On 18 November 2016, the FCA published an interim report in relation to its asset management market study. This interim report was due to be published in the summer of 2016 but the timeline has been stretched, both due to changes at the FCA and by the volume of material that has been gathered.
The FCA uses market studies as a tool for examining the way in which competition works in financial markets, and to assess whether it should intervene or act in any way. The asset management market study was launched in November 2015 to examine whether competition is working effectively in the asset management sector – to enable both retail and institutional investors to obtain value for money when purchasing asset management services. The FCA is also interested in understanding whether there are any barriers to innovation or technological advances which may be preventing new ways of doing business that could benefit investors. The interim report sets out the FCA’s current analysis, and invites comments from industry bodies ahead of the publication of the full report, which is expected in the first half of 2017.
Key features of the interim report
The introduction to the interim report states that in the asset management industry “the investor bears virtually all the risk”. It is therefore clear that the FCA wants more protection for investors. The interim report sets out a variety of proposed measures to remedy what it feels is a lack of competition in the asset management sector, and to redress the risk balance between investors and managers.
- Best interests of investors: The interim report suggests that there should be a strengthened duty on asset managers to act in the best interests of investors, and suggests that the final report will include reforms that will hold asset managers accountable for how they deliver value for money.
- Ability to negotiate: The FCA suggests that only the biggest institutions are able to negotiate fees effectively. In the case of retail investors, the FCA has found that there is no ability to negotiate directly and that fund governance bodies representing retail investors’ interests do not focus on value for money. In the case of small pension schemes, the ability of the pension trustees to negotiate price varies. However, generally, smaller pension schemes are less well-resourced and knowledgeable and have weaker bargaining positions. The FCA therefore concludes that significant cost savings could be achieved by pooling of pension scheme assets and proposes to explore the potential benefits of greater pooling with the government.
- Independence element on fund oversight committees: The interim report states that fund governance bodies, whether in-house or outsourced, lack independence from the fund managers and do not appear to effectively challenge value for money. Oversight bodies should be independent of the funds they are monitoring. Boards should have a majority of independent members and an independent chair.
- All-in fees: It can be hard for an investor to compare fees and expenses across different funds. Introducing an all-in fee approach to quoting charges will enable investors to easily see what is being taken from the fund. The interim report goes on to state that asset managers should be required to be clearer about communicating fund charges to investors, in particular retail investors, and the impact these charges have upon investor returns. The report did not go so far as to introduce a cap on the fees that asset managers charge, but it was clear that the FCA wants managers to justify fees – especially where large fees are charged despite poor performance of funds.
- Extra transparency: It is acknowledged that there is a greater need for transparency across the asset management industry. The FCA recognises that there has been a shift in recent years towards improved transparency and that institutional investors are increasingly pushing managers for greater clarity and comparability. The FCA is concerned, however, about how asset managers communicate their objectives and outcomes to investors, particularly where funds are actively managed (and therefore expensive) but are only mirroring the performance of the market. Asset managers will be required to be clearer about the objectives of a fund, and report against these on an on-going basis, using appropriate benchmarks.
- Active/passive funds: The evidence gathered suggests that whilst actively managed investments have substantial costs, they often do not outperform their benchmark after costs and some active funds actually offer similar exposure to passive funds, but charge significantly more. Since the interim report was published, the Financial Times has reported that passive fund managers are “poised to profit” from the FCA’s findings, as active managers will come under pressure to justify their fees.
- Competition Markets Authority (CMA): The FCA intends to consult on whether to make a market investigation reference to the CMA for in-depth investigation of the institutional investment advice market. The report highlights that there is very limited scrutiny of the asset allocation advice given by investment consultants and the quality of this advice, in terms of the returns it generates or the value added, is not measured or monitored in any consistent and comparable way. The FCA therefore believes that the market for investment consultancy advice would benefit from an investigation and that the CMA is best placed to carry out such investigation.
- HM Treasury: The FCA is considering recommending that HM Treasury brings the provision of institutional asset allocation advice within the FCA’s regulatory perimeter. This is an important part of the asset management sector that is currently unregulated. Bringing this within the FCA’s regulatory ambit would not only improve regulatory oversight on this activity, it would also mean that the FCA would be in a position to implement any recommendations put forward by the CMA should it undertake a market investigation reference.
Practical impact for the industry
Whilst the study is being conducted under a competition banner and only a relatively small number of industry participants were interviewed for the report (37 asset managers, 13 investment consultants and 8 platforms), the proposals go much further than simply addressing competition issues. It is worth noting that the study has adopted a very broad definition of “asset management“. It covers a wide range of industry sub-sectors, including: collective portfolio management, segregated mandates, wealth management, investment advisers and providers of ancillary services (such as custody or fund administration) and third party products and services (including, for example, stock lending services and benchmarking data). The interim findings are therefore relevant to, and will have a fundamental impact on, the entire industry.
The Investment Association has welcomed the interim report and the “spirit behind [the report] to improve confidence in the industry“. The interim report has been well received within the market, perhaps with relief that the report does not suggest the introduction of more extreme measures, such as price caps. However, the tone of the report is such that asset managers will be left in no doubt that the FCA is serious about improving the asset management sector for investors, with focus on governance, fee clarity, and transparency around investment objectives all aimed at making it easier for investors to compare services offered and make a more informed choice as to how to invest.
It is expected that the FCA’s final ruling on the asset management industry will be published in the first half of 2017.