," including R6 shares, and filed registration statement amendments to add "T Shares" to 33 Federated Funds prior to the Final Fiduciary Rule's current April 10, 2017 effective date.
The 2014 Money Fund Rules and Guidance, Final Fiduciary Rule, and Other Regulatory Developments discussed above, and related regulatory oversight, also impacted, and/or may impact, Federated's customers and vendors, their preferences and their businesses, which hasbusinesses. For example, these developments have caused, and/or may cause, certain product line-up, structure, pricing and product development changes, as well as money market, equity, fixed incomefixed-income, alternative/private markets or balancedmulti-asset fund products to be less attractive to institutional and other investors, reductions in the number of Federated Funds offered by intermediaries, changes in the fees Federated, retirement plan advisors and intermediaries will be able to earn on investment products and services sold to retirement plan clients, and reductions in AUM, revenues and operating profits, as well asprofits. In addition, these developments have caused, and/or may cause, changes in asset flows, levels and mix, andas well as customer relationships.
Federated will continue to monitor regulatory developmentsRegulatory Developments as necessary, and may implement additional changes to its business and practices as Federatedit deems necessary or appropriate. Further analysis and planning, or additional refinements to Federated's product line and business practices, may be required in response to market, customer or regulatory changes and developments, such as further money market fund regulation, the Final Fiduciary Rulenew conflict of interest or fiduciary rules and Otherother Regulatory Developments, or any additional regulation or guidance issued by the SEC or other regulatory authorities.
International
Until a Free Trade Agreement is expected to take two years or morereached and result inthe transition period ends, significant political, economic, legal and economicregulatory uncertainty whilecontinues to exist regarding the UK government and the European Commission negotiate the withdrawal agreement covering the termsimpact of the UK's exit and its future relationship with the EU.Brexit. See Item 1A - Risk Factors under the caption Potential Adverse Effects of a Decline or Disruption in the Economy or Financial Markets for further discussion of the risks of political instability, currency abandonment and other market disruptions on Federated and its business. The UK's exit from the EU also will likely affect the requirements and/or timing of implementation of legislation and regulation applicable to doing business in the UK, including the laws and regulations applicable to Federated, as well as to the sponsoring, management, operation and distribution of Federated's products and services, both in and outside the UK. For example, while EU Directives have been approved by the UK Parliament, EU regulations generally are effective in the EU without local parliament action and will need to be approved by the UK Parliament to remain in effect post-Brexit. If the UK does not remain part of the single European market (referred to as either a "Hard or Clean Brexit"),Uncertainty exists regarding the ability to passport fund distribution and management services could be eliminated between the UK and EU, increasing regulatory burdens and compliance and other costs for UK funds being distributed in the EU and EU funds (such as Irish-domiciled funds) being distributed in the UK. The
ability to engage investment managers for EU funds and UK funds also could be impacted, resulting in structural and other changes for UK- and EU-domiciled funds. The UK Financial Conduct Authority (FCA) has implemented a temporary permissions regime that allows EEA-domiciled investment funds that market in the UK under a passport to continue temporarily marketing in the UK, and allows EEA-based firms currently passporting into the UK to continue new and existing regulated business within the scope of their current permissions in the UK for up to three years, while they seek full FCA authorization. EU governments, such as, among others, France, the Netherlands, Italy and Germany also have adopted similar temporary permission regimes or other laws to permit UK products to be sold, and EU-UK financial transactions to continue, for a period of time in their countries in the event of a hard Brexit. UK and EU industry groups have been asking regulators to adopt an EU-wide temporary permissions regime to avoid having to comply with requirements imposed by each EU country. It also remains unclear whether Brexit may impact various initiatives underway in the EU, such as money market fund reform and the implementation of an FTT.
Federated is monitoring the impact of Brexit, and, while Brexit has not had a significant impact on Federated's business as of December 31, 2016,2019, Federated remains unable to assess the degree of any potential impact Brexit, and resulting changes, may have on Federated's business, results of operations, financial condition and/or cash flows. Federated continues to expend internal and external resources on contingency planning for Brexit. For example, Hermes organized a subsidiary based in Dublin, Ireland, and established offices in Germany and Denmark, as part of Brexit contingency planning for its business. The Hermes Acquisition increased the potential impact Brexit, and resulting changes, may have on Federated's business, results of operations, financial condition and/or cash flows.
The European Commission has issued four legislative proposals relating to its Action Plan on Sustainable Finance. The legislation addresses, among other things, the establishment of a framework to facilitate sustainable investment, including a unified EU classification system setting harmonized criteria to determine whether an economic activity is environmentally sustainable, disclosures relating to sustainable investments and sustainability risks, amendments to the Benchmark Regulation to create a new category of benchmarks comprising low-carbon and positive carbon impact benchmarks, and amendments to the Markets in Financial Instruments Directive (MiFID II) to provide consistency and clarity for institutional investors integrating ESG factors into their investment decision-making process. Pursuant to the Action Plan on Sustainable Finance, in August 2019 the European Commission commissioned studies on sustainability ratios and research, with the objectives of designing a coherent legal and economic classification of sustainability-related products and services and exploring the integration of ESG risks into the EU banking prudential framework and into banks' business strategies and investment policies.
On December 7, 2016,November 8, 2019, the Committee of Permanent Representatives from Member States approved the initial draftCouncil of the EU moneyadopted the Low Carbon Benchmark Regulation (LCBR), which requires new categories of financial benchmarks, one being an EU climate transition benchmark and one being a "Paris-aligned" benchmark
that brings investment portfolios in line with the Paris Agreement (a 2016 agreement within the United Nations Framework Convention on Climate Change dealing with greenhouse-gas-emissions mitigation, adaptation, and finance). The providers of these benchmarks will have to disclose whether or not, and to what extent, the benchmarks ensure a degree of overall alignment with the target of reducing carbon emissions or the attainment of the objectives of the Paris Agreement is ensured. The LCBR also requires all benchmark providers to disclose whether their benchmarks pursue ESG objectives and whether the provider offers such ESG-focused benchmarks.
On November 8, 2019, the Council of the EU also adopted the Disclosure Regulation, which is aimed at raising market fund reforms. awareness of sustainability and eliminating "greenwashing" or the provision of unsubstantiated or misleading claims regarding the sustainability characteristics and benefits of an investment product. The Disclosure Regulation also aims to harmonize disclosures by providing a uniform format for disclosures. Firms are required to disclose procedures that integrate ESG risks into their investment and advisory processes, the extent to which those risks may impact the profitability of investments, and information on how environmentally friendly strategies are implemented. The Disclosure Regulation covers investment funds, investment advice, private and occupational pensions, insurance-based investment products and insurance advice.
On December 8, 2016,November 27, 2019, the European Parliament Committeepassed the Sustainability-Related Disclosures Regulation (SRDR), which requires certain website, prospectus and annual report disclosures and implements a product classification system. Under the SRDR, a firm will be required to (1) disclose on Economicits website(s) information about the integration of sustainability risks into the firm's decision-making processes and Monetary Affairs approvedinvestment advice, (2) disclose on its website(s) adverse sustainability impacts arising from the initial draftfirm's investment decisions, (3) include pre-contractual disclosures on the integration of sustainability risks into investment decisions and the reforms. Final approvallikely impacts of sustainability on investment returns, and (4) disclose on its website(s) information explaining how remuneration policies are consistent with the reforms by the Councilintegration of Ministerssustainability risks. The SRDR also defines "Dark Green Products" as products having an objective of "sustainable investment" and Plenary in"Light Green Products" as products that promote environmental or social characteristics. The SRDR became effective on December 29, 2019, with compliance for a majority of its provisions being required from and after March 10, 2021.
On December 18, 2019, the European Parliament and Council of the EU agreed upon the Taxonomy Regulation, which is expected lateraimed at establishing a framework to facilitate sustainable investment. The EU and Member States will be required to apply the taxonomy when adopting measures (e.g., labels or standards) setting requirements regarding financial products or corporate bonds presented as "environmentally sustainable". The Taxonomy Regulation applies to financial market participants (e.g., institutional investors and asset managers) who offer financial products. Among other requirements, it requires disclosures for all financial products (with an opt-out with a disclaimer for non-green products) regarding how and to what extent the investments that underlie the financial products support economic activities that meet the criteria of the taxonomy (including details on the respective proportions of enabling and transition activities). Climate change mitigation and adaptation criteria are to be adopted by the end of 2020 with application by the end of 2021. Other environmental objectives (e.g. water and marine resources, circular economy, biodiversity) are to be adopted by the end of 2021 with application by the end of 2022. Member States, the EU, and covered market participants will have to start complying with the Taxonomy Regulation requirements beginning December 31, 2021.
Federated continues to assess the potential impact that Sustainable Finance proposals may have on its non-U.S. business, results of operations, financial condition and/or cash flows.
On October 12, 2019, the European Securities and Markets Authority (ESMA) published the final report on the draft regulatory technical standards (RTS) under Article 25 of the regulation on European long-term investment funds (ELTIF). The new regulatory framework includes revised cost disclosure requirements applicable to packaged retail investment and insurance-based products (PRIIPs). In March 2019, ESMA released a consultation paper on the draft RTS, mainly because of differences between cost disclosure requirements in the firstPRIIPs and under the UCITS Directive. In the final report, ESMA indicated that it would postpone the finalization of the draft RTS until the new PRIIPs delegated acts have been published, and that upon finalization of the review of the PRIIPs Delegated Regulation 2017/653, it will assess the most appropriate way to finalize the draft ELTIF RTS and may carry out another round of consultations.
On September 30, 2019, the FCA's new requirement took effect requiring UK managers to undertake an annual assessment of whether funds under their advisement provide value. Various factors are to be considered, including the fees the fund charges, performance, whether economies of scale are being obtained and passed on to investors, the quality of service provided to investors, etc. Managers must make a public statement of the outcome of the value assessment. Similarly, the Central Bank of Ireland (CBI) has also imposed a value assessment requirement for Irish UCITs funds.
The Fifth Anti-Money Laundering Regulations were implemented in the UK on January 10, 2020. A key extension of the regulations is to the letting sector of the real estate industry. The regulations will require additional due diligence to be
undertaken on tenants going forward. There are also new additional high-risk factors to consider when assessing the need for enhanced due diligence. Firms must understand the ownership and control structure of their corporate customers, and record any difficulties encountered in identifying beneficial ownership. Furthermore, there is a new requirement for firms to report to the UK Companies House discrepancies between the information the firm holds on its customers compared with the information held in the Companies House Register.
Investment management industry participants, including Federated, continued, and will continue, to monitor, plan for and implement certain changes in response to new proposed or second quarter of 2017.adopted rules, such as the following (which Federated previously described in greater detail in its prior public filings):
On October 6, 2019, the FCA rules on improving shareholder engagement in connection with the Shareholder Rights Directive II became effective. The FCA previously issued a Policy Statement, final rules and a consultation paper on the Shareholder Rights Directive II on May 31, 2019. The final reforms providerules and guidance apply to regulated life insurers, asset managers and companies with shares admitted to trading on a regulated market. The Policy Statement confirmed that firms, such as asset managers, had to implement an engagement policy, and make certain disclosures regarding their engagement policy and investment strategies (or explain why they have not done so), by June 10, 2019. The engagement policy is required to cover how firms integrate shareholder engagement in their investment strategies, how they monitor investee companies on strategy, financial and non-financial performance, capital structure and social impact, environmental impact and corporate governance, how they conduct dialogue and exercise voting, cooperate with other shareholders, communicate with other stakeholders and manage conflicts of interest. In addition to engagement policy implementation, the detailed rules require firms to send details of portfolio composition, turnover and turnover costs to certain clients. Firms that are required to make annual disclosures must do so for the followingfirst full period after the rules come into effect. For Federated's non-U.S. operations (excluding Hermes) Federated elected to disclose support for the Shareholder Rights Directive II but not adopt a new set of engagement policies. Hermes also supports the Shareholder Rights Directive II and previously published its engagement policies.
On September 20, 2019, the FCA issued a policy statement on illiquid assets and open-end funds, which sets forth new rules and guidance applicable to non-UCITS retail schemes (NURS), but not other types of funds (including UCITS). Under the policy statement, NURS holding property and other immovables will be required to suspend dealing when there is material uncertainty about valuation of at least 20% of a fund's property. Authorized fund managers will be allowed to continue to deal where they agree with the NURS' depositary that doing so is in the best interests of investors. Fund managers investing mainly in illiquid assets will also be required to produce contingency plans for dealing with liquidity risks. A fund will also be required to include additional disclosure in its prospectus describing the fund's liquidity risk management strategies, including the tools that will be used and the possible impact on investors. A standard risk warning also will be required in financial promotions to retail investors. Compliance with the policy statement is required by September 30, 2020.
