The FCA has referred the investment consultancy market to the CMA for an in-depth review. This is the first time the FCA has used its powers to make such a reference.
The Financial Conduct Authority (FCA) made the referral to the Competition and Markets Authority (CMA) on 14 September 2017.
In November 2016, in its interim report on the asset management market study, the FCA announced it had made a provisional decision to refer the investment consultancy market to the CMA for an in-depth investigation.
The FCA has the power to make a market investigation reference where it has reasonable grounds to suspect that any features of a financial services market prevent, restrict or distort competition. The FCA considered that there were a number of features giving rise to competition concerns:
- Weak Demand Side: Pension trustees are required to obtain and consider proper advice on whether an investment is satisfactory, and as such trustees are likely to rely heavily on investment consultants (or other professional trustees that are perceived as having greater investment knowledge). The FCA considered that this reliance means that a high proportion of trustees rarely challenge their consultant on the investment choices proposed to them. The FCA also found that around 90% of investors had not switched consultants in the last five years.
- Difficulties in assessing the quality of advice: The FCA considered that it is almost impossible for an institutional investor to assess whether good performance was achieved as a result of the implementation of high quality advice on asset allocation and/or manager selected or other factors such as luck. It can therefore be challenging to monitor and hold consultants to account for the quality of their advice. The FCA considered that in absence of comparable performance information, investment consultants are often compared and compete on their quality of service rather than their advice.
- Stability of the market: The FCA has previously found that the top three firms (Aon Hewitt, Wills Towers Watson and Mercer) make up around 60% of the market. While there has been a small decline in the market share of these largest firms in recent years, the FCA considered that the market is very stable.
- High barriers to entry and expansion: The barriers to enter the market are not particularly high as there is no need for extensive infrastructure and a number of small firms have managed to enter the market by offering bespoke and niche services to clients. However, the FCA considered that expanding in the market can be difficult. Reputation and the size of a firm are key considerations for institutional investors when choosing an investment consultant. The FCA considered that pension trustees in particular are unlikely to choose a firm without an established name as they are concerned about their own liability.
- Vertically integrated business model: Fiduciary management and fund of fund products have traditionally been offered by asset managers rather than investment consultants. The FCA heard persistent concerns from asset managers and institutional investors that once an investment consultant had developed its own product offerings, it would be more likely to recommend its own products even when better products were offered elsewhere. According to the FCA, this vertically integrated business model inherently leads to a greater risk of conflicts of interest. While investment consultants are aware of these risks, the FCA was unable to conclude on whether they were effectively managed.
Undertakings in Lieu
In February 2017, Aon Hewitt, Wills Towers Watson and Mercer offered undertakings in lieu of the FCA referring the investment consultancy market to the CMA.
The FCA has the power to accept undertakings in lieu of a reference; however these should only be accepted if they offer the most comprehensive solution that is reasonable and practicable.
The three firms offered the following undertakings:
- Tender regimes: to encourage regular tendering of the investment service contracts to which they act as investment consultants.
- Performance disclosure: to provide quarterly public information on their performance for both the fiduciary management business and the active asset management performance.
- Disclosure of fee and cost structures: to provide prospective fiduciary management services clients with a fee disclosure statement to enable them to compare the services provided for the charges quoted with other providers. The parties offered to provide annual disclosure statements to current clients of their fiduciary management services.
- Conflicts of interest: to maintain a gifts, hospitality and entertainment policy; not to manage a competitive tender process where they were also competing and to inform clients about the difference between their advisory and fiduciary work.
- Complaints procedure and code of conduct: to formalise their complaints and redress procedures and to abide by the Investment Consultants’ Code of Conduct.
In June 2017, the FCA announced its provisional view that accepting the undertakings prior to a full market investigation would not be appropriate. The FCA gave a number of reasons for this, primarily centring around being unable without a full market investigation to confirm its understanding of the competition issues in the sector, meaning that the FCA would not feel confident at this stage that the proposed undertakings would remedy the adverse effects on competition identified.
The FCA also expressed concerns that the undertakings would only apply to the share of the market represented by Aon Hewitt, Wills Towers Watson and Mercer and competition concerns in a large part of the market would still remain unaddressed. The FCA publically consulted on its provisional decision in June 2017.
The FCA received 19 responses to its consultation on the undertakings in lieu. The majority of these respondents were investment consultants, with the remaining responses from trade bodies and other interested parties. The majority view supported the FCA’s decision to refer the market investigation to the CMA and considered that the proposed undertakings did not go far enough to address the concerns raised by the FCA.
Comment and next steps
This is the first time the FCA has used its powers to make a market investigation reference to the CMA. Executive Director of Strategy and Competition at the FCA, Christopher Woolard, commented that it is a significant step for the FCA, and that the FCA has serious concerns about the investment consultancy market and believes the CMA is best placed to undertake this work.
The CMA will now carry out an 18 month market investigation into the investment consultancy market to determine whether there are any adverse effects on competition in this sector. As part of its investigation, the CMA will engage with key participants and gather a large amount of information, including running a bespoke market survey.