On 28 June 2017, the FCA published both its final report on the Asset Management Market Study (the Final Report) and a consultation paper which looks at implementing some of the remedies and changes to the FCA Handbook (CP17/18).
The Final Report confirms both the findings set out in the interim report and a number of the remedies that were proposed back in November 2016. Those remedies will build on a number of forthcoming regulatory frameworks, namely: MiFID II and PRIIPS, in relation to investor protection disclosures; and the extended senior managers and certification regime in relation fund managers acting in the best interests of their investors.
In this article, we provide an overview of the proposed remedies set out by the FCA in light of its findings and consider when these are likely to be implemented and therefore directly impact your business.
What were the findings?
The findings discussed below focus on a number of key topics and drive the package of remedies being suggested. This will leave a substantial “to do” list for the regulator with further consultations published and expected, and new areas to be considered for regulation. So to an extent, the industry remains in a position of wait and see.
The FCA’s findings focus on:
- price competition – the FCA found weak price competition in a number of areas of the asset management industry, and also commented on the persistently high levels of profit earned by asset management firms (as one indication of weak competition). The FCA specifically commented on the fact that charges for retail investors are typically higher than for institutions, which it considered was not fully explained by higher costs of servicing this sector; nevertheless, the FCA made no specific proposals in this regard;
- performance – the FCA found that on average both actively and passively managed funds failed to outperform their own benchmarks after fees and that there was no clear relationship between charges imposed and the gross performance of retail active funds;
- clarity of objectives and charges the FCA has concerns about how asset managers communicate their objectives and that investors’ awareness and focus on charges is mixed and often poor;
- investment consulting and other intermediaries – the FCA found that some institutional investors, typically the smaller ones, rely heavily on investment consultants. It also had certain concerns about the investment consultancy market; and felt that retail investors do not appear to benefit from economies of scale when pooling their money through consumer platforms.
What are the proposed remedies and when will these proposals impact your business?
The final report states that implementation of the remedies will take place in a number of stages. Some do not require consultation and are being taken forward immediately; whilst others will be consulted on later this year. As a result, the remedies are split into three categories – each of which is summarised below.
1. Final remedies to be implemented immediately
HM Treasury should consider bringing investment consultants into the regulatory perimeter
This applies to those that advise on asset allocation, which is not currently regulated as long as no investment-specific advice is given.
DWP should remove certain barriers to pension scheme consolidation and pooling
The FCA recognises that some DB schemes may benefit from pooling, but that there are barriers restricting this at the moment. Although the removal of these barriers could encourage pooling this will require legislation to be changed and further guidance to be issued to trustees. The FCA agrees that whilst there are opportunities for pooling, it is not necessary to make this mandatory. As a result, the FCA will work with the DWP to take this forward.
Industry and investor representatives should agree a standardised disclosure of costs and charges to institutional investors
The FCA is proposing to ask an independent person to convene a stakeholder group to develop a standardised template for disclosure of costs and charges to institutional investors. Following this, it will work with stakeholders to consider whether any other action is necessary to ensure that institutional investors get the information they need to make effective decisions.
The FCA has indicated that this will also be applied to private equity and hedge funds, despite those funds being outside the scope of the AMMS. This is an area on which any alternative investment fund manager would therefore be advised to keep an eye for further developments. The current market study did not include private equity funds or hedge funds, but there is some suggestion amongst industry commentators that this type of fund may be next on the FCA’s list more generally.
The FCA’s thinking here appears slightly at odds with its separate comments made in respect of MiFID II implementation, noting that:
- MiFID II, when it takes effect in January 2018, will impose increased obligations on MiFID firms with regard to disclosure on costs and charges;
- The FCA specifically comments in the Final Report that it considers the information required by MiFID II will give institutional investors a clear understanding of the costs and charges that they are incurring; but
- In its subsequent Policy Statement on the implementation of MiFID II issued this July (PS 17/14) the FCA confirmed that it will not, for now, consider proposing a standardised format setting out disclosure requirements. Unless a firm is carrying on MiFID scope business but is exempt as a result of Article 3 (this would not cover AIFMs, who are exempt under Article 2 unless they are also separately carrying on MiFID business alongside their fund management business), its existing disclosure rules will continue to apply to firms doing non-MiFID business. In other words, it is not proposing to extend the MiFID II rules to AIFMs at present; nor is it proposing to impose a standardised reporting format.