On September 2, 2019, ESMA published guidelines on liquidity stress testing in UCITS funds and alternative investment funds (AIFs), with the objectives of increasing the standardization, consistency and frequency of liquidity stress testing currently being undertaken and promoting the convergent supervision of liquidity stress testing by each National Competent Authority (NCA). The guidelines recommend that, when designing liquidity stress testing models, fund managers should determine the risk factors that may impact a fund's liquidity, the types of scenarios to utilize and their severity, the indicators to be monitored based on the liquidity stress testing results, the manner in which liquidity stress testing results will be reported to management, and how the results will be utilized. The guidelines further recommend that fund managers should have a strong understanding of the liquidity risks arising from a fund's assets and liabilities and a fund's overall liquidity profile to enable the fund manager to implement appropriate liquidity stress testing for the fund. The guidelines apply beginning on September 30, 2020. The ESMA guidelines followed an August 7, 2019 letter from the CBI in which it reminded the investment industry that responsibility for liquidity risk management, which includes compliance with all legal and regulatory obligations in respect of liquidity of each fund under management, rests with the boards of fund companies, individual directors and relevant designated persons. In September 2019, the FCA also informed asset managers that it wants all open-end funds to adhere to new liquidity rules as soon as possible. With the increased focus on liquidity, Federated has begun enhancing its formal liquidity procedures for its investment products.
On July 19, 2019, ESMA published a Final Report on Guidelines on stress test scenarios under the EU Money Market Fund Regulation (MMF Regulation) and a Final Report on reporting to competent authorities under Article 37 of the MMF Regulation, which are aimed at ensuring a coherent application of the MMF Regulation. As required by Article 28 of the MMF Regulation, the Guidelines on stress testing establish common reference parameters of the stress test scenarios money market funds or managers of money market funds should include in their stress testing scenarios. As required by Article 37 of the MMF Regulation, the Guidelines on reporting provide guidance on how to fill in the EU: (1) Government constant NAV (CNAV) funds; (2) Low volatility NAV (LVNAV) funds; (3) Short-term variable NAV (VNAV) funds;reporting template on
money market funds that their managers will transmit to competent authorities as of the first quarter of 2020. Federated continues to analyze the new Guidelines and (4) standard VNAV funds. Among other characteristics, the government CNAV funds will needrequirements for compliance.
A European FTT also continues to invest 99.5% of their assets in public debt securities, which includes government debt/assets, reverse repurchase agreements securitized by government debt/assets of any eligible sovereign nation as determined by the funds' managers, andbe discussed although it remains unclear when an agreement will be able to utilize amortized cost accounting to value all portfolio securities. Among other characteristics, the LVNAV funds will be able to invest in money market instruments, such as government, corporate and asset-backed commercial paper, among other instruments. LVNAV funds will be able to utilize amortized cost accounting to value securities with maturities of 75 days or less so long as the amortized cost value of the securities is within 10 basis points of the mark-to-market value of the securities, and will need to utilize mark-to-market/mark-to-model values for securities with maturities over 75 days. The LVNAV funds' NAVs, which will be rounded to two decimal places, will move only if the NAV moves outside of a 20 basis point collar. Short-term VNAV funds and standard VNAV funds will be able to invest in money market instruments like LVNAV funds, but will need to utilize mark-to-market/mark-to model values for portfolio securities rather than using amortized cost accounting.
five countries with the highest incomes would be applied on Groupshare a small part of Ten (G10) shares (i.e., shares issued by issuers locatedtheir revenues with the other countries, so that each participating country would receive at least €20 million of FTT revenue. No formal action was taken as of December 31, 2019. The weakening economy in the G10 countries). InEurope may increase this case, the G10 countries include Austria, Belgium, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. After a transition period, the FTT would be extendedrisk. The exact time needed to all shares unless participating Member States decide otherwise. Regarding derivatives, the proposal provides that for option-type derivatives the tax base should be based on the option premium. For derivatives other than options, the proposal provides that a term-adjusted notional amount or market value (where applicable) may be considered as the appropriate taxable base. The proposal also indicates that adjustments to the tax rates or to the definition of the tax base may be necessary in order to avoid distortions. Under the new proposal, repurchase agreements and reverse repurchase agreements and transactions of public debt managers and their counterparts would be exempt from the FTT. Derivatives "with public debt to 100% as direct underlying" (e.g., futures, forwards and options that have all sovereign bonds issued by governmental entities as the underlying asset) also would initially be exempt from the FTT. After a transition period, the FTT would be extended to such derivatives with public debt unless participating Member States decide otherwise. With the exceptions noted above, the new proposal would subject all derivatives to the FTT. Under the new proposal, a reduced minimum rate (80% of the normal tax rate) could be applied for market makers bound by a contract with a specific trading venue to carry out market making activities with regard to specific shares, irrespective of whether it is proprietary trading or market making. As proposed, when applicable to securities transactions, the FTT would be applied on the gross transaction amount. The FTT also would apply to all transactions involved in a transaction chain, except with respect to transactions by agents or clearing members when the agents and clearing members act as facilitators. Under previous proposals, it had been agreed that the impact of the FTT on the real economy and pension schemes should be minimized, subject to further analysis. The participating Member States agreed that further analysis with regard to real economy and pension funds is required, and did not address these matters in the new proposal. While participating Member States had agreed that the European Commission would present draft legislation regarding the FTT before the end of 2016, it has been reported that, at a December 6, 2016 meeting of the EU Economic and Financial Affairs Council, Austria's Finance Minister, Hans Jorg Schelling, indicated that certain more critical participating Member States have not yet provided data that the European Commission would need to complete a final assessment of the FTT's impact on the real economy. It has been reported that government officials in Belgium are concerned over the FTT's potential negative impact for Belgium's pension funds and national financial market. It also has been reported that Austria and Italy are hoping forreach a final agreement on thea FTT, sometime in the first half of 2017. At a mid-January 2017 plenary session of the European Parliament, a debate on the progress of the negotiations on the FTT was undertaken and it was reported that a final text of a legislation proposal for the FTT could be expected by mid 2017. Discussions continued at a February 21, 2017 meeting of the economic and finance ministers of the participating Member States where a number of issues were discussed, including an exemption for pension funds, without any final decisions being reached. The time needed to implement any agreement and enact legislation is not known at this time. As noted above, however, Brexit also could delay agreement on, and implementation of, the FTT in Europe.the EU or UK. The Labour Party in the UK has also separately proposed a UK FTT, but with the uncertainty surrounding the impact of Brexit, it is unclear whether a UK FTT will be advanced in 2020.
The activities of the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) also continue to be monitored by the investment management industry, including Federated. Building on consultations and other reports published for comment on March 6,from 2015 a second consultative document on "Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions" (Second Consultation). In the Second Consultation, the FSB and IOSCO took a more inclusive approach setting forth revisedthrough 2019 regarding methodologies for assessing the systemic risk of investment funds with an increased focus on leverage, and a new methodology for asset managers that focuses on activities that are conducted by a particular asset manager and may have the potential to generate systemic risk and warrant consideration. Each methodology contemplated the application of a materiality threshold to determine an assessment pool and requires assessment of global systemic importance for entities selected for further analysis by reviewing "impact factors" (e.g., size, interconnectedness, complexity, substitutability, and cross jurisdictional activities) based on sector-specific indicators relating to each of the relevant impact factors. As noted in its May 29, 2015 comment letter submitted to the FSB and IOSCO on the Second Consultation, Federated believes that the application of the Second Consultation's criteria should generally result in the exclusion of funds and asset managers that do not make significant use of leverage or derivatives from being designated asidentifying non-bank non-insurance company global systemically important financial institutions. Management believes that money market funds should not be designated as non-bank, non-insurance company global systemically important financial institutions. On June 17, 2015, IOSCO announced that its risk analysis will initially focus on industry activities and managers in the broader global financial context in identifying potential systemic risks, rather than on the size of asset managers, but that after that review is complete, work on methodologies for the identification of individual entities should be reassessed. On July 30, 2015, the FSB announced that it has decided to wait to finalize the assessment methodologies for non-bank non-insurance companynon-insurer global systemically important financial institutions, until after its current work on financial stability risks stemming from asset management activities is completed. The FSB indicated that, after discussing its initial findings in September 2015, it will develop activities-based policy recommendations.
Global securities regulators are urging the adoption of new risk free reference rates as alternatives to LIBOR. Separate working groups have been formed in the UK, the U.S., the EU, Japan and Switzerland to recommend an alternative to LIBOR for their respective markets. The FCA and the Bank of England (BoE) Prudential Regulation Authority continue efforts started in September 2018 regarding the transition from LIBOR to the Sterling Overnight Index Average (SONIA) by the end of 2021. The BoE continues to encourage firms to consider their actions and preparations in managing the transition from LIBOR to alternative interest rate benchmarks, and to seek assurances that firms' senior managers and boards understand the risks associated with this transition. In early June 2019, representatives of the BoE and FCA told banks that it is "last orders" for LIBOR and that banks must stop adding to their post-2021 LIBOR exposures. On January 16, 2020, the BoE, FCA and the Working Group on Sterling Risk-Free Reference Rates (RFRWG) published a series of documents outlining priorities and milestones for 2020 with respect to the LIBOR transition. The priorities include (1) ceasing issuance of cash products linked to
sterling LIBOR by the end of the third quarter of 2020, (2) throughout 2020, taking steps that demonstrate that compounded SONIA is easily accessible and usable, (3) taking steps to enable a further shift of volumes from LIBOR to SONIA in derivative markets, (4) establishing a framework for the transition of legacy LIBOR products, in order to significantly reduce the stock of LIBOR referencing contracts by the first quarter of 2021; and (5) considering how best to address issues such as "tough legacy" contracts. Regulators in the U.S. and other countries are also working on the transition from LIBOR. For example, the SEC and other regulators in the U.S. are undertaking efforts to identify risks and prepare for the transition from LIBOR to the Secured Overnight Financing Rate (SOFR) by the end of 2021. The SOFR was selected as the preferred LIBOR replacement in the U.S. by the Alternative Reference Rates Committee at the Federal Reserve Bank of New York. In early June 2019, a representative of the Federal Reserve Bank of New York urged the finance industry to ramp up preparations for the end of LIBOR and take the warnings seriously. On July 12, 2019, the SEC issued a "Staff Statement on LIBOR Transition" in which the SEC staff indicated that the expected discontinuation of LIBOR could have a significant impact on the financial markets and may present a material risk for certain market participants, including through, among other efforts, imposing requirements or providing guidance on business continuitypublic companies, investment advisers, investment companies and broker dealers. The SEC staff further noted that the risks associated with the discontinuation and transition planning. Regarding securities lending,will be exacerbated if the Final FSB Recommendations focuswork necessary to effect an orderly transition to an alternative reference rate is not completed in a timely manner, and reported that the staff is actively monitoring the extent to which market participants are identifying and addressing these risks. IOSCO previously published on monitoring for situations where indemnifications provided by asset managersJuly 31, 2019 a statement endorsing risk free reference rates as a robust alternative to their clients in relation to securities lending activities indicate the development of material risks or regulatory arbitrage that may adversely affect financial stability and recommend that regulatory authorities verify and confirm asset managers adequately cover potential credit losses. The Final FSB Recommendations also set forth preliminary results of the FSB's analysis regarding potential vulnerabilities of pension funds and sovereign wealth funds and address additional considerations relating to the liquidity transformation of exchange traded funds. Management, while generally supporting many of the recommendations in the Final FSB RecommendationsLIBOR that can be viewed as guidanceused in the majority of products, and urged transitioning to risk free reference rates "now." On December 18, 2019, the FSB published its "Annual Progress Report on liquidity, leverageImplementation of Recommendations to Reform Major Interest Rate Benchmarks" in which the FSB emphasized that the continued reliance of global financial markets on LIBOR poses risks to financial stability. In the report, the FSB calls for significant and sustained efforts by regulators and by financial and non-financial firms across many jurisdictions to transition away from LIBOR by the end of 2021. The phase-out of LIBOR may cause the renegotiation or re-pricing of certain credit facilities, derivatives or other related risks,financial transactions to which investment management industry participants, including Federated and its products, customers or service providers, are parties, alter the accounting treatment of certain instruments or transactions, or have other unintended consequences, which, among other effects, could require additional internal and external resources, and may increase operating expenses. Federated continues to respectfully disagree withassess the premiseimpact that the regulated fund industry, particularly in the U.S., creates financial stability risktransition from LIBOR will have on Federated and believes that additional burdensome regulation is not warranted.Federated's products and strategies, customers and service providers.
