The FCA has completed its Investment Platforms Market Study, which started in July 2017, and published its final report in March. Whilst the report presents a largely positive view of the market, it specifically reminds platforms of their existing obligations and suggests some tightening of market rules to protect consumer interests, which is likely to have implications for asset managers.
Investment platforms facilitate access to retail investment products for consumers by arranging, administering and safeguarding investments on their behalf. The industry has seen huge expansion, buoyed by innovative technology and consumer demand for easy access to higher investment returns. According to the FCA, the market for investment platforms had grown from £250bn of assets under administration (AUA) in 2013 to over £500bn in 2016, driven in part by an increase of 2.2 million retail client accounts over a similar period.
In July 2017, the FCA published its terms of reference for an assessment of the market in investment platforms, with particular focus on competition between platforms, and their role in a wider landscape of wealth and fund managers and financial advisors. Their Interim Report, published in July 2018, presented a mixed picture of the state of the market, and the FCA’s final conclusions follow similar lines; whilst there are many aspects of the investment platform market which deliver value to consumers, there remains room for improvement.
Whilst the FCA intends to observe some continuing market trends, and re-review some areas in coming years, the FCA has decided to consult on some potential remedies to improve the investment platform market via their consultation paper CP 19/12 which is due to close on 14 June 2019.
The FCA has highlighted the importance of clear information allowing consumers to assess cost and value across platforms, encouraging mobility and competition in the market. The Final Report has identified a range of factors impacting consumers’ ability to assess and understand the value presented by different platforms.
Unsurprisingly, the FCA has observed that consumers are concerned by the fees incurred in using their chosen platform. Consumers can find it difficult to assess respective platforms’ differing costs. However, the FCA has observed, to the market’s credit, some recent improvement in price transparency, including the adoption of worked examples to more clearly lay out costs. This was anticipated in the Interim Report, where the FCA noted that the ongoing effect of MiFID II disclosure requirements would likely create improvements for consumers. The FCA has also acknowledged the contributions of industry bodies for their work in improving consumer understanding.
In light of positive market trends, the FCA has not proposed any new measures, but intends to undertake a further review of platform cost transparency in 2020/21.
Presenting and Promoting Funds
As a result of the Market Study, the FCA considered a range of different ways in which fund charges are presented on platforms – a majority presented these on their main charges page, but some failed to do so. Almost all fund charges were offered in percentage terms, and not in pounds and pence. Despite seeing room for improvement, the FCA acknowledged the ongoing impact of MiFID II and the innovations driven by industry bodies, and proposes to reassess the presentation of fund charges in 2020/21.
The FCA also acknowledged the relationship between platforms and fund managers themselves. Whilst noting that fund managers no longer remunerate platforms from commission, with platforms instead seeking revenues produced by the higher usage flows which fund promotion brings, the FCA observed an inclination towards platforms favourably promoting in-house funds. A 2017 Occasional Paper by the FCA observed ‘Best Buy’ lists published by funds regularly gave prevalence to relatively unsuccessful in-house funds. In a trend which must be seen as a positive development for the asset management industry generally, the FCA has since observed a marked improvement.
Instead of requiring further legislating, the FCA notes that unjustified promotion of in-house funds falls foul of well-established rules on managing conflicts of interest.
As well as fund promotion and charges, the FCA acknowledges the potential for platform competition to be stifled through the negotiation of fund discounts by larger platforms, and ‘most-favoured nation’ clauses preventing other platforms from negotiating better discounts. The FCA noted that the Interim Report received little feedback on this topic.
In light of the recent criticism of most-favoured nation clauses in online and price-comparison markets, the report reminds firms these may fall afoul of competition laws should they cause consumer detriment.
Clarity of Model Portfolios
Also popular on platforms are ‘Model Portfolios’ where an investor will select a template array of pre-selected investments, labelled according to the risk of the respective portfolio. The FCA observed in its Interim Report that 17% of non-advised platform users used model portfolios, and in-house model portfolio-based investments increased from £5bn in 2011 to £38bn in 2017. A growing array of model portfolios are making the market increasingly complex, and varying terminology and disclosure levels between platforms make it difficult for consumers to discern between offerings.
The FCA noted that low investment levels in non-advised platform-based model portfolios means the risk is disproportionately low, but stated it will be continuing its review of the model portfolio market.