The FCA will launch a market study into investment platforms
Building on the proposal in its interim report for further work on the retail distribution of funds, the FCA announced that it would conduct a market study into “direct-to-customer” and intermediated investment platforms. In particular, the FCA indicated that the study would likely examine:
- how direct-to-consumer and intermediated investment platforms compete to win (and retain) new customers; and
- whether and to what extent these types of platforms enable retail investors to access investment products that offer value for money.
On 17 July 2017, the FCA published its terms of reference for the study.
2. Remedies which are subject immediate consultation
The FCA considers that if the majority of investors are unlikely to drive value for money, they require strong fund governance measures to look out for their interests. It proposes, therefore, a number of measures to improve governance:
- value for money – the FCA is proposing to introduce a new rule requiring fund managers to assess whether value for money has been provided to fund investors. This assessment would need to take place on an on-going basis and be formally documented at least once a year. It would need to cover certain prescribed areas, such as fees and charges, and quality of services; and
- directors – the FCA is proposing that asset managers should include a minimum of two independent directors on their boards, or have independent directors make up at least 25% of the total board membership. These independent directors would need to meet certain criteria and could only be appointed for a set length of time. The proposals would apply regardless of the size of the fund manager.
Risk-free box profits
The FCA proposes to prohibit fund managers from retaining risk-free box profits (requiring these profits to be passed to the fund) and to require fund managers to disclose their approach to box management in the fund prospectus, in order to increase transparency for investors.
Switching investors to better value share classes
The FCA is consulting on proposals to facilitate switching, by clarifying in its guidance that a fund manager can undertake mandatory conversion in certain circumstances, when dealing with an unresponsive unitholder.
Consultation on investment consultancy market investigation reference (MIR)
In its interim report, the FCA provisionally decided to make an MIR to the CMA in relation to the market for investment consultancy services.
In response, the three market leaders proposed a series of “undertakings in lieu”, hoping to address the FCA’s concerns and fend off a full market investigation. However, the FCA indicated in its Final Report that it was provisionally inclined to reject the proposed undertakings and consulted separately in order to take a final decision in September. On 14 September 2017, the FCA published its decision to refer the supply and acquisition of investment consultancy services and fiduciary management services to institutional investors and employers in the UK to the CMA for a market investigation.
In addition to these remedies, CP17/18 goes on to consider two things which may be of relevance. Firstly, it asks for views on whether the FCA should consider introducing an end to the payment of trail commission. The regulator specifically asks whether it should stop the payment of historic trail and if so, over what time period. It asks whether firms face contractual or other barriers in switching off trail without regulatory intervention.
Secondly, it considers whether some of the proposals in this consultation should be extended to include other retail investment products, specifically mentioning investment companies. The FCA is not consulting on rule changes for these sectors at this stage, but sets out some early thoughts on the issues and invites stakeholders to comment – specifically asking for views on whether it would be appropriate and proportionate for the FCA to consider introducing similar rules for investment companies, and whether there is a risk of investor harm or disruption to the market if they don’t do so.
3. Remedies to be consulted on later this year
Disclosure of a single all-in fee to investors
Whilst the interim report had prepared the industry for the possibility of an “all-in fee”, the FCA concluded in the Final Report that it did not, at this stage, intend to move forward with any one of the options originally proposed.
Instead, it recognises the work being done in these areas under MiFID II and PRIIPs and has chosen to concentrate on disclosure and transparency instead of any radical change to the way in which charges are packaged. The FCA is considering, for example, whether wider use of pounds and pence disclosure should be introduced and the benefits of consistency between point-of-sale and on-going disclosures.
Consulting on benchmarks and performance reporting
The FCA will consult on whether performance fees should be allowed only where the fund performs above its most ambitious target.
Introducing a working group on investment objectives
The FCA is continuing to explore options to improve the language used in, and clarity of, objectives. To this end, the FCA will chair a working group on the issue and consider whether that group’s output should be turned into rules on how fund objectives should be written.
Other comments of interest in the Final Report
The FCA commented briefly on some responses received which noted that MFN provisions can act as a barrier to fee reductions. However, the FCA concluded that it did not see significant or specific evidence to suggest that any regulatory intervention was required in this regard.
In addition to the points outlined above, the FCA comments in the Final Report that the engagement process with the industry identified a lack of understanding of how competition law impacts the asset management industry. Whilst much of the report does not require immediate action from the industry, we would advise firms to consider the findings and proposals identify areas of concern for their particular business models and start considering how each, including the competition remit could or should be tackled. The FCA will expect firms to act quickly when proposals are finalised and ensuring changes have been considered in sufficient detail ahead of go live dates will be hugely beneficial commercially and in terms of relationships with the regulator.