Management believes that ana UK FTT or EU FTT, particularly if enacted with broad application, would be detrimental to Federated's business and could materially and adversely affect, potentially in a material way, Federated's business, results of operations, financial condition and/or cash flows. Management also is continuingcontinues to monitor and evaluate the potential impact of European money marketregulatory reforms on Federated's business, results of operations, financial condition and/or cash flows. Regulatory reforms stemming from Brexit or FCA, FSB, IOSCO or other initiatives or Regulatory Developments, as well as the potential political and economic uncertainty surrounding Brexit, the Final FSB Recommendations or other initiatives also may adversely affect, potentially in a material way, Federated's business, results of operations, financial condition and/or cash flows. Similar to Federated'sits efforts in the U.S., Federated has dedicated, and continues to dedicate, significant internal and external resources to analyze and address European reforms that impact Federated's fundinvestment management and stewardship business.
European regulatory developments,Regulatory Developments, and Federated's efforts relating thereto, have had, and may continue to have, an impact on Federated's expenses and, in turn, financial performance. As of December 31, 2016,2019, Federated is unable to conclusively assess the potential impact that European money market reforms, thea FTT or other regulatory reforms or initiatives may have on its business, results of operations, financial condition and/or cash flows until such regulatory developments receive final approval and become effective or the FTT is enacted.flows. Federated also is unable to conclusively assess at this time whether, or the degree to which, Federated, any of its investment management subsidiaries or any of the Federated Funds, including money market funds, or any of its other products, could ultimately be determined to be a non-bank, non-insurance company global systemically important financial institution at this time.institution. The Hermes Acquisition increased the potential impact that the above matters may have on Federated's business, results of operations, financial condition and/or cash flows.
Employees
At December 31, 2016,2019, Federated employed 1,4631,826 persons.
Information about our Executive Officers of Federated Investors, Inc.
The following section sets forth certain information regarding the executive officers of Federated as of February 24, 2017:21, 2020:
| Name | Position | Age | |||
| J. Christopher Donahue | President, Chief Executive Officer, Chairman and Director of Federated | ||||
| Gordon J. Ceresino | Vice Chairman of Federated | ||||
| Thomas R. Donahue | Vice President, Treasurer, Chief Financial Officer and Director of Federated | ||||
| John B. Fisher | Vice President and Director of Federated | ||||
| Richard A. Novak | Vice President, Assistant Treasurer and Principal Accounting Officer of Federated | ||||
| Saker A. Nusseibeh | Chief Executive Officer, Hermes Fund Managers Limited | 58 | |||
| Paul A. Uhlman | Vice President of Federated | ||||
| Stephen P. Van Meter | Vice President and Chief Compliance Officer of Federated | ||||
| * | Federated Advisory Companies include the following: Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, Federated Global Investment Management Corp., Federated Investment Counseling, Federated Investment Management Company and Federated MDTA LLC, each wholly owned by Federated. |
Mr. John F. Donahue is a co-founder of Federated. He served as director and Chairman of Federated since Federated's initial public offering in May 1998, and now serves as Chairman Emeritus effective April 28, 2016. He previously served as a director or trustee of 38 investment companies managed by subsidiaries of Federated until April 28, 2016. Mr. Donahue is the father of J. Christopher Donahue who serves as President, Chief Executive Officer, Chairman and director of Federated and Thomas R. Donahue who serves as Vice President, Treasurer, Chief Financial Officer and director of Federated.
Mr. Gordon J. Ceresino has served as Vice Chairman of Federated since 2007. He is President of Federated International Management Limited and Federated International Securities Corp. and Vice Chairman of Federated MDTA LLC, botheach of which are wholly owned subsidiaries of Federated. He serves as a director of Hermes Fund Managers Limited. Mr. Ceresino also serves as a director, trustee or President or Chief Executive Officer of certain other wholly owned subsidiaries of Federated involved in Federated's non-U.S. operations.
Mr. Thomas R. Donahue has served as Vice President, Treasurer and Chief Financial Officer of Federated since 1998. Mr. DonahueHe previously served as a member of the Board from May 1998 to April 2004 and was re-elected to the Board onin April 28, 2016. He also serves as an Assistant Secretary of Federated and he is President of FII Holdings, Inc., a wholly owned subsidiary of Federated. Mr. DonahueHe serves as a director of Hermes Fund Managers Limited. He also serves as a director, trustee or officer of various otherother Federated subsidiaries. He is also a director or trustee of six investment companies managed by subsidiaries of Federated. Mr. Donahue is the son of John F. Donahue who serves as Chairman Emeritus of Federated and the brother of J. Christopher Donahue who serves as President, Chief Executive Officer, Chairman and director of Federated. He is also a director or trustee of seven investment companies managed by subsidiaries of Federated.
Mr. John B. Fisher has served as Vice President of Federated since 1998. Mr. FisherHe previously served as a member of the Board from May 1998 to April 2004 and was re-elected to the Board onin April 28, 2016. He has also been President and Chief
Executive Officer of Federated Advisory Companies since 2006 and serves as a board member for each of these subsidiaries that are wholly owned by Federated. He serves as a director of Hermes Fund Managers Limited. He also serves as a director, trustee or officer of certain other Federated subsidiaries. He is President of three investment companies managed by subsidiaries of Federated. He is also director or trustee of 26 investment companies managed by subsidiaries of Federated. Prior to 2006, heMr. Fisher served as President of the Institutional Sales Division of Federated Securities Corp., a wholly owned subsidiary of Federated.
Mr. Eugene F. Maloney has served as Executive Vice President of Federated since March 2009. Prior to that time, he served as Vice President of Federated since 1998. He is also Executive Vice President of Federated Investors Management Company, a wholly owned subsidiary of Federated. Mr. Maloney provides certain legal, technical and management expertise to Federated's sales divisions, including regulatory and legal requirements relating to a bank's use of mutual funds in both trust and commercial environments.
serves as a director, trustee or trusteeofficer of certain other subsidiaries of Federated.various Federated subsidiaries. Mr. McGonigle isGermain also Secretary andserves as Chief Legal Officer, Executive Vice President and Secretary of 33 registered32 investment companies managed by subsidiaries of Federated.
Mr. Richard A. Novak has served as Vice President, Assistant Treasurer and Principal Accounting Officer of Federated since 2013. Prior to that time, he served as Fund Treasurer of Federated's domestic mutual funds beginning in 2006 and served as the Controller of Federated from 1997 through 2005. He also serves as Senior Vice President, Treasurer, Assistant Treasurer, Assistant Company Secretary, President or director for various other subsidiaries of Federated. Mr. Novak is a Certified Public Accountant.
Mr. Saker A. Nusseibeh is Chief Executive Officer of Hermes, a majority-owned subsidiary of Federated beginning July 1, 2018. He joined Hermes in 2009 and was appointed Chief Executive Officer in May 2012, having served as acting Chief Executive Officer since November 2011. He formerly served as Global Head of Equities at Fortis Investments USA, having initially been appointed as Head of Global Equities in 2005. He also serves as a director of Hermes and as a director or officer of certain subsidiaries of Hermes.
Mr. Paul A. Uhlman has served as Vice President of Federated, and President and a director of Federated Securities Corp., a wholly owned subsidiary of Federated, since June 15, 2016. He is also a director, trustee or officer of certain subsidiaries of Federated. As President of Federated Securities Corp., Mr. Uhlmanhe is responsible for the marketing and sales efforts of Federated. Mr. UhlmanHe had previously served as a Vice President of Federated Securities Corp. since 1995, and most recently served as Executive Vice President of Federated Securities Corp. since 2010. Mr. Uhlman also held the position of National Sales Director, Institutional Sales, from 2007 through June 15, 2016.
Mr. Stephen P. Van Meter has served as Vice President and Chief Compliance Officer of Federated since July 2015. Between October 2011 and July 2015, Mr. Van Meterhe served as Compliance Operating Officer at Federated. Between October 2007 and October 2011, Mr. Van Meterhe served as Senior Counsel in the Division of Investment Management, Office of Chief Counsel, at the SEC. Between September 2003 and October 2007, heMr. Van Meter served as Senior Counsel in the SEC's Division of Enforcement.
Available Information
Federated makes available, free of charge, on its website, www.FederatedInvestors.com,www.FederatedHermes.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, annual information statements and amendments to those reports, including those filed or furnished pursuant to Section 13(a) or 15(d) of the 1934 Act, as soon as reasonably practicable after such information is electronically filed with or furnished to the SEC.
Other Information
All references to the Notes to the Consolidated Financial Statements in this Form 10-K refer to those in Item 8 - Financial Statements and Supplementary Data (Consolidated Financial Statements). All other information required by this Item is contained in Item 6 - Selected Financial Data and Note (3)(5) to the Consolidated Financial Statements.
All cross-references between Items in this 10-K are considered to be incorporated into the Item containing the cross-reference.
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ITEM 1A – RISK FACTORS
As an investment manager, risk is an inherent part of Federated's business. U.S., UK and other global financial markets, by their nature, are prone to uncertainty and subject participants to a variety of risks. If any of the following risks actually occur, Federated's business, results of operations, financial condition and/or cash flows could be materially adversely affected. The risks described below are not the only risks involved in Federated's business. Additional risks not presently known to Federated or that Federated currently considers to be immaterial may also adversely affect its business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of a Material Concentration in Revenue.Revenue. At any point in time, a meaningful or significant portion of Federated's total AUM or revenue may be attributable to one or more products or strategies, or asset classes, offered by Federated, or one or more clients or customer intermediaries with whom Federated has a relationship. See Note (3)(5) to the Consolidated Financial Statements for information on material concentrations in Federated's revenue. A significant and prolonged decline in the AUM of a strategy, asset class or fund with a material concentration could have a material adverse effect on Federated's future revenues and, to a lesser extent, net income, due to a related reduction in distribution expenses associated with these funds. Likewise, significant negative changes in Federated's relationship with a customer with a material concentration could have a material adverse effect on Federated's future revenues and, to a lesser extent, net income due to a related reduction in distribution expenses associated with this customer. A significant change in Federated's investment management business or a significant reduction in AUM due to regulatory changes or developments, changes in the financial markets, such as significant and rapid increases in interest rates over a short period of time causing certain investors to prefer direct investments in interest-bearing securities, non-competitive performance, the availability, supply and/or market interest in repurchase agreements and other investments, significant deterioration in investor confidence, a return to declining or additional prolonged periods of low short-term interest rates or negative yields and resulting fee waivers, investor preferences for deposit products or other Federal Deposit Insurance Corporation (FDIC)-insured products, or exchange-traded funds, index funds or other passive investment products, changes in product fee structures, changes in relationships with financial intermediaries, or other circumstances, could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Low Short-Term Interest Rates. In December 2015, the FOMC increasedRates. After raising the federal funds target rate range by 25 basis points to 0.25%-0.50% four times during 2018 (the ninth such increase since December 2015), slightly raising short-term interest rates. Throughout 2016, the FOMC deferred making increases in this target rate, but in December raisedFederal Open Market Committee of the Federal Reserve Board (FOMC) decreased the federal funds target rate range by an additional 25 basis points0.25% three times during 2019 to 0.50%-0.75%its current target of 1.50-1.75%. The federal funds target rate, which drives short-term interest rates, had been close to zero for nearly seven years prior to the December 2015 increase.As a result of the The long-term near-zerolow interest-rate environment resulted in the gross yield earned by certain money market funds is not being sufficient to cover all of the fund's operating expenses. SinceAs a result, beginning in the fourth quarter of 2008, Federated has experienced Voluntaryimplemented voluntary waivers (either through fee waivers or reimbursements or assumptions of expenses) in order for certain money market funds to maintain positive or zero net yields (Voluntary Yield-related Fee Waivers.Waivers). These fee waivers have beenwere partially offset by related reductions in distribution expense and net income attributable to noncontrolling interests as a result of Federated's mutual understanding and agreement with third-party intermediaries to share the impact of the Voluntary Yield-related Fee Waivers. In addition, while
During periods of a low interest-rate environment, Voluntary Yield-related Fee Waivers are calculated as a percentage of AUM in certain money market funds and thus can vary depending upon the asset levels and mix in such funds. While increases in short-term interest rates generally have the effect of decreasing, and have decreased, these fee waivers for certain money market funds, the corresponding increases in yields and the resulting decrease in fee waivers are notneither certain nor directly proportional.
With regard to asset mix, changes in the relative amount of money market fund assets in prime and government money market funds (or between such funds and other money market funds or other products) as well as the mix among certain share classes that vary in pricing structure willcan impact the level of fee waivers. Generally, prime money market funds will waive less than government money market funds as a result of higher gross yields on the underlying investments. As such, as an isolated variable, an increase in the relative proportion of average managed assets invested in prime money market funds as compared to total average money market fund assets should typically result in lower Voluntary Yield-related Fee Waivers. The opposite would also be true.
