The Financial Conduct Authority (FCA) has published its much anticipated final report of its Asset Management Market Study. Although many of the proposals were trailed in the interim study, and remain subject to consultation, the report is wide-ranging and is likely to have a far-reaching impact on the asset management industry. Importantly, the FCA has detailed new proposals on governance arrangements, requiring that the Board oversees obligations imposed on fund managers prescribed through the Senior Managers Regime around acting in the customer’s best interests.The FCA has also restated its support to the disclosure of a single all-in-charge inclusive of an estimate of transaction costs and has proposed other measures to ensure that asset managers provide greater transparency around their objectives and charges. While there are limited immediate actions for firms following the publication of the final report, firms will need to be aware of the material changes in prospect, particularly around accountability and disclosure.
The FCA’s final findings
The FCA has found that there is “weak” price competition in some areas of the asset management industry. In particular, its findings suggest that retail investors or smaller institutional investors are not always getting a “good deal”. The report openly juxtaposes the high levels of profitability and average profit margins of 36% - identified as amongst the highest of any UK economic sector - for the firms sampled, with a lack of price competition in a number of areas. The FCA’s measures are, therefore, intended to enable investors, through their improved understanding of charges and fund objectives, to exert greater pressure on asset managers to become more competitive.
One of the criticisms from the industry following the FCA’s interim report, was that the FCA’s findings appeared to suggest that passive funds were preferable to active funds. While the final report stipulates that this is not the case, it also notes that, on average, both actively managed and passively managed funds did not outperform their own benchmarks after fees and there is no clear distinction between charges and the gross performance of retail active funds in the UK. The FCA’s proposals are intended to address these issues, but the implication of this stance is that ultimately passive management provides better value for money than active.
The FCA is also concerned that investor awareness and focus on charges is mixed and often poor, or non-existent. For example, its “clickstream data” findings on engagement suggest that of the visits to the website to look at funds during a 6 day sample period, fewer than 9% of customers looked at charges; under 3% looked at documents (including the Key Investor Document mandated under the Packaged Retail Investment and Insurance Products Regulation); and, remarkably no more than 0.1% sorted funds by charges (an activity that the FCA takes as indicative of a wish to minimise charges).
From a fund governance perspective, the FCA found that the relevant bodies tended to lack independence and did not appear to exert effective challenge on value for money. In particular, AFMs often do not compare the asset manager’s fees for managing a retail fund’s portfolio with the fees the asset manager charges comparable institutional accounts.
Further, the FCA found that firms do not disclose some charges, particularly transaction costs, to investors before they make investment decisions.
Issues regarding investment consulting and other intermediaries are also raised. In particular, there are strong concerns around the relatively high and stable market shares for the three largest providers, a weak demand side, relatively low switching levels and conflicts of interest in the consulting market.
Overview of Proposed Remedies
The FCA has set out a vast package of proposals. Nevertheless most of these are subject to further consultation:
- Strengthening the duty on fund managers to act in the best interests of investors through regulatory reform which clarifies FCA expectations around value for money, increasing accountability under the Senior Managers and Certification Regime and introducing a minimum level of independence in governance structures. These requirements will include at least two independent non executives on the fund board.
- The disclosure of a single all-in fee to investors (MiFID II will introduce this for intermediaries). This will include the asset management charge and an estimate of transaction costs and has been a source of some concern for the industry. Importantly, the FCA appears not to want to go beyond the information disclosures prescribed by MIFID, but instead to explore additional ways in which the costs can be presented, for example through “pounds and pence” presentations. Note again, however, that the FCA has yet to cross the Rubicon here: it will consult on any proposals later this year. The FCA is asking that both industry and investor representatives agree to a standardised template of costs and charges, as it considers that the way in which this information is presented to investors will affect how the information is used. A consultation will be released later this year.
- Benchmarks and performance reporting to be consulted on later this year, including whether performance fees should only be permitted above the fund’s most ambitious target after ongoing fees.
- Requiring fund managers to return any risk-free box profits to the fund and disclose box management practices to investors.
- Launching a market study into investment platforms in short order. The FCA will assess the extent to which platforms are dependent on third party fund rating firms and how platforms ensure any conflicts do not affect the quality of information they make available to investors and financial advisers.
- Facilitating switching investors to cheaper share classes. The FCA will consider introducing a phased-in sunset clause for trail commissions.
- A recommendation that the Treasury considers bringing investment consultants into the regulatory perimeter, subject to the outcome of the provisional market investigation by the Competition and Markets Authority.
- A recommendation that the Department for Work and Pensions removes barriers to pension scheme consolidation and pooling.
- Convening a working group on objectives and consulting on any rule changes at a later stage, subject to the outcome of the working group.
Importantly, the FCA is not asking firms to implement any changes just yet. Most of the remedies set out in the report will be subject to consultation, but, if ultimately implemented, these changes will have a profound effect on the industry. Indeed, the proposals set out in the report provide another compelling example of how the FCA can exercise its competition powers to address its consumer objectives.
The proposals on governance are likely to be among the most significant for firms. They will require changes to individual accountability, to fee charges and well established current practices. The FCA intends to introduce a new prescribed responsibility on the chair of AFM Board to act in the best interests of investors to increase the Board’s effectiveness to influence decisions. It has also proposed a new rule to require the AFM to assess whether value for money has been provided to fund investors and assess whether charges are reasonable in relation to the costs incurred. This will result in significant shifts in policies, fund managers reasoning and documentation.
On benchmarks and reporting, the FCA intends to consult on requiring managers to be clear about why or why not a benchmark has been used. Where managers present past performance, they must do so against the most ambitious target held out to investors. This – along with the requirement for the fund manager to return any risk-free box profits to the fund – will result in a material shift in current practice for the industry and, for some firms, a negative effect on profits.
The investment platforms study is likely to result in significant changes, particularly in areas such as conflicts of interest and transparency that could lead to a further compression of margins longer term.
There is also likely to be greater work for firms around disclosures, which build on the requirements of PRIIPs and MiFID II around presentation of costs and charges. This may come at a time when firms are already struggling to finalise implementation plans in advance of the 1 January 2018 deadline for PRIIPs and 3 January 2018 deadline for MiFID II.
The overall direction of travel is clear and, through competitive pressure, is likely to lead a steady, on-going compression of the margin between active and passive fund management costs. That said, implicit in the FCA’s competition analysis is that asset managers have sufficient margin to absorb the cost of these changes. New entrants to the market may use the proposals set out in the report as a basis for providing greater disclosures and obtaining a competitive advantage against incumbents. The review of platforms could also well lead to further downward pressure on the aggregate fees retail investors pay to invest their money.