The Financial Conduct Authority (FCA) published its long-awaited interim report for the asset management market study today, Friday 18 November 2016. The interim report has found that there is weak price competition in a number of areas of the asset management industry.
It has proposed a number of potentially significant and intrusive remedies which include:
- a strengthened duty on asset managers to act in the best interests of investors;
- introducing an ‘all-in fee’ approach to quoting charges so that investors in funds can easily see what is being taken from the fund;
- exploring with government the potential benefits of the greater pooling of pension scheme assets;
- consulting on whether to make a market investigation reference to the Competition and Markets Authority (CMA) for in-depth investigation of the institutional investment advice market;
- recommending that the Treasury considers bringing the provision of institutional investment advice within the FCA’s regulatory perimeter; and
It has also suggested a number of other remedies designed to increase the transparency of costs in the sector to ensure those seeking information can get it and to ‘provide greater clarity of fund objectives and performance reporting and protections for investors’.
Many of the FCA’s proposals are investor protection related, despite the FCA badging the study as a competition study. The competition label may, however, lead to different and more far-reaching results.
The FCA is now consulting on these proposed remedies. Responses must be submitted by 20 February 2017.
What should asset managers do?
Asset managers will need to establish whether or not the findings and proposed remedies will have an impact on their businesses. Any firm affected by the proposed remedies should respond to the FCA’s consultation on the interim findings, since this will be the last opportunity to do so before they are finalised.
We advise that asset managers:
- make representations if your firm is affected by the findings, even if it did not receive a request for information from the FCA and / or has not been involved in the process to date, or only to a limited extent;
- make representations to ensure the ultimate findings of the report accurately represent the true state of competition in the asset management market;
- include the firm’s assessment of proposed remedies, whether they are proportionate and likely to achieve the FCA’s stated aims;
- wherever possible, managers should support representations on findings and remedies with compelling evidence; and
- consider requesting a meeting with the FCA to discuss their reaction to the interim report.
The FCA published its terms of reference for its competition market study into the asset management industry, on 18 November 2015. For more information on the terms of reference, topics covered and the background on the FCA's Asset Management market study can be found on our website. One year later, it is publishing its interim findings, which were intended for publication in summer 2016.
The terms of reference set out three main questions for the market study:
- How do asset managers compete to deliver value?
- Are asset managers willing and able to control costs and quality along the value chain?
- How do investment consultants affect competition for institutional asset management?
In addressing all three questions, the FCA considered whether there any barriers to innovation and technological advances.
The scope of the FCA’s market study covered retail and institutional investors.
The FCA’s main finding is that price competition is weak in a number of areas of the asset management sector, which affects the returns investors can expect due to the sums paid for asset management services. The FCA sets out the evidence in its report which it considers supports this finding.
Competition between asset managers
Price trends, charging practices and profitability
- The FCA has found that while charges for passive funds have fallen over the past five years, charges for mainstream actively managed funds have generally remained unchanged.
- In addition, it found considerable price clustering for active equity funds, many funds being priced at 1% and 0.75%, particularly those funds with more than £100m assets under management. The FCA notes that this is “consistent with firms’ reluctance to undercut each other by offering lower charges”. The FCA considers that the benefits of economies of scale are captured only by fund managers and not passed to investors since charges do not fall as fund sizes increase.
- The FCA found that cost control was mixed, with managers being better at managing costs that were straightforward and cheap to monitor. While costs were found to be higher in actively managed funds than for passive funds (as expected), the FCA found that profits were also higher in absolute terms for actively managed products.
- The FCA’s evidence suggests that overall, actively managed funds do not outperform their benchmark after costs.
- According to its findings, the outcome is worse for funds available to retail investors, which do not outperform their benchmark and only marginally better for institutional investor products whose returns are not significantly greater than the benchmark.
There is no clear correlation between price and fund performance: funds with higher charges do not generally yield greater returns before or after costs. According to the FCA active funds offer similar exposure to passive funds but in some instances the charges are significantly greater.
Transparency and clarity of objectives and investment outcomes
- Progress has been made on transparency in recent years and following the introduction of the Ongoing Charges Figure but there is more to be done (noting the current FCA Consultation on a standardised methodology to calculate transaction costs for defined contribution workplace pensions).
- Charges for ancillary services bought by asset managers are usually clear to investors (such as administration, record keeping and services to safeguard the assets) and are included in the Ongoing Charges Figure or the investment management agreement.
- Transaction costs are not given upfront to investors meaning these cannot be taken into account when the investor is making its investment decision and can result in additional costs of around 50bps on average for active management for equity investments.
- Fund managers do not effectively communicate their investment strategy, charges and investment outcomes to investors.
- The FCA has also raised specific concerns relating to how absolute return funds (funds that aim to deliver a positive return) report their performance and the fact that some of these funds charge a performance fee even where performance is below the fund’s stated performance objective.
The FCA looked at how investors choose asset managers and investors’ ability to negotiate with their asset managers.
Factors that drive investor choice
- The FCA found that generally, ‘value for money’ is a combination of return achieved, price paid, risk taken and quality of any additional service provided by the asset manager. The FCA therefore conclude that investors think of value for money as risk-adjusted net returns.