The impact of such fee waivers on various components of Federated's Consolidated Statements of Income was as follows for the years ended December 31:
| in millions | 2016 | 2015 | 2014 | |||||||||
| Total Revenue | $ | (87.8 | ) | $ | (333.6 | ) | $ | (410.6 | ) | |||
| Less: Reduction in Distribution expense | 65.8 | 240.6 | 280.9 | |||||||||
| Operating income | (22.0 | ) | (93.0 | ) | (129.7 | ) | ||||||
| Less: Reduction in Noncontrolling interest | 0.0 | 7.1 | 10.7 | |||||||||
| Pre-tax impact | $ | (22.0 | ) | $ | (85.9 | ) | $ | (119.0 | ) | |||
FOMC implied in its economic projections that it would continue to raisedecreased the federal funds target rate range by 0.25% in a measuredAugust, September and gradual way,October 2019. Despite the FOMC reducing interest rates three times in 2019, there were no Voluntary Yield-related Fee Waivers in 2019. See Potential Adverse Effects of Increased Competition in the Investment Management Business in this section for information on competitive waivers currently being implemented by Federated, other than the Voluntary Yield-related Fee Waivers discussed above.
There is no guarantee that the FOMC will continue to maintain the federal funds rate at its current level. Federated is unable to predict when, or to what extent, the FOMC will maintain or further decrease or increase their target for the federal funds rate. As such, Voluntary Yield-related Fee Waivers and the related reduction in distribution expense and net income attributable to noncontrolling interests could continue for the foreseeable future. Assuming asset levels and mix remain constant and based on recent market conditions, management estimates that Voluntary Yield-related Fee Waivers for the first quarter of 2017 may result in a negative pre-tax impact on income of approximately $1 million, which is less than the impact to each quarter of 2016 (see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption Business Developments - Low Short-Term Interest Rates for additional information on management's expectations regarding fee waivers and Note (19) to the Consolidated Financial Statements for additional information on the quarterly impact of these fee waivers). Any potential waiver recovery may be partially offset by changes in asset mix and customer relationshipswill remain at or arrangements, among other potential factors. While the level of these fee waivers are impacted by various factors, increases in short-term interest rates that result in higher yields on securities purchased in money market fund portfolios would likely reduce the negative pre-tax impact of these waivers. Management estimates that an increase of an additional 25 basis points in gross yields on securities purchased in money market fund portfolios could nearly eliminate these waivers. near zero.
The actual amount of future fee waivers, if any, the resulting negative impact of theseany waivers and Federated's ability to recover the net pre-tax impact of such waivers (that is, the ability to capture the pre-tax impact going forward, not re-capture previously waived amounts) could vary significantly from management's estimatesprior years as they are contingent on a number of variables including, but not limited to, changes in asset levels and mix within the money market funds or among customer assets, yields on instruments available for purchase by the money market funds, actions by the Governors, the FOMC, the U.S. Treasury Department, (Treasury Department), the SEC, the DOL, the FSOC and other governmental entities, changes in fees and expenses of the money market funds, changes in customer relationships, changes in money market product structures and offerings, demand for competing products, changes in distribution models, changes in the distribution fee arrangements with third parties, Federated's willingness to continue the fee waivers and changes in the extent to which the impact of the waivers is shared by any one or more third parties. The continuation, duration, level and impact of a further decline in interest rates and/or future Voluntary Yield-related Fee Waivers, if any, as well as Federated's ability to recover the net pre-tax impact of such waivers (that is, the ability to capture the pre-tax income going forward, not re-capture previously waived amounts) as money market yields increase, could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Rising Interest Rates. Despite the expectation that further increases in short-term interest rates above the current low rate range of 0.50%-0.75% will further reduce the impact of the Voluntary Yield-related Fee Waivers, increases Increases in interest rates could also have an adverse effect on Federated's revenue from money market, fixed-income, alternative/private markets and other fixed-income products and strategies. The value of equity securities (such as dividend paying equity securities) also may rise and fall in response to changes in interest rates. In a rising short-term interest rate environment, certain investors using money market products and strategies or other short-term durationshort-duration fixed-income products and strategies for cash management purposes may shift these investments to direct investments in comparable instruments in order to realize higher yields than those available in money market and other products or strategies holding lower-yielding instruments. In addition, rising interest rates will tend to reduce the fair value of securities held in various investment products and strategies. Rising interest rates also may impact demand for and cost to finance real estate and impact the value of real estate or returns on real estate and other alternative products and strategies. Among other potential adverse effects, rising interest rates may result in decreased liquidity and increased volatility in financial markets and could negatively impact the performance of Federated's products and strategies and Federated's revenue. Management cannot estimate the impact of
rising interest rates (including, for example on Federated's revenue), but such impact could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of a Decline or Disruption in the Economy or Financial Markets.Markets. Economic or financial market (including securities, real estate, credit and other markets) downturns, disruptions or other conditions (domestic or international) may cause volatility, illiquidity and other potential adverse effects in the financial markets and adversely affect, potentially in a material way, the supply of investments, such as money market or municipal (tax-exempt) securities and the profitability and performance of, demand for and investor confidence in Federated's investment products, strategies and strategies.services. Such economic or financial market downturns, disruptions or other conditions (domestic or international) may include, for example, disruptions in the securities, real estate and credit markets, defaults or poor performance in certain sectors of the economy, unemployment, excessive corporate debt levels, the commencement, continuation or ending of government policies and reforms (including those of new administrations or otherwise), stimulus programs, and other market-related actions, quantitative easing or tightening or other changes in monetary policy, central bank activism through continued ownership, exchange, cancellation or issuance of debt or other means, increased regulation or a slower pace for new regulation or deregulation, increases or decreases in interest rates, changes in oil prices or other changes in commodity markets or prices, changes in currency values, changes in property values and financial costs, or exchange rates or currency abandonment, inflation or deflation, index changes, widening bid/ask spreads, changes in the allocation of capital to market-making, restructuring of government-sponsored entities, imposition of economic sanctions, trade friction or trade wars and increased trade tariffs, economic or political weakness, geopolitical tensions or military escalation or other instability in certain countries or regions, technology-related or cyber-attacks or incidents, terrorism, the prospects for or concerns about any of the foregoing factors or events, or other factors or events that affect the financial markets. For example, regarding currency abandonment and political instability, there is considerableremains uncertainty as a result of Brexit, as toregarding the final arrangements that will apply to the UK's relationship with the EU and other countries leading up to, and following, the UK's withdrawal from the EU.post-Brexit. This long-term uncertainty may affect other countries in the EU and elsewhere. The UK's departure from the EU also may cause volatility within the EU, triggering prolonged economic downturns in certain European countries or sparking additional
Member States to depart, or contemplate departing, from the EU. In addition, Brexit creates the perceptionpossibility of additional economic stresses for the UK, including the view that there may be potential decreased trade, difficulty in, or increased expenses relating to, marketing and selling UK funds and other financial products in the EU and EU funds and other financial products in the UK, capital outflows, devaluation of the British pound sterling, wider corporate bond spreads due to uncertainty, worker dislocation or restrictions, and possible declines in business and consumer spending as well as foreign direct investment. See Item 1 -1- Business under the caption Regulatory Matters for additional information on Brexit. Each of the above factors, among others, may cause or contribute to economic or financial market downturns, disruptions or other conditions and their potentially adverse effects. In addition, Federated's products and strategies may be adversely affected, potentially in a material way, by changes in U.S., UK, EU or other markets, downgrades of U.S., UK or other countries' credit ratings, the U.S. debt ceiling or other developments in the U.S., UK and other countries as well as by actual or potential deterioration in international sovereign, commodity or currency market conditions.
At December 31, 2016,2019, Federated's liquid assets of $310.3$359.1 million included investments in certain Federated-sponsored money market and other fluctuating-value fundsFederated Funds that may have direct and/or indirect exposures to international sovereign debt and currency risks. Federated and the money market and other fluctuating NAV funds managed or distributed by Federated also interact with various other financial industry participants, such as counterparties, broker/dealers, banks, clearing organizations, other investment products and customers, as a result of operations, trading, distribution and other relationships. As a result, Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows could be adversely affected by the creditworthiness or financial soundness of other financial industry participants, particularly in times of economic or financial stress or disruption. There can be no assurance that potential losses that may be realized as a result of these exposures will not have a material adverse effect on Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows.
The ability of Federated to compete and sustain asset and revenue growth is dependent, in part, on the relative attractiveness of the types of investment products and strategies Federated offers and its investment performance under prevailing market conditions. Adverse market conditions or other events also could impact Federated's customers. In the event of extreme circumstances, such as economic, political, or business crises, Federated's products and strategies may suffer significant net redemptions in AUM causing severe liquidity issues in its short-term, fixed-income or certain other sponsored investment products and strategies and declines in the value of and returns on AUM, all of which could cause material adverse effects on Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows.
Custody, depository and portfolio accounting services for all of Federated's fund productsthe Federated Funds generally are outsourced to one of four third-party financial institutions that are leading providers of such mutual fund services. Accounting records for Federated's fundsthe Federated Funds are maintained by these service providers (or vendors). These service providers, or other service providers of Federated and its products or customers, could also be adversely affected by the adverse market conditions described above. It is not possible to predict with certainty the extent to which the services or products Federated receives from such service providers would be interrupted or affected by such situations. Accordingly, there can be no assurance that a potential service interruption or Federated's ability to
find a suitable replacement would not have a material adverse effect on Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Changes in Laws, Regulations and Other Rules on Federated's Investment Management Business. Business. Federated and its investment management business are (and any new business line commenced or acquired by Federated would be) subject to extensive regulation both in and outside the U.S. and abroad. Federated and its products, such as the Federated Funds, and strategies are subject toto: federal securities laws, principally the 1933 Act, the 1934 Act, the 1940 Act and the Advisers Act,Act; state laws regarding securities fraud and registration,registration; and regulations or other rules, promulgated by various regulatory authorities, self-regulatory organizations or exchanges, both domestically and abroad, including, but not limited to, the SEC, the Financial Industry Regulatory Authority (FINRA)FINRA, FCA, CBI and the New York Stock Exchange (NYSE). From time to time, the federal securities laws have been or may be augmented or amended substantially. For example, among other measures, Federated and its products and strategies have been impacted by the Dodd-Frank Act, the Sarbanes-Oxley Act of 2002, the Patriot Act of 2001 and the Gramm-Leach-Bliley Act of 1999 and the Dodd-Frank Act. 1999.
Federated and its domestic products (such as the Federated Funds) and strategies, and any offshorenon-U.S. products (such as offshorenon-U.S. Federated Funds) and strategies to the extent offered in the U.S., continue to be primarily regulated by the SEC. Federated, and certain Federated Funds, are also subject to regulation by the U.S. Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA), due to certain Federated Funds investingtheir investment in futures, swaps or certain other commodity interests in more than de minimis amounts. In addition, during the past several years, regulators, self-regulatory organizations or exchanges such as the SEC, FINRA, CFTC, NFA, NYSE and NYSEstate or local governments and regulators, have adopted, and may continue to adopt, other regulations, rules and amendments that have increased Federated's operating expenses and affected the conduct of its business, as well as Federated's AUM, revenues and operating income, and may continue to do so. Federated's business is affected by laws, regulations, and regulatory authorities that impact the manner in which Federated's products are structured,
distributed, provided or sold, such as, for example, the DOL's Final Fiduciary Rule.sold. Federated and its products and strategies also are affected by certain other laws and regulations governing banks and other financial institutions or intermediaries. While the pace of regulation has slowed in 2018 and 2019, the results of the 2020 presidential election may result in increased regulation, which could further increase the cost of compliance for Federated.
Federated's and its products' operations outside of the U.S. are subject to foreign laws and regulation, which are promulgated or amended from time to time, by foreign regulatory or other authorities, such as the U.K. Financial Conduct Authority (FCA)FCA for London-based operations, the Central Bank of IrelandCBI for Dublin-based operations, the German Federal Financial Supervisory Authority for Frankfurt-based operations, the Cayman Island Monetary Authority for Cayman Island products, and the Ontario (and certain other provincial) Securities Commission for Canadian operations.
In addition, the Dodd-Frank Act provided for a systemic risk regulation regime under which it is possible that Federated, and/or any one or more of its products (such as the Federated Funds), could be subject to designation as a systemically important financial institution by the FSOC. Similarly, it is possible that the FSB could designate Federated, and/or one of its products (such as the non-U.S. Federated Funds), as a non-bank, non-insurance company global systemically important financial institution. Among other potential impacts, any such designation would result in Federated and/or its products being subject to additional banking regulation and bank-oriented measures, including, for example, capital and liquidity requirements, leverage limitations, enhanced public disclosures and risk management requirements, as well as oversight by the Governors or FSB, in addition to being subject to primary regulation by securities regulators such as the SEC, FCA and CBI.
As Federated's business grows (whether organically or through acquisition or whether through new products, strategies or services being offered or through growth of existing products, strategies and services, or otherwise), Federated's products, strategies and operations need to comply with applicable laws, rules, regulations, interpretations and government policies, which increases compliance risk and operating expenses, including the costs associated with compliance. As Federated's businessCompliance risk and operating expenses also can increase when Federated expands the potential impactits use of such changesESG, sustainability, stewardship or other data inputs or investment techniques in laws, regulations, rules, interpretationsproviding its investment products, strategies and services, enters new countries or governmental policies, compliance and the risks and costs associated with compliance may increase.
