The FCA found that retail investors do not usually have the ability to negotiate with asset managers and that fund governance bodies acting on their behalf do not typically focus on value for money. The FCA considers that fund governance bodies should have a more defined role in driving better outcomes for investors and increased accountability for those outcomes.
What’s the background to this proposal?
On 28 June 2017, the FCA published its final report and consultation paper 17/18 in respect of its asset management market study. The study was launched in November 2015 to explore whether competition was working effectively in the asset management sector and whether institutional and retail investors are getting value for money when buying asset management services.
What is our view?
One is enough?
There will be a wide range of views on these proposals. They will include views on why the requirements are to have at least two directors and at least 25% of the board as independent NEDs? In a board of nine, this means three independent NEDs. Surely, if independent NEDs are needed, one is enough?
Inconsistent with directors’ duties?
We think the proposed new regulatory duties and directors’ duties under the Companies Act can be reconciled. In order to promote the success of the company, the company (and its senior managers) must comply with their regulatory requirements. At one stage, there was discussion about amending directors’ Companies Act duties to preserve the financial safety and soundness of a bank but after a while the view was taken that this was already part of the duty to promote the company’s success.
Must the Chairman be an independent NED?
The FCA proposals are rightly open-minded about whether the chairman has to be an independent NED. Given the proposed responsibilities of the chairman as a senior manager, independent NED candidates may be reluctant to take on the role of chairman unless that role is suitably substantive and remunerated to take on those regulatory responsibilities. While it is not unlawful for one person to be a director of two companies which directly compete against each other, in practice, the conflict of interest can be very difficult to manage. If the independent NEDs (like other directors) are to get access to the commercially confidential information about the fund to which they are entitled and need, we foresee it as very hard to manage the conflict if the same person is an independent NED on the board of another AFM directly competing with the first one.
Consistency with the SMR?
These proposals need to be read alongside the proposals for the extension of the Senior Managers and Certification Regime (SMR) to the category of AFMs which are neither Core Firms nor Enhanced Firms, the so called Limited Scope Firms, which would be outside the SMR (and so not required to have senior managers) but within scope of these governance proposals and therefore required to have, at least, two independent NEDs and at least 25% of their board as independent NEDs. At least at the smaller end of the Limited Scope Firms, this feels disproportionate and quite possibly not practical.
Inconsistency with the SMR?
There appears to be a disconnect between the two consultations. This one contemplates that the chairman can be either an independent director or an executive. The consultation on extending the SMR envisages that the chairman of Core and Enhanced Firms would be a non-executive.
Value for money?
So, one size never did fit all. The FCA’s governance proposals cannot be viewed in isolation, they are secondary to the fundamental issue of the ability of the board of an AFM to understand and apply the concept of “value for money”. The FCA propose that “value for money” should at least consider factors such as the sharing of economies of scale, the reasonableness of fees and charges, the appropriateness of share classes and the quality of services received by investors, but these proposals are themselves subject to consultation and the assessment of value for money is itself a complex issue.
The deadline for responding to the consultation is 28 September 2017. We will be submitting a response and, in the meantime, would welcome views and feedback on these proposals and points for our consultation response.
How important is the UK asset management industry?
The UK’s asset management industry is the second largest in the world, managing £6.9tn of assets. Over £1tn is managed for UK retail (individual) investors and £3tn managed on behalf of UK pension funds and other institutional investors. The industry also manages around £2.7tn on behalf of overseas clients.
What does the FCA’s final report say?
The final report broadly confirms the findings identified in the interim report including:
- finding 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.
But, it does delay the implementation of some controversial remedies, including the introduction of a compulsory all in fee, until further consultation has been conducted. The final report does, however, propose a new “value for money rule” requiring AFMs to assess whether investors have received value for money on a continuing basis.
Will there be a new statutory duty to act in the best interests of investors?
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 interest of its customers and treat them fairly) already embeds a duty to act in the best interests of investors.
What changes to the governance of an AFM board are proposed?
The final report and consultation paper 17/18 also proposes governance changes at the AFM board level to the effect that:
- AFMs must appoint at least two independent directors to the board
- independent directors must make up at least 25% of the AFM board
- AFMs 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
- there would be no stated limit on the number of AFM boards on which independent directors may serve.
Which AFMs are in scope for the proposals?
The FCA’s proposals apply to all UK-authorised firms that carry out the function of an AFM for collective investment schemes that are authorised and domiciled in the UK, as well as a UK Undertakings for Collective Investments in Transferable Securities (UCITS) management company managing EEA UCITS schemes. They will not apply to UCITS management companies domiciled in the EEA that are accessing the UK market through the UCITS management passport, nor to full-scope alternative investment fund managers that operate UK funds, or market funds domiciled in the EEA in the UK.
Why is the FCA not proposing a limit on the number of NED board appointments one person can have?
