We held a client call on 05 July 2017 to discuss the final report
. This article continues that analysis.
On 28 June 2017, the FCA published its final report in relation to its Asset Management Market Study. The market study was launched in November 2015 in order to explore whether competition was working effectively in the asset management sector and whether institutional and retail investors are getting value for money when purchasing asset management services.
The interim report provoked significant reaction from the industry, particularly in relation to some of the remedy proposals, such as the introduction of an all-in fee and a strengthened duty on asset managers to act in the best interests of investors.
The final report broadly confirms the findings identified in the interim report including the finding of weak price competition particularly for retail active asset management services; that fund performance is not always reported against an appropriate benchmark; and investor awareness and focus on charges is often poor. However it does delay the implementation of a number of controversial remedies, including the introduction of a compulsory all-in fee, until further consultation has been conducted.
It appears that the FCA has dropped (for the moment) any proposal that would involve all retail funds implementing a single all-in fee charging structure. However, the FCA has made it clear that it continues to support the disclosure of a single all-in fee to investors on the basis that it considers that the all-in fee will provide investors with greater clarity about likely product charges to enable them to make an informed decision when investing. The FCA is waiting to see how certain regulatory changes which come into effect next January play out as well as promising to consult later on in the year on the way costs and charges disclosures are made in practice (as part of its smarter customer communications initiative).
This leaves a number of unanswered questions on how costs and charges disclosures under UCITS, PRIIPs and MiFID2 are supposed to interact from January next year:
- UK authorised retail funds that are UCITS are required to issue a “Key Investor Information Document” or “KIID” at the point of sale which contains the disclosure of three cost figures: (a) one-off charges; (b) the “On-going Charges Figure” or “OCF” (which excludes transaction costs); and (c) other fees that arise in certain circumstances (such as performance fees). UCITS are required to continue producing UCITS KIIDs up to 31 December 2019 after which they will be required to switch to a PRIIPs KID (see below).
- From January next year UK authorised retail funds that are non-UCITS will be subject to PRIIPs which requires retail investors to be provided with a “Key Information Document” or “KID” - the costs information on that document also includes three cost figures: (a) one-off costs; (b) on-going charges (which includes transaction costs) and; (b) other fees that arise in certain circumstances (such as performance fees).
- Again, from January next year, where either a UCITS or a Non-UCITS retail fund is sold through an intermediary, MiFID2 will require the intermediary to issue a “MiFID Costs and Charges Information Document” to its client which will include a single all-in figure for the “Product Costs”. The intermediary may provide a breakdown of that single cost figure into its different components including (a) one-off costs; (b) ongoing costs; (c) transaction costs and; (d) incidental costs. The intermediary will be required to disclose as a separate single figure its own service cost.
If we have understood the interaction of the above regulatory requirements correctly, different sets of information will be provided to an investor depending on the nature of the investment and whether they purchase direct or through an intermediary. So, during the course of next year, if an investor subscribes for a share in a UCITS direct from the authorised fund manager, they will only be provided with the UCITS KIID (which will give costs figures but will exclude transaction costs). If the same investor invests through a platform, the investor will receive two documents: (a) the UCITS KID (with costs figures excluding transaction costs); plus (b) the MiFID Costs and Charges Information Document (with cost figures including transaction costs) - so, investors investing through a platform may be better informed - but, perhaps, confused by the different sets of costs information and what it all means. Perhaps it is this potential inconsistency and confusion that the FCA will look to address in its consultation later this year.
The FCA is currently consulting on the requirement for fund managers to return any risk-free box profits to the fund and disclose box management practices to investors. This is in respect of dual-priced funds where there is a spread between prices to buy and sell the fund.
“Risk free” profits arise where the manager matches the day’s redemptions with that day’s subscriptions such that the spread between the bid and offer price for units in the fund creates a risk free profit for the manager.
The final report acknowledged that dual pricing can benefit existing investors by protecting them from the effects of dilution and does not propose to stop firms from operating dual priced funds. However, the FCA agrees with the majority of respondents to the interim findings, who suggest that risk-free box profits should not accrue to the manager. The FCA is therefore proposing (in CP 17/18) that:
- authorised fund managers must pass risk-free box profits back to the fund, and
- the authorised fund manager’s approach to box management must be disclosed in the fund prospectus.