Management continues to monitor and evaluate the impact of Brexit, valuation practices, share class selection, fixed-incomethe Regulatory Developments discussed above (and in Item 1- Business under the caption Regulatory Matters) on Federated's business, results of operations, financial condition and/or cash flows. These Regulatory Developments include, among others, stress testing requirements, fund of funds rules, Regulation Best Interest, a new SEC derivatives rule, Brexit-related regulation, a potential FTT, new EU regulatory requirements, liquidity rules, and high yield liquidity, liquidity controls, liquid alternatives, cybersecurity, side-by-side management of private funds, private placements, separately managed or wrap-fee accounts, excessive trading, "distribution in guise," marketing support payments, and intermediary and other payments and related disclosures.
EU money market fund regulation. Among other potential impacts, these regulatory requirements and developmentsRegulatory Developments have increased, or will likelyand may continue to increase, in addition to compliance risks as well asand compliance costs, the costs associated with technology, legal, compliance, operations and other efforts to address regulatory-related matters,matters. These regulatory requirements and developments also have caused, and may continue to cause, certain product line-up, structure, pricing and product development changes, changes in the ability to utilize "soft dollars" to pay for certain research and brokerage services (rather than Federated paying for such services directly), money market, equity, fixed-income, or balanced fundalternative/private markets and multi-asset products to be less attractive to institutional and other investors, reductions in the number of Federated Funds offered by intermediaries, changes in the fees Federated, retirement plan advisors and intermediaries will be able to earn on investment products and services sold to retirement plan clients, and reductions in AUM, revenues and operating profits, as well as changes in asset flows, levels and mix and customer relationships. As examples, it became necessary for Hermes to establish offices in Ireland, Germany and Denmark, as Brexit may result in it becoming more difficult to passport products between the UK and EU Member States. In addition, the Dodd-Frank Act provided for a new systemic risk regulation regime undercertain money market funds or other products or strategies may become less attractive to institutional or other investors, which it is possible that Federated, and/or any one or more of its products (such as the Federated Funds), could be subject to designation as aresult in changes in asset mix and reductions in AUM, revenues and operating income.
On a cumulative basis, Federated's regulatory, product development and restructuring, and other efforts in response to the 2014 Money Fund Rules and Guidance, Final Fiduciary Rule and Other Regulatory Developments discussed above, including the internal and external resources dedicated to such efforts, have had, and may continue to have, a material impact on Federated's expenses and, in turn, financial performance. The floating NAV for institutional and municipal (or tax-exempt) money market funds, and redemption fees and liquidity gates, required by the 2014 Money Fund Rules and Guidance, effective October 14, 2016, resulted in a shift in asset mix from institutional prime and municipal (or tax-exempt) money market funds to stable NAV government money market funds across the investment management industry and at Federated, which impacted its AUM, revenues and operating income. While 2018 and 2019 saw a shift in asset mix back toward institutional prime and municipal (tax-exempt) money market funds, there is no guarantee such shift will continue and return asset mix between institutional prime, municipal (or tax-exempt) and government money market funds to pre-October 2016 levels. The regulatory changes and developments in the current regulatory environment, and Federated's efforts in responding to them, could have a material and adverse effect on Federated's business, results of operations, financial condition and/or cash flows. While the FSOC's change in focus and continuing transparency efforts have reduced the possibility of any Federated products being designated a systemically important non-bank financial company, management also believes that the designation of Federated and/or one or more products as a systemically important financial institution or a non-bank, non-insurance company global systemically important financial institution by the FSB, and/or the issuance of final regulations or reforms relating to such designations, would be detrimental to Federated's money market fund business and could materially and adversely affect Federated's business, results of operations, financial condition and/or cash flows. Given the current regulatory environment including the October 14, 2016 final compliance date for the 2014 Money Fund Rules and the potential for deregulation under President Trump's administrationa slower pace for new regulation or future additional or modified regulation or guidance, Federated is unable to fully assess the degree of the impact of adopted or proposed regulations and other regulatory developments,Regulatory Developments, and Federated's efforts related thereto, on its business, results of operations, financial condition and/or cash flows.
Changes in laws, regulations, rules, interpretations or governmental policies, domestically and abroad, also impact the financial intermediaries, service providers (or vendors), customers and other third-parties with whom Federated, and its products (such as the Federated Funds), conduct business. For example, the DOL is expected to issue a new fiduciary rule in early 2020. Additionally, provisions of the Dodd-Frank Act or the Final Fiduciary RuleRegulation Best Interest, may affect intermediaries' sale or use of Federated's products or strategies. Among other potential impacts, these changes are affecting, and may continue to affect, Federated's arrangements with these intermediaries, and may continue to increase fee pressure, reduce the number of Federated products and strategies offered by intermediaries, cause certain clients or intermediaries to favor passive products over actively managed products, increase respective operating expenses and distribution costs, result in lower AUM, change asset flows, levels and mix, and otherwise affect the conduct of Federated's or such intermediaries' respective businesses. This also resulted, and will likely continue to result, in Federated or one or more of these third parties seeking to restructure or alter their compensation or other terms of the business arrangements between Federated or its products (including the Federated Funds) and one or more of these third parties. The above factors could have a material adverse impact on Federated's business, results of operations, financial condition and/or cash flows.
Finally, Federated's business also has been, and will continue to be, impacted by the Tax Cuts and Jobs Act of 2017 (Tax Act), signed into law on December 22, 2017. See Note (16) to the Consolidated Financial Statements for additional information. In addition, various service industries, including, for example, mutual fund service providers, have been, and continue to be, the subject of changes in tax policy that impact their state and local tax liability. Changes that have been adopted or proposed include (1) an expansion of the nature of a service company's activities that subject it to tax in a jurisdiction, (2) a change in the methodology by which multi-state companies apportion their income between jurisdictions, and (3) a requirement that affiliated companies calculate their state tax as one combined entity. As adopted changes become effective and additional jurisdictions effectenact similar changes, among other potential impacts, there could be a material adverse effect on Federated's tax liability and effective tax rate and, as a result, net income. Various investment products also may be impacted by tax changes, which could have an adverse effect on the products and Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effect of Providing Financial Support to Investment Products. Federated may, from time to time, elect to provide financial support to its sponsored investment products (such as the Federated Funds). Providing such support utilizes capital that would otherwise be available for other corporate purposes. Losses resulting from such support, or failure to have or devote sufficient capital to support products, could have a material adverse effect on Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows.
Risk of Federated's Money Market Products' Ability to Maintain a Stable Net Asset Value. Approximately 45%40% of Federated's total revenue for 20162019 was attributable to money market assets. An investment in money market funds is neither insured nor guaranteed by the FDIC or any other government agency. Federated's retail and governmentgovernment/public debt money market funds, as well as its private and collective money market funds, seek to maintain a stable or constant NAV. Federated
also offers non-U.S. low volatility money market funds that seek to maintain a constant NAV, but will move to a four-digit NAV if such fund's net asset value falls outside of a twenty basis point collar. Although stable or constant NAV money market funds seek to maintain an NAV of $1.00 per share, it is possible for an investor to lose money by investing in these funds. Federated also offers institutional prime or municipal (or tax-exempt) money market funds which transact at a fluctuating NAV that uses four-decimal-place precision ($1.0000). Federated also offers a short-term variable NAV non-U.S. money market fund. It is possible for an investor to lose money by investing in these funds. Federated devotes substantial resources, such as significant credit analysis and attention to security valuation in connection with the management of its products and strategies. However, the NAV of an institutional prime or municipal (or tax-exempt) money market fund, or variable NAV fund or, if the above described conditions are met, a low-volatility NAV fund, can fluctuate, and there is no guarantee that a government/public debt or retail (i.e. stable or constant NAV) money market fund, or a low-volatility money market fund, will be able to preserve a stable or constant NAV in the future. Market conditions could lead to a limited supply of money market fund securities and severe liquidity issues and/or declines in interest rates or additional prolonged periods of low yields in money market products or strategies, and regulatory changes or developments could lead to shifts in asset levels and mix, which could impact money market fund NAVs and performance. If the NAV of a Federated stable or constant NAV money market fund were to decline to less than $1.00 per share, such Federated money market fund would likely experience significant redemptions, resulting in reductions in AUM, loss of shareholder confidence and reputational harm, all of which could cause material adverse effects on Federated's business, results of operations, financial condition and/or cash flows. It is also possible that, if the fluctuating NAV of an institutional prime or municipal (or tax-exempt) money market fund's fluctuatingfund, or variable NAV money market fund or low-volatility money market fund consistently or significantly declines to less than $1.0000 per share, such Federated money market fund could experience significant redemptions, resulting in reductions in AUM, loss of shareholder confidence and reputational harm, all of which could cause material adverse effects on Federated's business, results of operations, financial condition and/or cash flows.
No Assurance of Access to Sufficient Liquidity. From time to time, Federated's operations may require more cash than is available from operations. In these circumstances, it may be necessary to borrow from lending facilities or to raise capital by
securing new debt or by selling shares of Federated equity or debt securities. Federated's ability to raise additional capital in the future will be affected by several factors including, for example, Federated's creditworthiness and the fairmarket value of Federated's common stock, as well as general market conditions. There can be no assurance that Federated will be able to obtain these funds and financing on acceptable terms, if at all, and, if Federated cannot obtain such funds, it could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows. If a Federated Fund requires liquidity to meet shareholder redemptions or for other reasons, there also can be no assurance that such Federated Fund will be able to access any available line of credit, rely on inter-fund lending arrangements or access other sources of liquidity on acceptable terms, if any at all, and, if such a Federated Fund cannot obtain sufficient liquidity, it could have a material adverse effect on such Federated Fund, result in redemptions and a corresponding reduction in Federated's AUM and Federated's revenue, and Federated may decide to provide credit support to such Federated Fund. These factors could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows.
Recruiting and Retaining Key Personnel. Federated's ability to attract or acquire, and motivate and retain, quality personnel has contributed significantly to its growth and success and is important to attracting and retaining customers. The market for qualified executives, portfolio managers, analysts, traders, sales representatives and other key personnel is extremely competitive. There can be no assurance that Federated will be successful in its efforts to recruit or acquire, and motivate and retain, the required personnel. In addition to competing opportunities, personnel elect to pursue other interests for business, personal and other reasons or retire from time to time. Federated has encouraged the continued retention of its executives and other key personnel through measures such as providing competitive compensation arrangements and, in certain cases, employment agreements. The loss of any such personnel could have an adverse effect on Federated. In certain circumstances, the departure of key employees could cause higher redemption rates for certain AUM or the loss of customer accounts or relationships. Moreover, since certain of Federated's products and strategies, or customer relationships, contribute significantly to its revenues and earnings, the loss of even a small number of key personnel associated with these products or strategies, or customer relationships, could have a disproportionate adverse impact, potentially in a material way, on Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Increased Competition in the Investment Management Business.Business. The investment management business is highly competitive. Federated competes in the management and distribution of investment products and strategies (such as mutual funds and Separate Accounts) and stewardship services with other fund management companies and investment advisors, national and regional broker/dealers, commercial banks, insurance companies and other institutions. Many of these competitors have substantially greater resources and brand recognition than Federated. Competition is based on various factors, including, among others, business reputation, investment performance, quality of service, the strength and continuity of management and selling relationships, distribution services offered, technological innovation (e.g., the use of financial technology or artificial intelligence in providing investment advice), the type (e.g., passive versus actively managed, fund
versus FDIC-insured deposits) and range of products and strategies offered and fees charged. As with any highly competitive market, competitive pricing structures are important. If competitors charge lower fees for similar products or strategies, Federated has reduced, or may decide to further reduce, the fees on its own products or strategies (either directly on a gross basis or on a net basis through fee waivers) for competitive purposes in order to retain or attract customers. Increased competition also may require changes in Federated's business model, products (e.g., launching ETFs) or strategies to respond to competition from existing and new market innovations and competitors, which can increase expenses and creates the risk that such changes will not be successful or Federated will not achieve its long-term strategic objectives. Such fee reductions, changes in business models or strategies, or other effects of competition, could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows.
Many of Federated's products and strategies are designed for use by institutions such as banks, insurance companies and other corporations. A large portion of Federated's managed assets, particularly money market, fixed-income and fixed-incomealternative/private markets assets, are held by institutional investors. If or when the structure of institutional investment products, such as money market funds, changes or becomes disfavored by institutions, whether due to regulatory or market changes, competing products (such as insured deposit products or non-transparent actively managed ETFs) or otherwise, Federated may be unable to retain or grow its share of this market and this could adversely affect Federated's future profitability and have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows. Certain of Federated's products and strategies also may be impact oriented and may not be suitable investments for certain fiduciary customers without obtaining appropriate consent. This may limit Federated's ability to market or grow assets in such products and this could adversely affect Federated's future profitability and affect, potentially in a material way, Federated's business, results of operations, financial condition and/or cash flows.
