As part of a wider package to improve competition in the asset management industry, the FCA has published its first set of rules and remedies aimed at promoting the overall value offered by authorised fund managers (AFMs) to investors.
The changes apply to UK AFMs in respect of authorised funds (authorised open-ended collective investment schemes).
In Consultation Paper 17/18: Consultation on implementing asset management market study remedies and changes to Handbook (CP17/18), the FCA consulted on proposals to change the way in which AFMs are regulated. These proposals were in response to the findings set out in the FCA’s Asset Management Market Study, which demonstrated weak competition in the asset management industry, and an inability for investors to adequately protect their own interests. We covered this consultation in our October 2017 update.
Practice Statement 18/8 (PS18/8) (published on 5 April 2018) is the outcome of that consultation and sets out the FCA’s feedback and final rules and guidance aimed at:
- improving fund governance;
- making it easier to move investors between share classes when this is in their interests; and
- ensuring fairer treatment of the dealing profits that may arise when AFMs deal as principal in the units of their funds.
- In CP17/18 the FCA asked for views on extending the governance proposals for authorised funds (authorised open-ended collective investment schemes) to other investment products, including investment trusts (also referred to as investment companies). The FCA is keeping under review the possibility of further changes to investment trust governance arrangements.
In addition, whilst the scope of the market study did not include alternative asset classes (such as private equity and hedge funds), the FCA had noted that greater clarity on charges should be provided to investors in these more complex fund structures. The FCA is notably silent on the issue in this latest Practice Statement.
Acting in the best interests of investors
The FCA’s core proposition is that, as part of its duty to act in the best interests of investors, an AFM should consider whether fund charges are justified in the context of the overall service and value provided. Fund charges include management fees received by the AMF as well as the fees of third party service providers. Whilst industry participants generally supported the FCA’s view that value is at the core of the asset management proposition, the FCA conceded that its draft rules could be interpreted as being overly focused on costs rather than the full value proposition of funds. It noted that this was not its intention and the rules should take into account the whole value provided to investors, including quality of service, performance and the fund’s potential to deliver value in the future. In other words, fund charges should be assessed in the context of the overall service delivered.
COLL 6.6.20R of the FCA Handbook has been amended to reflect this approach (the FCA noted that rules rather than guidance will create a level playing field and aide comparison across the sector). The new rules require AFMs to provide a public annual assessment of value of each scheme managed, which should consider whether the payments made from scheme property are justified in the context of the overall value delivered to investors. This approach is very similar to the Gartenberg standard in the U.S.
- There is a non-exhaustive list of factors that must be considered when assessing value: quality of service, performance, AFM costs, economies of scale, comparable market rates, comparable services and classes of units (see COLL 6.6.21R). This list sets a minimum basis for the assessment, but it does not constrain the exercise of judgement by AFMs on other elements of their service that they consider relevant.
- AFMs can assess performance over a time period appropriate to the fund’s investment objective, policy and strategy.
- For a fund set up as an umbrella, the value assessment will take place on a sub-fund-by-sub-fund basis. The statement setting out a description of the assessment of value will need to describe each sub-fund individually.
- The assessment of value must be set out either in the fund’s annual report or in a separate composite report, which must be published within 4 months of the end of the relevant annual accounting period. There is a transitional rule in respect of accounting periods that end before 30 September 2019.
Implementation date: 30 September 2019
To address the perceived imbalance being struck by AFM boards between the interests of a fund’s investors and the AFM’s own shareholders, the FCA has proposed that: a) all AFMs (irrespective of how large or how long it has been operating) appoint a minimum of two independent directors to their board; and b) independent directors should comprise at least 25% of the total board membership (COLL 6.6.25R). In particular:
- Once the rules come into force, existing independent directors can serve for a maximum term of five years (renewed once to a maximum of ten years).
- It is up to AFMs to decide if they accept independent directors who serve on multiple boards, across different commercial groups as this may give rise to concerns over confidentiality and conflict of interest.
- AFMs that already have independent directors, prior to the implementation date of these rules, can keep those directors on their boards provided they meet the independence requirements set out in COLL 6.6.25 R.
- The independent directors should have a role providing input and challenge to the fund’s annual value assessment.
Implementation date: 30 September 2019
Senior manager’s regime
In PS18/8, the FCA sets out a new specific ‘Prescribed Responsibility’ for a Senior Manager (usually the chair of the board of an AFM). That person must take reasonable steps to ensure that the firm complies with its obligation to carry out the assessment of value, recruit independent directors, and act in the best interests of fund investors. The FCA has also clarified that it is the AFM’s decision on whether or not to appoint an independent chair as part of this regime.
Implementation date: This rule will be an extension of the senior managers and certification regime, which the FCA expects to come into effect in mid to late 2019.
Share class conversions
The FCA has published final recast guidance that removes the need for AFMs to get individual consent from each investor before moving (or ‘converting’) investors to cheaper but otherwise identical classes of the same fund. The guidance recommends that AFMs make a simple one-off notification to investors, which does not require a response, a minimum of 60 days before a mandatory conversion. The FCA envisages this guidance being used primarily in situations where AFMs have already attempted to contact investors.
The AFM should not make other changes to investors’ rights as part of a mandatory conversion to a cheaper but otherwise identical class.
Implementation date: 5 April 2018
The FCA has confirmed that any risk-free profits made by managers of dual-priced authorised funds (i.e. so-called ‘box profits’), should be repaid to the fund for the benefit of investors. In particular:
- The final rules provide some flexibility in how risk-free profits should be allocated fairly and in the interests of investors. The guidance indicates that profits could be allocated fairly by paying them to the fund or to individual investors who have bought and sold units.
- To assist firms that will need to implement systems and procedural changes in light of this new guidance, the FCA has provided more detailed technical commentary in Annex 2 of PS18/8.
Implementation date: 1 April 2019
The FCA’s well-balanced rules are a display of regulatory pragmatism, which should be welcomed by both consumers and the asset management industry as a whole. Given the other political and regulatory changes in the pipeline (in particular, the challenges of preparing for Brexit), AMFs have no doubt heaved a sigh of relief at the FCA’s decision to extend the implementation periods for a number of these proposals.
The delivery of value to investors is at the heart of the asset management industry, and allowing public scrutiny of these assessments should help to correct any information imbalances and encourage competition and innovation in the market. Similarly, making it easier for firms to switch investors to cheaper but otherwise identical classes of the same fund should enhance value for investors on a very practical level.
However, given the breadth and diversity of funds and their strategies, a challenge for AFMs will be ensuring that the new rules, once effective, are implemented properly across all funds, whilst ensuring that the costs incurred in doing so do not negatively impact the ultimate objective – delivery of value to investors.