- Although past performance is often used by investors when choosing asset managers this is not a good indicator of future risk-adjusted net returns since it is difficult to accurately interpret and compare past performance and where fund managers do outperform their peers, this is rarely maintained for more than a few years.
- While institutional investors are focussing increasingly on fund charges, many retail investors are unaware that they pay these.
- The FCA states that for competition to work well investors need to be able to assess whether their products have delivered value for money and switch if they have not. The incentives to switch funds are low – there are costs associated with switching (explicit charges, taxes, time and effort) and investors may be concerned about switching if this would involve crystallising a loss or cutting short a recommended holding period. In addition it can be hard for investors to know if they would gain from switching.
- The FCA has said that asset managers find it difficult to switch investors to new, cheaper share classes, even if this would be in the interests of investors, since it is difficult to obtain the necessary consent from investors.
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 a weaker bargaining position. The FCA therefore concludes that significant cost savings could be achieved by pooling of pension scheme assets.
Role of intermediaries
- With a view to best buy lists and fund ratings, the FCA found that in recent years the funds on the list, while outperforming those not on the list, have not outperformed their benchmarks.
- Retail investors have not benefitted from economies of scale by pooling their money together through platforms and the FCA raises concerns about the value provided by platforms. They propose further work in this area for the future.
- The FCA found that investment consultants’ ratings influence which managers are chosen by institutional investors but the ratings do not help identify better performing managers or funds. Smaller institutions are not helped by investment consultants to negotiate or drive price competition between investment managers.
- There is a concentration in the investment consultancy market and firms tend not to switch consultants often - being unable to assess the performance of the advice received.
- The FCA highlights scenarios in which investment consultants face a conflict of interest and raises concerns about the ability of consultants to act in investors’ interests. As a result, the FCA is consulting on making a market investigation reference to the CMA on the investment consultancy market.
The FCA has proposed a substantial package of remedies to address the concerns it has identified, these are set out in the report as follows:
- A strengthened duty on asset managers to act in the best interests of investors, including reforms that will hold asset managers accountable for how they deliver value for money, and introduce independence on fund oversight committees;
Introducing an all-in fee approach to quoting charges so that investors in funds can easily see what is being taken from the fund helping retail investors identify the best fund for them by:
- Requiring asset managers to be clear about the objectives of the fund and report against these on an ongoing basis.
- Clarifying and strengthening the appropriate use of benchmarks.
- Providing tools for investors to identify persistent underperformance.
- Making it easier for retail investors to move into better value share classes.
- Requiring clearer communication of fund charges and their impact at the point of sale and in communication to retail investors.
- Requiring increased transparency and standardisation of costs and charges information for institutional investors.
- Exploring with government the potential benefits of greater pooling of pension scheme assets.
- Requiring greater and clearer disclosure of fiduciary management fees and performance.
- Consulting on whether to make a market investigation reference to the CMA on the institutional investment advice market.
- Recommending that HM Treasury also considers bringing the provision of institutional investment advice within the FCA’s regulatory perimeter.
Institutional investment consultants are often outside the regulatory perimeter where they are advising on strategic asset allocation, investment manager selection and asset/liability matching. However, the FCA has said that this remedy alone will not address the issue structural measures may be required such as additional disclosures, restrictions on certain fee structures and other demand side remedies.
In addition, the FCA is proposing further work on the retail distribution of funds. The particular focus of this work will be the effect that financial advisers and investment platforms have on value for money. The FCA is also taking on further work to understand the impact of fund closures and mergers on investor outcomes.
The deadline for responses to the interim report is 20 February 2017. Firms impacted by the market study are advised to make representations to ensure the findings of the final report are accurate and that any final remedies are proportionate to the aims they seek to achieve. The final report and proposed amendments to the FCA's rules are expected to be published in Q2 2017.
Arising out of the wholesale market review, this market study is the first time the FCA has taken an in-depth look at competition in the asset management market. The delay to the original timetable can perhaps be explained by the complexity of this sector and the potential impact the report could have on markets - this is clearly something the FCA had in mind with a 7am release time.
At the time of writing, the markets have reacted with some relief that the report does not introduce more extreme interventions such as divestments or structural changes, or price caps. For example, it is worth noting that certain pension schemes already have a charge cap of 75 basis points. However, the paper’s tone and certain conclusions will make uncomfortable reading for some in the industry and the proposals are interventionist and significant for the sector.
There is a strong investor protection theme and some of the conclusions clearly have that objective in mind despite the competition overlay. Many of the themes such as governance, clarity of investment objectives/policies and cost transparency, for example, reflect issues which the FCA has been pursuing for some time.
For the investment consultant industry, the spectre of a CMA referral may mark the start of fundamental changes to practice. If the reference goes ahead, firms in the institutional investment advice sector can expect in-depth and intense scrutiny of their business and practices by the CMA. The implications of a market investigation can be very serious for firms as the CMA has a wide range of remedial powers arising from market investigations, including structural remedies (e.g. divestiture), behavioural remedies (e.g. price caps) or it can make recommendations (e.g. to Government or other regulatory bodies).
For the asset management industry at large, the proposals target costs and charges, corporate governance and corporate actions among other broad topics while some particular practices are singled out and may become difficult to justify in future.