A significant portion of Federated's revenue is derived from providing products (such as mutual funds) and strategies to the wealth management and trustU.S. Financial Intermediary market, comprising approximately 2,500over 7,700 national, regional and independent broker/dealers, banks and other financial institutions. Futureregistered investment advisors. The future profitability of Federated will be adversely affected if it is unable to retain or grow its share of this market, and could also be adversely affected by consolidations in the banking and securities industries, as well as regulatory changes or developments impacting its customers.
Potential Adverse Effects of Changes in Federated's Distribution Channels. Federated acts as a wholesaler of investment products and strategies to financial intermediaries, including, for example, banks, broker/dealers, registered investment advisors and other financial planners. Federated also sells investment products and strategies, and stewardship services, directly to corporations, institutions and other customers. There can be no assurance that any product diversification efforts (whether to Federated's fund line-up or geographically), ESG positioning or investments in data and analytics to bolster Federated's distribution efforts will be successful. There also can be no assurance that Federated will continue to have access to any financial intermediary or financial intermediaries that currently distribute Federated products and strategies, or that Federated's relationship with any one or more financial intermediaries or other customers will continue over time or on existing economic terms.terms, or that Federated's sales or distribution efforts will achieve any particular level of success. The impact of Voluntary Yield-related
Fee Waivers, other waivers for competitive purposes, and related reductions in distribution expense can vary depending upon, among other variables, changes in distribution models, changes in the distribution fee arrangements with one or more financial intermediaries, changes in customer relationships and changes in the extent to which the impact of the waivers is shared by one or more financial intermediaries. In addition, exclusive of the impacts of Voluntary Yield-related Fee Waiverswaivers and related reductions in distribution expense, Federated has experienced increases in the cost of distribution as a percentage of total fund revenue from 31%25% in 20072018 to over 37%26% in 2016.2019. Federated expects such costs to continue to increase in total due to asset growth, and per dollar of revenue earned due to the competitive pressures of the investment management business. Higher distribution costs reduce Federated's operating and net income.
Potential Adverse Effects of Declines in the Amount of or Changes in the Mix of Assets Underunder Management. A significant portion of Federated's revenue is derived from investment advisory fees, which are typically based on the value of managed assets and vary with the type of asset being managed, with higher fees generally earned on equity and multi-asset products and strategies than on fixed-income, alternative/private markets and money market products and strategies. Likewise, mutualFederated also may earn performance fees or carried interest on certain products and types of assets. Mutual fund and other fund products generally have a higher management-fee rate than Separate Accounts. Additionally, certain components of distribution expense can vary depending upon the asset class, distribution channel and/or the size or structure of the customer relationship. Consequently, significant fluctuations in the value of securities held by, or the level of redemptions from, the products (such as the Federated Funds) or strategies advised by Federated, and overall asset mix among products and strategies, may materially affect the amount of managed assets and thus Federated's revenue, profitability and growth. Similarly, changes in Federated's average asset mix across both asset and product or strategy types have a direct impact on Federated's revenue and profitability. Federated generally pays out a larger portion of the revenue earned from managed assets in money market and multi-asset funds than the revenue earned from managed assets in equity, or fixed-income and alternative/private markets funds. Substantially allA significant
portion of Federated's managed assets areis in investment products or strategies that permit investors to redeem or withdraw their investment at any time. Capacity constraints, where the size of AUM in a particular product, strategy or asset class make it more difficult to trade efficiently in the market, can result in certain products, strategies, or asset classes being closed to new investment, which may result in redemptions or a reallocation of assets to other products, strategies or asset classes. Additionally, changing market conditions may cause a shift in Federated's asset mix towards money market and fixed-income products or strategies, and regulatory changes or developments may cause a shift between money fund products or from money market funds to other products, whichproducts. Each of the above factors may cause a decline in or otherwise affect, potentially in a material way, Federated's revenue and net income.business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Poor Investment Performance. Success in the investment management business is largely dependent on investment performance relative to market conditions and the performance of competing products and strategies. Good performance generally assists retention and growth of managed assets, resulting in additional revenues. Good performance can also result in performance fees or carried interest being earned on certain products. Conversely, poor performance, or the failure to meet product or strategy investment objectives and policies, tends to result in decreased sales and increased redemptions, withand failure to earn performance fees, carried interest and/or other fees. A product or strategy being, or becoming, an unsuitable product or strategy for a customer, whether due to changes in customer investment objectives or otherwise, also tends to result in decreased sales and increased redemptions, and failure to earn performance fees, carried interest and/or other fees. For certain products or strategies, failure to integrate and apply acceptable environmental, societal, or governance standards, sustainability or responsible investment may be considered, or result in, poor performance, and result in decreased sales and increased redemptions, and failure to earn performance fees, carried interest and/or other fees. The failure to earn performance fees, carried interest and/or other fees results in a corresponding decreasesdecrease in revenues and non-operating income to Federated. Poor performance could, therefore, have a material adverse effect on Federated's business (including, but not limited to, business prospects), results of operations, financial condition and/or cash flows. Market conditions, such as volatility, illiquidity and rising interest rates, among other conditions, can adversely affect the performance of certain quantitative or other investment strategies or certain products, asset classes or sectors. The effects of poor performance on Federated could be magnified where assets or customers are concentrated in certain strategies, products, asset classes or sectors. Changes in foreign currency exchange rates and poor performance of investments made by Federated, or derivatives (including, for example, hedges or forward contracts) or other financial transactions entered into by Federated, can result in investment or capital losses and also can materially adversely affect Federated's business, results of operations, financial condition and/or cash flows.
Operational Risks. Federated's products, business and operations are supported internally and through management of relationships, including, for example, outsourcing relationships with various third party service providers (or vendors), both domestically and internationally. In turn, service providers' operations rely on additional relationships with other third parties. Operational risks include, but are not limited to, improper, inefficient, or unauthorized execution, processing, pricing and/or monitoring of transactions, deficiencies ininadequate, inefficient, inflexible, deficient or non-scalable technology, operating systems or other infrastructure, poor performance by internal resources or third party service providers, failure to appropriately supervise internal resources or third party service providers, business disruptions, inadequacies or breaches in Federated's, its products' or a service provider's internal control processes, unauthorized disclosure or manipulation of, or access to, confidential, proprietary or non-public personal information and noncompliance with regulatory requirements.requirements, investment mandates and related investment parameters, or customer-imposed restrictions. As Federated's and its relevant service providers' businesses expand and require additional scalability, operational risk increases both domesticallyincreases. There is a risk that changes in operational systems and internationally.business processes are not completed correctly, in a controlled manner, in a timely manner or in a manner that achieves intended results. Management relies on its employees, systems and business continuity plans, and those of relevant service providers, to comply with established procedures, controls, and regulatory requirements.requirements, investment parameters or customer-imposed restrictions. Breakdown or improper use of systems, human error or improper action by employees or service providers, or noncompliance with regulations or other rules, investment parameters or customer-imposed restrictions, could cause material adverse effects on Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows.
No Assurance of Successful Acquisitions. Federated's business strategy contemplates seeking acquisition candidates, including acquisitions of other investment management companies and investment assets, both domestically and internationally. There can be no assurance that Federated will find suitable acquisition candidates at acceptable prices and with an aligned business culture and vision, have sufficient capital resources to realize its acquisition strategy, be successful in entering into definitive agreements for or consummating desired acquisitions, or successfully collaborating with acquired companies or integrating acquired companies or assets into Federated, or its products or strategies, orstrategies. There also can be no assurance that any such acquisitions, if consummated, will not increase organizational stress to unacceptable levels or cause process failures, or that any such acquisition, if consummated, will increase value or otherwise prove to be advantageous to Federated. On the other hand, successful collaboration with acquired companies or integration of acquired companies or assets may increase the value
of such acquired companies or assets and result in increased contingent deferred payments or other payment obligations for Federated, which can affect Federated's business, results of operations, financial condition and/or cash flows.
Impairment Risk. At December 31, 2016,2019, Federated had intangible assets including goodwill totaling $733.1 million$1.2 billion on its Consolidated Balance Sheets, the vast majority of which represents assets capitalized in connection with Federated's
acquisitions and business combinations. Federated may not realize the value of these assets. Management performs an annual review of the carrying values of goodwill and indefinite-lived intangible assets and periodic reviews of the carrying values of all other assets to determine whether events and circumstances indicate that an impairment in value may have occurred. A variety of factors could cause the carrying value of an asset to become impaired. Should a review indicate impairment, a write-down of the carrying value of the asset would occur, resulting in a noncash charge which would adversely affect Federated's financial position and results of operations for the period.
Systems, Technology and Cybersecurity Risks. Federated utilizes software and related technologies throughout its business (both domestically and internationally) including, for example, both proprietary systems and those provided by outside service providers (or vendors). Service providers to, and customers of, Federated and its products, and third parties on which such service providers and customers rely, also utilize software and related technologies in their businesses. Federated continues to increase its investment in systems and technology, including externally hosted systems and technology, for investment management and trading operations, information and data management, disaster recovery, compliance and other areas of its business, and is exploring innovative technological solutions and products involving artificial intelligence and financial technology. Unanticipated issues could occur with any software, system or other technology and it is not possible to predict with certainty all of the adverse effects that could result from a failure of Federated or a third party to address technology or computer system problems. Along with cyber incidents described more fully below, data or model imprecision, software or other technology malfunctions, human error, programming inaccuracies and similar or other circumstances or events may impair the performance of systems and technology. Accordingly, there can be no assurance that potential system interruptions, other technology-related issues or the cost necessary to rectify the problems would not have a material adverse effect on Federated's business (including, but not limited to, its reputation and business prospects), results of operations, financial condition and/or cash flows.
In addition, like other companies in the investment management industry and elsewhere, Federated's business relies on the security and reliability of information and communications technology, systems and networks. Federated uses digital technology, including, for example, networked systems, email and the Internet, to conduct business operations and engage clients, customers, employees, products, accounts, shareholders and relevant service providers, among others. The use of the Internet and other electronic media, computers and technology exposes Federated, its business, its products and strategies and services, customers, and relevant service providers, and their respective operations, to potential risks from frequent cybersecurity attacks, events or incidents (cyber incidents). For example, Federated and relevant service providers collect, maintain and transmit confidential, proprietary and non-public personal customer and employee information (such as in connection with online account access and performing investment, reconciliation, transfer agent, custodian and other recordkeeping and related functions) that can be targeted by cyber incidents. Federated, as well as its products and certain service providers, also generate, compile and process information for purposes of preparing and making filings or reports to governmental agencies, and a cyber incident that impacts that information, or the generation and filing processes, may prevent required regulatory filings and reports from being made. Cyber incidents involving Federated or its products or service providers, regulators or exchanges to which confidential, personally identifiable or other information is reported or filed also may result in unauthorized disclosure or compromise of, or access to, such information.
Cyber incidents can result from intentional (or deliberate) attacks or unintentional events by insiders or third parties, including cybercriminals, competitors, nation-states and "hacktivists," among others. Cyber incidents may include, for example, phishing, use of stolen access credentials, unauthorized access to systems, networks or devices (for example, through hacking activity), structured query language attacks, infection from or spread of malware, ransomware, computer viruses or other malicious software code, corruption of data, and attacks (including, but not limited to, denial-of-service attacks on websites) which shut down, disable, slow, impair or otherwise disrupt operations, business processes, technology, connectivity or website or internet access, functionality or performance. Like other companies, Federated has experienced, and will continue to experience, cyber-incidents consistently. As of December 31, 2016, cyber incidents have not had a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows. In addition to intentional cyber incidents, unintentional cyber incidents can occur (for example, the inadvertent release of confidential or non-public personal information).
Like other companies, Federated has experienced, and will continue to experience, cyber incidents on a daily basis. As of December 31, 2019, cyber incidents have not had a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows. Cyber incidents can affect, potentially in a material way, Federated's relationships with its customers, employees, products, accounts, shareholders and relevant service providers. A cyber incident may cause Federated, its business, products or services, its employees, customers, or relevant service providers, to lose proprietary, sensitive, confidential or non-public business, customer, employee or personal information, or intellectual property, suffer data corruption or business interruption, lose operational capacity (for example, the loss of the ability to process transactions, calculate NAVs,
or allow the transaction of business)business, or other disruptions to operations), and/or fail to comply with applicable privacy and other laws. Among other potentially harmful effects, cyber incidents also may result in theft, unauthorized monitoring and failures in the physical infrastructure or operating systems. Any cyber incident could cause adverse impacts,lost revenues, the occurrence of other financial losses, diminished future cash flows, significant increases in compliance or other costs or expenses and exposure related to regulatory penalties, litigation, reputational damage, and additional compliance(such as costs associated with compliance with cybersecurity laws and regulations and with protection, detection, remediation and corrective measures.measures), exposure to increased litigation and legal risks (such as regulatory actions and penalties, and breach of contract or other litigation-related fees and expenses), reputational damage, damage to competitiveness, stock price and shareholder value, and other negative or adverse impacts. Cyber incidents affecting issuers in which Federated's or its customers' assets are invested also could cause such investments to lose value. Any of these cyber incidents may become incrementally worse if they were to remain undetected for an extended period of time.