Switching share classes
The final report notes that it should be easier for fund managers to switch investors to cheaper share classes. The report proposes a modification to the FCA’s Finalised Guidance: Changing customers to post-RDR unit classe
s (FG14/4) to clarify that when dealing with unresponsive unitholders, the authorised fund manager can undertake a mandatory conversion if the following conditions are met:
- the power to undertake a mandatory conversion must be set out in the prospectus in line with COLL 4.2.5R5(d)
- the authorised fund manager must have made all reasonable attempts to contact unitholders, and
- the authorised fund manager is satisfied on reasonable grounds that the change will not result in detriment to investors.
This is a sensible, practical step to overcome investor inertia when it is clearly in investors’ best interests for the fund manager to act. The FCA is currently consulting (in CP 17/18) on this proposed clarification to FG14/4.
The FCA is seeking views on whether it should also consider introducing a phased-in sunset clause for trail commissions. This is another perceived impediment to moving investors to low charging "clean" share classes as legacy trail has to continue being paid, despite the (arguable) lack of ongoing service from relevant advisers. The FCA would like firms to provide information about trail commission payments to advisers on share classes sold prior to 31 December 2012.
Prescribed Responsibility to act in the best interests of investors under the Senior Managers and Certification Regime (SM&CR)
The FCA no longer proposes to introduce a statutory duty to act in the best interest of investors on the basis that FCA Principle 6 (A firm must pay due regard to the interests of its customers and treat them fairly) already embeds a duty to act in the best interests of investors and some regulated firms are subject to more specific duties for example, in the case of UCITS management companies to act solely in the interests of the UCITS and its unit holders. Instead the FCA believes it will secure “value for money” for investors through regulatory reform to embed accountability.
One of the reforms proposed in the final report is a consultation (as part of the wider consultation on the extension of the SM&CR later this year) to introduce a new and specific Prescribed Responsibility under the SM&CR. The FCA proposes that this Prescribed Responsibility will be held by the chair of the authorised fund manager board, who will be responsible for taking (and being able to demonstrate) “reasonable steps” to ensure that the authorised fund manager and its board is operating in compliance with the FCA’s current and proposed rules in this space (which would include the rules concerning assessing value for money on an ongoing basis).
Practical consequences of this proposal would mean that a Senior Manager would:
- need to be approved by the FCA (who look at competence, fitness and proprietary, interview)
- need to have a Statement of Responsibility, and
- be exposed to personal liability (through enforcement action) if the FCA considered the rules had been breached.
Value for money
In the final report (and in CP 17/18), the FCA also proposes a new “value for money rule”, which would require authorised fund managers to assess whether investors had received value for money on an ongoing basis and which would need to be documented formally on an annual basis (as part of each fund’s annual report or through a separate dedicated report).
The FCA proposed that any “value for money” assessment should at least consider:
- Economies of scale - authorised fund managers must identify economies of scale in the direct and indirect costs of operating funds, consider the introduction of break points and consider whether any savings should be shared with investors.
- Fees and charges - authorised fund managers must assess whether charges are reasonable in relation to the costs incurred, including by considering charges applied to similar sized institutional mandates.
- Share classes - authorised fund managers must consider the different share classes available to investors and whether each class represents value for money. Where multiple classes are available, the authorised fund manager must assess and explain why some investors are in more expensive classes.
- Quality of services - authorised fund managers must assess the quality of services investors are receiving, identify the criteria used and explain the results of that assessment.
Under the FCA’s proposals, the value for money assessment published by the authorised fund manager would include (i) an analysis of the assessment performed by reference to each of the minimum requirements, (ii) a description of the tasks undertaken and the outcomes achieved in order to discharge the obligations to achieve value for money, and (iii) an explanation of the steps taken to address any poor value for money practices identified as a result of the ongoing assessment performed by the authorised fund manager. The FCA considers that requiring transparency in this area will lead to managers competing to show publically how they have acted to effect value for money in a way that will be picked up by industry commentators, platforms and intermediaries.
