The publication of the Financial Conduct Authority's Consultation Paper CP17/18 (the CP) and Asset Management Market Study mark a further milestone in the FCA's work on the functioning of the asset management industry. Summarising the FCA's conclusions in blunter, and less precise terms than it uses itself, it finds the industry to be too comfortable and too profitable. Price competition is said to be weak in a number of areas, resulting in charges eroding investors' returns unnecessarily. One phrase that appears repeatedly in the CP is "value for money".
The FCA has proposed, either in principle or in detail, a number of new measures to address its concerns. Among the most interesting are those relating to governance and, in particular, to the role of the "value for money" concept.
New governance measures proposed
UK authorised collective investment schemes are required to have an Authorised Fund Manager (AFM). The new measures proposed are directed at the boards of AFMs, and come under two broad headings:
- A new requirement for AFMs to appoint independent directors to their boards –
- there must be no fewer than two independent directors, and independent directors must make up at least 25% of the board;
- there is detailed guidance as to what "independence" means in this context; and
- the appointment of an independent director is time-limited to a maximum five-year term, which can be renewed once, following which the individual will be ineligible as an independent director of the AFM for a period of five years.
- A requirement that the board of the AFM considers annually whether value for money has been provided to investors –
- the proposed new rules set out four required areas that the value for money assessment must consider;
- the board must report (in the fund's annual report, or in a composite report produced by the AFM in relation to the funds for which it is responsible) on the findings of its assessment and the actions it has taken or will take as a result; and
- failure to take sufficient steps to address any instances of poor value for money may be relied on as tending to establish contravention of requirements (in broad terms) to act in the best interests of investors and treat them fairly.
In addition, the CP states that the FCA's consultation on the roll-out of the Senior Managers Regime to all authorised firms (expected later this summer) will impose on the chairmen of AFM boards a prescribed responsibility to act in the best interests of investors, including by considering value for money.
The issues that the FCA seeks to address are complex, and it is doubtful that there is any measure it could suggest that would be free from controversy. Nonetheless, the FCA's proposals contain troublesome aspects that will require careful handling if firms are to comply with them properly.
The main difficulty with the FCA's requirements in this area is that assessing value for money is inescapably a subjective exercise. Customers buying anything from groceries to theatre tickets are routinely asked whether they feel they have received good value for money, and their answers probably differ a great deal. Given that investments are substantially more complicated as a product, such judgements become even more fraught with difficulty. This point was plainly made to the FCA in response to its interim report, and it has taken steps to address it, seeking to clarify the assessment it wants AFM boards to undertake. That assessment will need to include:
- identification of economies of scale in the operating costs of the fund, consideration of whether break points (where charges decrease once assets under management reach a certain level) are appropriate, and whether savings should be shared with investors;
- whether fees and charges are reasonable, including their appropriateness considered against the quality of service, comparable market rates and ancillary services;
- whether different share classes available offer value for money (the specific issue of switching between share classes is considered separately in the CP); and
- quality of service – the AFM will need to explain the criteria used to assess this, and the conclusions reached.
These criteria are helpful, in that they direct the AFM's board towards specific relevant areas. However, there is still a substantial element of subjectivity to the assessment that must be undertaken, and it is hard to say that it will definitely provide the investor with a consistent picture of comparative value for money across the range of funds in which he, she or it might invest.
In addition, it is unclear who will formulate the criteria each AFM will use in order to judge quality of service. Quality of service is likely to include a number of elements, and there will be no single, correct way in which to weigh those elements up against each other. Making the criteria realistic, but rigorous enough to do the job that the FCA wants, is likely to be a difficult task, and one that is likely to fall to industry bodies. If it does, then the FCA may achieve the consistent approach it is likely to wish.
By way of example, the FCA refers to consideration of "comparable market rates" – how much weight, however, should be placed on comparative analysis (either of charges or service)? The FCA has found that the asset management market is not functioning as competitively as it should. In such circumstances, if an analysis of value for money places too much weight on comparative data, it seems unlikely to be helpful, and there might be a risk that standards across the industry as a whole will not rise in the way the FCA wants.
Appointment of independent directors
The CP suggests that implementation of the FCA's proposals will require the recruitment of some 480 independent directors. Such people will need (as the FCA accepts) the right skills, experience and expertise. There is no restriction on the number of directorships that each appointee can hold, so it is not clear how many individuals (realistically) will need to be recruited. However, if the FCA is to avoid the requirement for independent directors simply adding an additional tier in a closed shop, it will presumably want to ensure that a reasonably wide range of individuals are appointed.
It is debatable, however, how easy it will be to find the right candidates. The FCA does not think that they will need to have previous financial services expertise. However, the types of judgements they will be required to make in the context of the value for money assessment alone may be difficult for those who have no financial services experience. This (together with the regulatory scrutiny which comes with holding a senior position within a regulated firm) may deter candidates from undertaking such roles. By way of example, the FCA's draft rules in relation to economies of scale require AFM boards to consider not only the introduction of break points, but also their modification. The answer to this may be that boards will need proper specialist advice on such points, but the task may still be a daunting one.
In addition, there are practical difficulties in terms of dealing with confidential information. The FCA also recognises this concern, but does not deal with it explicitly. In circumstances where part of the exercise the AFM's board will have to undertake in assessing value for money involves a comparative exercise (as stated above), it is difficult to see that independent directors of AFMs will easily be able to compartmentalise their knowledge, if they undertake the role for more than one fund.
Part of a wider future for "value for money"?
It will be an interesting new departure to require AFMs (in effect) to tell investors that their own funds are not providing good value for money. The FCA is introducing such a requirement in the expectation that it will help ensure that AFMs act in the best interests of their investors. There are, however, arguably some limitations as to how far investors' interests are consistent with brutal honesty. If investors are told that their fund provides poor value for money, they might be forgiven for taking their money elsewhere. If the fund shrinks, then savings achieved through economies of scale, for example, might be lost.
These are hypothetical difficulties, and illustrate the complexity of rule changes as significant as those the FCA proposes to make. Nonetheless, the concept of a value for money assessment is an interesting one and, if it works here, it is easy to see it being rolled out to other areas of the financial services industry. The FCA is already debating its possible future use for other investment products, and it remains to be seen where the idea goes from there.