The operating systems of Federated, its products, its customers and relevant service providers are dependent on the effectiveness of information security policies and procedures which seek to ensure that such systems are protected from cyber incidents. Federated has established a committee to oversee Federated's information security and data governance efforts, and updates on cyber incidents and risks are reviewed with relevant committees, as well as Federated's Board of Directors (or a committee thereof), on a periodic (generally quarterly) basis (and more frequently when circumstances warrant) as part of risk management oversight responsibilities. Federated has, and believes its products and its service providers have, established risk management systems that are reasonably designed to seek to reduce the risks associated with cyber incidents. Federated employs various measures aimed at mitigating cyber risk, including, among others, use of firewalls, system segmentation, system monitoring, virus scanning, periodic penetration testing, employee phishing training and an employee cybersecurity awareness campaign. Among other vendor management efforts, Federated also conducts due diligence on key service providers (or vendors) relating to cybersecurity. However, there is no guarantee that such efforts will be successful, either entirely or partially.partially, as there are limits on Federated's ability to prevent, detect or mitigate cyber incidents. Among other reasons, the cybersecurity landscape is constantly evolving, the nature of malicious cyber incidents is becoming increasingly sophisticated and Federated, and its relevant affiliates and products, cannot control the systems and cybersecurity systems and practices of issuers, relevant service providers or other third parties. Federated's risk from cyber incidents also can increase as a result of expansion into new markets, domestic or international acquisitions, new technology, or previously unexploited vulnerabilities in software or related patches becoming activated (or "weaponized") by hackers. While Federated has obtained cyber-insurance, there is no guarantee that a particular incident would be covered by such insurance. In certain circumstances, insurance coverage may not be available or deductible amounts may not be exceeded, and Federated or the Federated Funds may have to bear the costs related to claims or any losses or other liabilities resulting from a cyber incident. While Federated cannot predict the financial or reputational impact to its business resulting from any cyber incident, depending upon the nature, magnitude and severity of a cyber incident, the occurrence of a cyber incident, or a similar situation or incident, could have a material adverse effect on Federated's business (including, but not limited to, its reputation), results of operations, financial condition and/or cash flows. The internal and external resources and efforts necessary to implement system and technology upgrades, data governance and cybersecurity policies, procedures and measures, including, for example, technology, systems, skilled personnel and service providers (or vendors), as well as vendor management, have, and will continue to, increase Federated's operating expenses, and can adversely effect,affect, potentially in a material way, Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Reputational Harm. Any material losses in customer (including shareholder) confidence in Federated, its products or strategies or in the mutual fund industry as a result of actual or potential regulatory proceedings or litigation, economic or financial market downturns or disruptions, material errors in public news reports, allegations of trade name, trade mark or other intellectual property infringement or misappropriation, allegations of breaches of fiduciary duty, misconduct or unprofessional, unethical or illegal behavior, abuse of authority, a cyber incident, rumors on the Internet or other matters could increase redemptions from and/or reduce sales of Federated's products (such as the Federated Funds) and strategies and other investment management products and services.services and/or negatively impact Federated's brand, culture, trusted status, reputation and/or stock price. If such losses were to occur, it could have a material adverse effect on Federated's business (including, but not limited to, business prospects), results of operations, financial condition and/or cash flows. There also is no guarantee that Federated's rebranding efforts will be successful. With increased focus from shareholders on sustainability, environmental, social, and governance matters by shareholders, any perceived deficiency in Federated's policies and practices on these matters may impact Federated's brand, reputation or stock price, as well as investor preference for Federated's securities, products, strategies and services, and, accordingly, adversely affect, potentially in a material way, Federated's stock price and business (including, but not limited to, business prospects), results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Termination or Failure to Renew Advisory Agreements.Agreements. A substantial majority of Federated's revenues are derived from investment advisory agreements with Federated Funds (and to a lesser extent, sub-advised mutual funds) registered under the 1940 Act that, as required by law, are terminable upon 60 daysdays' notice. In addition, each such investment advisory agreement must be approved and renewed annually by each mutual fund's board of directors or trustees,
including independent members of the board, or its shareholders, as required by law. Failure to renew, changes resulting in lower fees under, or termination of, certain or a significant number of, these agreements could have a material adverse impact on Federated's business, results of operations, financial condition and/or cash flows. As required by the 1940 Act, each investment advisory agreement with a mutual fund automatically terminates upon its assignment, although new investment advisory agreements may be approved by the mutual fund's directors or trustees and shareholders. A sale or other transfer of a sufficient number of shares of Federated's voting securities to transfer control of Federated could be deemed an assignment in certain circumstances. An assignment, actual or constructive, will trigger these termination provisions and may adversely affect Federated's ability to realize the value of these agreements. Federated's investment advisory agreements for Separate Accounts that are not investment companies subject to the 1940 Act are generally are terminable by Federated's customers upon notice to Federated (or, in certain cases, after a 30 day, 60 day or similar notice period). As required by the Advisers Act, investment advisory agreements for Separate Accounts that are not investment companies subject to the 1940 Act also provide that consent is required from Federated's customers before the agreements may be assigned and an assignment, actual or constructive, also will trigger these consent requirements and may adversely affect Federated's ability to realize the value of these agreements. Regarding the investment advisory agreements with non-U.S. registered Federated Funds, shareholder notice or consent can be required if, after an investment advisory agreement is entered into, there are changes to fees, and such investment advisory agreements are generally terminable for any reason, without cause, after a 30-day to 90-day notice period. Customer consent to amend investment advisory agreements for non-U.S. Separate Accounts can be required for amendments to such agreements, and such agreements also are generally terminable for any reason, without cause, after a 30-day to 90-day notice period.
Under the terms of a 2005 settlement agreement with the SEC and New York State Attorney General, as amended, a Federated investment advisory subsidiary may not serve as investment advisor to any registered investment company unless: (1) at least 75% of the fund's directors are independent of Federated; (2) the chairman of each such fund is independent of Federated; and (3) no action may be taken by the fund's board of directors or trustees or any committee thereof unless approved by a majority of the independent board members of the fund or committee, respectively; and (4) the fund appoints a senior officer who reports to the independent directors or trustees and is responsible for monitoring compliance by the fund with applicable laws and fiduciary duties and for managing the process by which management fees charged to a fund are approved.respectively.
Potential Adverse Effects of Unpredictable Events.Events or Consequences. Unpredictable events, such as a natural disaster, pandemic (e.g., the coronavirus outbreak), war, terrorist attack or other business continuity event, or unexpected market, economic or political developments, could adversely impact Federated's, its customer'sproducts', its customers' and their respective service providers' (or vendors') ability to conduct business. Such events or consequences could cause disruptions in economic conditions and financial markets, governmental processes, system interruption, loss of life, unavailability of personnel, an inability to provide information or services, either at all or in accordance with applicable requirements, standards, or restrictions, and/or additional costs. For example, the current outbreak of the coronavirus, which was impossible to predict, has affected travel to China and led to global economic uncertainty which has impacted markets negatively. Given that the region is an important component of Federated's global distribution strategy, any scenario whereby the current situation persists for any significant period of time may adversely affect the potential business and, in turn, returns of Federated. Among other effects, market disruptions and the other events can cause a decline in the value of investments and a decline in the value of Federated's AUM, which tends to result in lower revenue for Federated. There also may be times when industry databases or other third parties publish or distribute information regarding Federated, or its products or services (including Federated Fund asset levels), that may be inaccurate or incomplete, and there can be no assurance that a third party will interpret or report information accurately. Unpredictable consequences, or side effects, of certain known or planned events, such as the planned phase-out of the LIBOR to SOFR, SONIA or another alternative interest rate expected to occur in 2021, also could adversely impact Federated's, its products', its customers', and their respective service providers' (or vendors') ability to conduct business. The SEC staff has indicated that the expected discontinuation of LIBOR could have a significant impact on the financial markets and may present a material risk for certain market participants, including public companies, investment advisers, investment companies and broker dealers. The phase-out of LIBOR may cause the renegotiation or re-pricing of certain credit facilities, derivatives or other financial transactions to which Federated, its products, customers or service providers are parties, alter the accounting treatment of certain instruments or transactions, or have other unintended consequences, which, among other effects, could require additional internal and external resources to address these effects thereby increasing operating expenses. While it is expected that market participants will amend financial instruments referencing LIBOR to include fallback provisions and/or other measures that contemplate the discontinuation of LIBOR or other similar market disruption events, neither the effect of the transition process nor the viability of such measures is known. While market participants have begun transitioning away from LIBOR, there are obstacles to converting certain longer term securities and transactions to a new benchmark or benchmarks. The effectiveness of multiple alternative reference rates as opposed to one primary reference rate has not been determined, nor has the effectiveness of alternative reference rates used in new or existing financial instruments and products. As market participants transition away from LIBOR, LIBOR's usefulness may deteriorate, which could occur prior to the end of 2021. The transition process may lead to increased volatility and illiquidity in markets that currently rely on LIBOR to determine interest rates. LIBOR's deterioration may adversely affect the liquidity and/or market value of securities that use LIBOR as a benchmark interest rate, including securities and other financial instruments held by Federated or the Federated
Funds. Further, the utilization of an alternative reference rate, or the transition process to an alternative reference rate, may adversely affect Federated's or the Federated Funds' performance. As such, there can be no assurance that unpredictable or unexpected events, reports or consequences, or the costs to address such events, inaccurate reports or consequences, would not have a material adverse effect on Federated's business (including, but not limited to, business prospects), results of operations, financial condition and/or cash flows.
Risks Related to Auditor Independence. Public companies, such as Federated, utilize the audit services of a registered public accounting firm (Accounting Firm) to audit or review their financial statements included in certain public filings, such as their Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q. The Accounting Firm is required to make a determination that such firm satisfies certain independence requirements under the federal securities laws. Like other public companies, there is a risk that activities or relationships of the Accounting Firm engaged by Federated, or such firm's partners or employees, can prevent a determination from being made that such firm satisfies such independence requirements with respect to Federated, which could render such firm ineligible to serve as Federated's independent Accounting Firm. Since Federated's independent Accounting Firm, like the Accounting Firms of many other public companies that sponsor and advise investment funds, acts in a similar capacity to several Federated Funds sponsored and advised by Federated, if a determination cannot be made that the Accounting Firm satisfies the independence requirements with respect to an applicable Federated Fund, the Accounting Firm also could be prevented from making a determination that it satisfies the independence requirements with respect to Federated, since Federated is an affiliate (i.e., the ultimate parent company) of the investment advisor to the relevant Federated Fund.
For example, Rule 2-01(c)(1)(ii)(A) of Regulation S-X (Loan Rule) prohibits Accounting Firms, or covered person professionals within the firms, from having certain financial relationships with their audit clients and affiliated entities. Federated's independent Accounting Firm, Ernst & Young LLP (EY), has advised Federated that under the then existing version of the Loan Rule (and may in the future advise
On June 20, 2016, the Division of Investment Management (Division) of18, 2019, the SEC issued a no-action letter under whichadopted amendments to the Loan Rule relating to the analysis that must be conducted to determine whether an Accounting Firm can continue to serve as anis independent registered public accountant forwhen the Accounting Firm (or covered person professionals within the firm) has a lending relationship with certain shareholders of an audit client, such as Federated or the Federated Funds. The amendments focus the analysis on beneficial ownership rather than on both record and beneficial ownership; replace the existing 10% bright-line shareholder ownership test with a significant influence test; add a known-through-reasonable-inquiry standard with respect to identifying beneficial owners of the audit client's equity securities; and exclude from the definition of audit client, for a fund under audit, any other funds that otherwise would be considered affiliates of the audit client under the rules for certain lending relationships. Under the Loan Rule amendments, a beneficial owner with whom an Accounting Firm (or a covered person professional within the firm) has a lending relationship would only have significant influence with respect to Federated or a Federated Fund (when Federated or the Federated Fund is an audit client of the Accounting Firm) if certain conditions are met,the beneficial owner has the ability to exert significant influence over Federated's or the Federated Fund's operating and financial policies, based on the totality of the facts and circumstances. In the case of a Federated Fund, the beneficial owner would have to have the ability to influence the Federated Fund's investment policies and day-to-day portfolio management processes, including those governing the selection, purchase and sale, and valuation of investments, and the distribution of income and capital gains (collectively, investment processes). Given Federated's dual-class structure, under which the entire voting power of Federated is generally vested in the holder of the outstanding shares of the Class A Common Stock and its publicly listed Class B Common Stock generally do not have voting power except in limited circumstances, the Loan Rule amendments make it less likely that a beneficial owner of its publicly traded Class B Common Stock would have significant influence over its operating and financial policies. Given that a majority of the members of the Federated Funds' Board of Directors/Trustees are independent and the Federated Funds delegate investment discretion over their portfolios to registered advisory subsidiaries of Federated which act as the primary investment advisers to the Federated Funds, the Loan Rule amendments make it less likely that a beneficial owner of a Federated Funds' equity securities would have significant influence over a Federated Fund's investment processes. Federated believes the Loan Rule amendments are an improvement on the Loan Rule and mitigate (but not entirely eliminate) the risk that Federated's or the Federated Funds' auditors will inadvertently implicate the auditor independence rules.