Significantly, the also FCA proposes that failure to take sufficient steps to remedy poor value for money practices may be relied on as tending to establish a contravention of the relevant rules and the work done in assessing value for money (including the published report and working papers) is likely to be a target for unhappy investors.
The final report and CP 17/18 also proposes governance changes at authorised fund manager level to the effect that:
- authorised fund managers must appoint at least two independent directors to the board
- independent directors must make up at least 25% of the authorised fund manager board
- authorised fund managers must ensure that information reasonably requested by the independent directors is provided in a complete and timely manner, including data and other information which may be considered to be commercially sensitive or confidential
- independent directors must be appointed for terms of no longer than five years with a cumulative duration of ten years, and
- no limit on the number of authorised fund manager boards on which independent directors may serve, which clearly brings challenges in terms of the sharing of market sensitive information.
The FCA estimates that approximately 480 independent directors will be required across the industry in order to meet these requirements. The FCA acknowledges that finding this number of experienced directors might be challenging, but that this should be feasible if there was a 12 month implementation period following the rules being finalised.
Investment advice market
In the interim report, the FCA proposed to refer the investment advice market to the CMA for further, in-depth review. The final report affirms its interim findings, namely that investors find it difficult to assess the advice they receive from investment consultants; there are low levels of switching in the market; and that the investment advice market is relatively concentrated.
Three of the largest investment advice firms (whom the FCA estimate make up over 60% of the advice market) submitted “undertakings-in-lieu” in order to avoid a market investigation reference to the CMA. However, the FCA is minded to reject these undertakings. The undertakings that were offered included:
- an undertaking to encourage regular competitive tendering of investment advice services
- a commitment to product industry standards for public disclosures of performance for both manager selection (active management) and fiduciary management (whole funds), and
- a commitment to be more transparent on fees and cost structures for fiduciary management services.
The FCA is minded to reject these undertakings, as it thinks they do not go far enough and that the CMA is better equipped to undertake a full analysis of competition issues. It is therefore consulting on the undertakings-in-lieu and a referral to the CMA until 26 July 2017, with a decision due in September.
The FCA has also recommended that investment advice be brought into its regulatory perimeter, suggesting that the FCA considers regulation to be the solution for the problems it has identified with this industry.
Extending the scope of the FCA’s proposals to other retail investment products
The FCA has raised “for discussion” a suggestion that it should extend the scope of its proposals to other retail investment products such as: unit-linked and with-profits funds, pension funds and investment companies which together account for a very significant amount of retail investment business. It argues that from the investor’s perspective the products share many common features and that investors expect the same or similar outcomes.
In overview, the FCA notes that these products are subject to their own governance regimes which, in the case of unit-linked funds, have been the subject of recent change. The FCA nonetheless is looking for views from stakeholders as to whether some or all of the proposals in the Final Report could and should be applied to these other retail products.
What comes next?
The FCA’s asset management market study was launched to investigate competition in the industry. The final report notes that there are some signs of competition, but this is not strong - firms are able to be highly profitable and there is significant price clustering. However, its remedies arguably go beyond addressing a lack of competition in the market.
Instead, the FCA’s final report proposals seem to be part of an ongoing regulatory trend, where change in firm behaviour is brought about by increasing the level of direct responsibility and accountability of key individuals. The FCA also seeks elements of standardisation of disclosure across the fund industry, to ensure transparency and to enable informed investor decision making. In this regard the FCA will soon launch an entirely new market study into the way investment platforms operate in relation investor costs and the fund distribution chain.
In terms of the asset management market study itself, the FCA’s consultation in CP 17/18 on the proposed remedies in relation to risk-free box profits; share class switching, best interest reforms and trail commission payments closes on 28 September 2017. Its consultation on the proposed referral of the investment advice market to the CMA closes on 28 July 2017. Therefore, although this market study is concluded, the FCA clearly feels it has more work to do in the asset management space.
The FCA has now referred the investment advice industry for an in-depth review.