The FCA is aware that issues could arise from sharing potentially market sensitive and confidential information if the independent directors serve on more than one board. But, it considers a series of controls exist in many sectors and that in particular it expects firms to comply with existing laws, including competition laws and so does not think is necessary to introduce a rule to limit the number of AFM boards on which a non-executive director may serve.
Is there a conflict with Companies Act duties of directors?
In relation to concerns that an independent director would be subject to company law which requires an independent director to promote the success of the company just as much as an executive director, the FCA acknowledges this point and recognises the legal duties of independent directors to the shareholders of AFMs are the same of those of the executive directors. But, it considers these duties will require the assessment of the best interests of a company beyond measuring financial success and that independent directors will bring an external perspective, supporting executive directors to fulfil these duties.
Will there be a transitional period?
The FCA recognises that recruiting approximately two-three independent directors for each AFM will create a challenge across the industry. It is proposing an implementation period of 12 months following the finalisation of these rules but welcomes representations on how feasible these timings are.
How many independent NEDs are needed?
The FCA’s supervisory experience indicates that AFM boards generally have five-eight directors, with typically no independent directors. Under the proposed requirement for at least 25% of AFM boards to consist of independent directors, and a minimum of two directors on each board, an AFM board with six members will need two independent directors, while AFMs with seven (to nine) would need three independent directors.
The FCA expects approximately 480 independent directors to be required. They consider that independent directors need to have sufficient experience and expertise to fulfil their role effectively but previous financial services expertise is not necessarily a pre-requisite for becoming an independent director of an AFM.
How much will independent NEDs be paid?
For each AFM the FCA has estimated (for the purpose of its cost benefit analysis) that each independent director will receive £40,000 a year in salary and other payments.
What does independent mean?
Acording to draft handbook rule changes, independent directors must be independent natural persons and not therefore corporate directors. The determination of whether a director is independent is made by the AFM. It must also take reasonable steps to ensure that independent directors have sufficient expertise and experience to be able to make judgements on whether the AFM is managing its scheme in the best interest of investors.
A member of an AFM’s governing body is unlikely to be considered independent if any of the following circumstances exist. They should not:
- be an employee of the AFM group or remunerated by them for any role other than as an independent board member. This includes not participating in any share option or performance-related pay scheme of the AFM group
- have been an employee of the AFM group (or any person to which the collective portfolio management of the scheme has been delegated) within the five years before their appointment
- have had any sort of material business relationship with the AFM group (or any person to which the collective portfolio management of the scheme has been delegated) within the last three years, and
- have received any sort of remuneration from the AFM group within the five years before their appointment.
For host AFMs, these requirements would apply to any commercial relationship the independent director has with the portfolio manager to whom the host AFM has delegated the portfolio management functions. And, independent members of host AFMs must not have been employed by the host AFM company for at least five years before their appointment.
How will SMR apply to the governance of UK asset managers?
On 26 July 2017 the FCA published its consultation paper 17/25 on the extension of the SMR. This includes the new and specific prescribed responsibility1 for the chairman of an AFM board (as previewed in its final report), who will be responsible for taking (and being able to demonstrate) “reasonable steps” to ensure that the AFM and its board is operating in compliance with the FCA rules (including the proposed rule about assessing value for money on a continuing basis). The FCA also proposes amendments to the COLL Handbook to embed this responsibility. But, the FCA do not plan to mandate that the Chairman must be an independent NED.
The practical consequences of these proposals would mean that the senior manager (for Core Firms and Enhanced Firms) would:
- need to be pre-approved by the FCA (who will assess fitness and propriety and possibly conduct interviews before granting approval)
- need to have a Statement of Responsibility setting out clearly the areas that they are responsible for, and
- be exposed to personal liability (eg enforcement action) if the FCA considers they (i) are responsible for the management of activities in their firm in relation to which their firm contravenes a regulatory requirement; and (ii) do not take such steps as a person in their position could reasonably be expected to take to avoid the contravention occurring (or continuing).
Senior managers of Enhanced Firms (firms which meet certain criteria including assets under management (AUM) of £50bn or more at any time with the previous three years) will be subject to additional requirements under SMR including (generally speaking) additional senior management functions and prescribed responsibilities, Responsibilities Maps and Handover Procedures. For more information please visit our dedicated SMCR extension microsite.
What’s on the bright side?
Looking on the bright side (as one must) there is an opportunity for the asset management sector to exceed achievement of all known diversity targets through the appointment of additional independent but diverse NEDs, as a result of these proposals.
Prescribed Responsibility 7 for Core Firms and Enhanced Firms and Prescribed Responsibility 9 for non-EEA branches “Responsibility for an AFM’s value for money assessments, independent director representation and acting in investors’ best interests”. This does not apply to Limited Scope Firms.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.