Among other sources of potential violations of the auditor independence requirements, Rule 2-01(c)(1)(i)(A) of Regulation S-X (Investment Rule) prohibits the Accounting Firm, or covered person professionals and their immediate family members, from having certain direct investments in audit clients and affiliated entities. Due to acquisitions that result in inadvertent investments in the auditing client or funds or other products that it or its affiliates manage, or other circumstances, an Accounting Firm may violate the Investment Rule and be required to timely and appropriately remedy such violation such that the audit client can make a determination is madethat it continues to believe that the Accounting Firm has the ability to exercise objective and impartial judgment on all issues encompassed within the Accounting Firm's objectivity or judgment has not been impaired. In each case involving EY noted above, the relief provided under the June 20, 2016 no-action letter has been relied upon. The no-action letter states that the Division would not object to a relevant entity (such as an investment fund, its affiliates or its investment advisor or such investment advisor's affiliates) continuing to satisfy (and would not recommend enforcement action if such a relevant entity continues to satisfy) applicable regulatory requirements under the federal securities laws by using the audit services provided by an Accounting Firm that may not be in compliance with the Loan Rule, so long as the requisite conditions are satisfied. If a circumstance arises in which the relief provided by the no-action letter would not be available, Federated and EY would explore other appropriate actions. The no-action letter is effective for 18 months from its June 20, 2016 issuance date (or until December 20, 2017).review services.
There can be no assurance that the circumstances in any particular case will satisfy the conditions of the no-action letter and, therefore, that the relief provided by the no-action letter will be able to be relied upon, or that the applicable independence requirements under the federal securities laws will otherwise continue to be satisfied such that EY will remain eligible to serve as the independent Accounting Firm to Federated. There also can be no assurance that the federal securities laws will be amended to address the issue under the Loan Rule within 18 months before the relief available under the no-action letter is no longer effective or that, if the Loan Rule is not amended, the relief available under the no-action letter will be extended by the Division.
If it were to be determined that the relief available under the no-action letter was improperly relied upon, or that the independence requirements under the federal securities laws were not otherwise complied with regarding Federated, Federated'sits previously filed Annual Reports on Form 10-K (including financial statements audited by EY) and Quarterly Reports on Form 10-Q (including financial statements reviewed by EY) may not be considered compliant with the applicable federal securities laws. If it were to be determined that EY did not comply with the independence requirements, among other things, the financial statements audited by EY and the interim financial statements reviewed by EY may have to be audited and reviewed, respectively, by another independent Accounting Firm, Federated's eligibility to issue securities under its existing registration statements may be impacted and certain financial reporting and/or other covenants with, and representations and warranties to, Federated's lenders may be impacted. Similar issues would arise for a Federated Fund for which EY (or another Accounting Firm) serves as such Federated Fund's independent Accounting Firm if it were to be determined that the no-action letter was improperly relied upon, or EY (or such other Accounting Firm) otherwise was not in compliance with the independence requirements under the federal securities laws, with respect to such Federated Fund. In either case, such events could have a material adverse effect on Federated's business, results of operations, financial condition and/or cash flows.
Potential Adverse Effects of Litigation, Investigations, Proceedings and Other Claims.Claims. Federated and the Federated Funds can be subject to routine, sweep and other examinations, inquiries, investigations, proceedings (administrative, regulatory, civil or otherwise) and other claims by its regulators (regulatory claims). Federated and the Federated Funds also can be subject to employee, former employee, customer, and other third-party, complaints, proceedings (such as civil litigation) and other claims (business-related claims). Among other factors, as Federated's business grows (whether organically or through acquisition or whether through new products, strategies or services being offered or through growth of existing products, strategies and services, or otherwise), the attention and resources devoted to compliance, and the possibility of noncompliance, also can increase. The attention and resources devoted to compliance, and the possibility of noncompliance, also can increase when Federated expands its use of ESG, sustainability, stewardship or other data inputs or investment techniques in providing its investment products, strategies expand,and services, enters new countries or markets, and financial products and other investments, as well as when markets and technology increase in complexity, the attention and resources that Federated devotes to compliance increases and the possibility and occurrences of non-compliance may increase.complexity. Federated has business-related claims asserted and threatened against it, and isFederated and the Federated Funds are subject to certain regulatory claims (such as routine and sweep examinations and other inquiries), in the ordinary course of business. In addition, Federated and the Federated Funds may be subject to business-related claims, claims related to Federated sponsorship or management of, or inclusion of proprietary Federated Funds in, its 401(k) plan or other benefit plans, and administrative, regulatory or civil investigations and proceedings or other regulatory claims, outside of the ordinary course of business. Federated cannot assess or predict whether, when or what types of business-related claims, fiduciary claims or regulatory claims (collectively, claims) may be threatened or asserted, the types or amounts of damages or other remedies that may be sought (which may be material when threatened or asserted), whether claims that have been threatened will become formal asserted pending investigations, proceedings or litigation, or whether claims ultimately may be successful (whether through settlement or adjudication), entirely or in part, whether or not any such claims are threatened or asserted in or outside the ordinary course of business. Federated may be initially unable to accurately assess a claim's impact. Given that the outcome of any claim is inherently unpredictable and uncertain, a result may arise from time to time that adversely impacts, potentially in a material way, Federated's business, results of operations, financial condition and/or cash flows. In certain circumstances, insurance coverage may not be available or deductible amounts may not be exceeded, and Federated, the Federated Funds or Separate Accounts managed by Federated may have to bear the costs related to claims or any losses or other liabilities resulting from any such matters, or from the operation of Federated's business, products and services generally.services.
Federated's Status as a "Controlled Company." Controlled Company. Federated has two classes of common stock: Class A Common Stock, which has voting power, and Class B Common Stock, which is non-voting except in certain limited circumstances. All of the outstanding shares of Federated's Class A Common Stock are held by the Voting Shares Irrevocable Trust for the benefit of certain members of the Donahue family. The three trustees of this trust are Federated's President and Chief Executive Officer and Chairman of the Board, Mr. J. Christopher Donahue, his brother, Thomas R. Donahue, Federated's Vice President, Treasurer and Chief Financial Officer and a director, and their mother, Rhodora J. Donahue. Accordingly, Federated qualifies as a "controlled company" under Section 303A of the NYSE Listed Company Manual. As a controlled company, Federated qualifies for and relies upon exemptions from several NYSE corporate governance requirements, including requirements that: (1) a majority of the board of directors consists of independent directors; and (2) the entity maintains a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee's purpose and responsibilities. As a result, Federated's board does not have a majority of independent directors nor does it maintain a nominating/corporate governance committee. Federated is also exempt as a "controlled company" from certain additional independence requirements and responsibilities regarding compensation advisors applicable to Compensation Committee members. While Federated believes its dual-class structure is appropriate and benefits its shareholders, and should be a factor taken into account by
shareholders when investing in Federated, as a company with a dual-class structure, Federated may be excluded from certain financial indexes, which may result in decreased investments in its Class B Common Stock and adversely affect its stock price.
ITEM 1B – UNRESOLVED STAFF COMMENTS
None.
ITEM 2 – PROPERTIES
Federated has material operating leases space sufficientrelated to meet its operating needs. Federated's operations are headquartered in Pittsburgh, Pennsylvaniacorporate headquarters where it occupies approximately 259,000 square feet in the Federated Investors Tower. Federated leases approximately 94,000 square feet at the Keystone Summit Corporate Park location in Warrendale, Pennsylvania and an aggregate of approximately 25,000 square feet at other locations in the Pittsburgh, area. Federated also leases office space in New York, New York, for the operations of Federated Global Investment Management Corp.; in Boston, Massachusetts, for the operations of Federated MDTA LLC; in Rochester, New York, for the operations of Federated Clover Investment Advisors, a division of Federated Global Investment Management Corp.; in Frankfurt, Germany, for the operations of Federated Asset Management GmbH; and in London, England for the operations of Federated Investors (UK) LLP.Pennsylvania. Federated's leased office space is used for its investment management business.
ITEM 3 – LEGAL PROCEEDINGS
The information required by this item is included in Note (17)(21) to the Consolidated Financial Statements.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
Part II
ITEM 5 – MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Federated's Class B common stock iswas traded on the NYSE under the symbol FII. The following table summarizes quarterly high and lowEffective February 3, 2020, Class B common stock began trading stock prices and quarterly dividends per common share for 2016 and 2015.under the ticker symbol FHI.
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2016 | ||||||||||||||||
| Stock price per share | ||||||||||||||||
| High | $ | 29.16 | $ | 32.81 | $ | 33.13 | $ | 29.96 | ||||||||
| Low | $ | 22.76 | $ | 26.60 | $ | 27.69 | $ | 24.52 | ||||||||
Cash dividends per share1 | $ | 0.25 | $ | 0.25 | $ | 0.25 | $ | 1.25 | ||||||||
| 2015 | ||||||||||||||||
| Stock price per share | ||||||||||||||||
| High | $ | 35.60 | $ | 35.75 | $ | 34.53 | $ | 32.01 | ||||||||
| Low | $ | 30.26 | $ | 33.23 | $ | 28.28 | $ | 27.51 | ||||||||
| Cash dividends per share | $ | 0.25 | $ | 0.25 | $ | 0.25 | $ | 0.25 | ||||||||
The approximate number of beneficial shareholders of Federated's Class A and Class B common stock as of February 8, 2017,7, 2020, was 1 and 27,41323,435, respectively. See Item 1A - Risk Factors under the caption Federated's Status as a Controlled Company for additional information on its Class A common stock.
The following table summarizes stock repurchases under Federated's share repurchase program during the fourth quarter of 20162019.
| Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs1 | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Program1 | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs1 | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs1 | |||||||||||||||||||
| October | 90,000 | $ | 28.73 | 90,000 | 4,516,916 | |||||||||||||||||||||
| November | 315,000 | 26.74 | 315,000 | 4,201,916 | ||||||||||||||||||||||
October2 | 93,650 | $ | 28.89 | 85,000 | 809,401 | |||||||||||||||||||||
November2 | 161,453 | 31.39 | 150,000 | 659,401 | ||||||||||||||||||||||
December2 | 301,000 | 28.18 | 300,000 | 3,901,916 | 165,949 | 23.58 | 112,646 | 546,755 | ||||||||||||||||||
| Total | 706,000 | $ | 27.61 | 705,000 | 3,901,916 | 421,052 | $ | 27.75 | 347,646 | 546,755 | ||||||||||||||||
| 1 |
| 2 | In October, November and December |
See Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for information on Federated's securities authorized for issuance under equity compensation plans.
Stock Performance Graph
The following performance graph compares the total shareholder return of an investment in Federated's Class B Common Stock to that of the Standard and Poor's MidCap 400® Index (S&P MidCap 400 Index) and to the S&P 1500 Asset Management & Custody Banks Index for the five-year period ended on December 31, 20162019.
The graph assumes that the value of the investment in Federated's Class B Common Stock and each index was $100 on December 31, 20112014. Total return includes reinvestment of all dividends. As a member of the S&P MidCap 400 Index as of December 31, 20162019, Federated is required to include this comparison. The historical information set forth below is not necessarily indicative of future performance. Federated does not make or endorse any predictions as to future stock performance.
| 12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2018 | 12/31/2019 | |||||||||||||||||||||||||||||||
| Federated | $ | 150.44 | $ | 222.29 | $ | 262.94 | $ | 235.90 | $ | 249.58 | $ | 89.69 | $ | 95.50 | $ | 126.31 | $ | 96.83 | $ | 123.04 | ||||||||||||||||||||
| S&P MidCap 400 Index | $ | 117.88 | $ | 157.37 | $ | 172.74 | $ | 168.98 | $ | 204.03 | $ | 97.82 | $ | 118.11 | $ | 137.30 | $ | 122.08 | $ | 154.07 | ||||||||||||||||||||
| S&P 1500 Asset Management & Custody Banks Index | $ | 128.04 | $ | 191.12 | $ | 209.43 | $ | 188.97 | $ | 209.68 | $ | 90.23 | $ | 100.12 | $ | 129.56 | $ | 97.00 | $ | 122.45 | ||||||||||||||||||||