Consumer Mobility – Switching Platforms
The impact of consumer information is limited if platform users find themselves unable to move between providers. The FCA has assessed the ability of consumers to shift investments between platforms, noting only around 3% of non-advised consumers switch platform each year, with 7% attempting to switch but finding that barriers prevented them from doing so. Similarly, a quarter of surveyed advisors remarked it was difficult to switch assets between platforms.
The work of industry and not-for-profit bodies in this area has been recognised following a 2015 FCA Report regarding transparent and smooth switching of investments, and clearer consumer communications in these processes. The FCA has recognised and applauded the efforts of industry bodies thus far, and also takes the opportunity in its Final Report to remind firms of their obligations to execute re-registration requests within a reasonable time and in an efficient manner.
The FCA intends to re-assess the switching process later this year/early 2020.
The FCA used the Market Study to draw attention to the barrier exit fees present to consumer mobility, noting around half of the top 20 platforms by AUA charge fees to exiting consumers. Whilst the FCA acknowledged industry responses which highlighted the administrative burden on platforms for de-boarding clients, and the inequity of non-moving platforms shouldering these costs, the FCA also noted the relative insignificance of these costs for platforms. Exit fees account for only around 0.2% of platforms’ revenue.
The FCA remains in favour of banning or restricting such administrative exit fees. It intends to consult on the nature and extent of such a ban.
Unit Class Conversion
The FCA has identified that unit class conversions present an issue in consumer switching processes. Some platforms provide ‘superclean units’ in particular funds – a unique unit class reflecting preferable rates negotiated for that platform’s users. These present a financial benefit to stationary consumers, but the lack of unit class consistency across different platforms means many platforms and fund managers do not facilitate movement, even if a consumer intends to invest in the same fund on both platforms. Instead, consumers may be required to divest from their unit classes, potentially exposing themselves to market risks, transactional costs and potential tax liability. This presents a similar difficulty for financial advisors who struggle to move their clients’ between platforms.
The FCA is consulting on new rules to require in-specie transfers of unit classes between platforms, and noted that it expects platforms to execute requests for unit conversion in a reasonable time and efficient manner, rather than aggregating requests in order to perform bulk conversions. This will clearly have an impact on asset managers who will need to look at how such unit conversions would be implemented.
Whilst the increase in direct-to-consumer (D2C) platforms has partly driven the dramatic growth in the platform industry, platforms specialised for use by financial advisors remain a significant proportion of the market, and the FCA considered whether these advisor platforms promote consumer interests.
Advisors Recommending Switches
The FCA found that whilst advisors might consider switching their client’s platform to facilitate new investments, they rarely recommend platform switches for existing investments. Advisors were not always confident that the switch would provide a clear net benefit to their client, which the FCA largely attributes to the current complexity of switching platforms. Since advisors consider the switching of a platform an ‘advisable event’, they were also likely to charge clients for the administrative cost of the switch, and the provision of advice.
The FCA is confident that planned measures to simplify platform switching would also improve advised mobility, and reminded advisors that on a switch they need only assess the suitability of the main changes presented by the switch in the platform.
In addition, the FCA recognised concerns that non-monetary benefits offered by platforms to advisors might shape decisions on platform switches in ways that do not suit consumers’ interests. The FCA saw no need to consult on new rules in this area, since this is already covered by existing FCA rules prohibiting inducements.
The FCA considered how ‘orphan clients’ – previously advised clients left without a financial advisor – were treated by platforms. Overall, the FCA found advisors typically notified platforms when they ceased to advise a client – the risk that such orphan clients might continue to have advisor fees deducted whilst not being advised was similarly low. Nevertheless the FCA reminded platforms they must have adequate procedures in place to reduce the risk of orphan clients being overlooked.
Similarly, the FCA found that, orphan clients were more likely to receive a better service on advisor platforms than D2C platforms – there are typically no restrictive services, and platforms tend to have appropriate processes for communicating with orphan clients and finding them new advisors. Despite this, the study did identify a few instances of platforms charging unjustifiable additional costs to orphan clients. The FCA acknowledged servicing orphan clients may increase costs, but charges can be unfair if they do not reflect these costs, or clients do not receive any different services.
Due to limited instances of these charges, the FCA has not proposed rule changes, but will contact individual firms to intervene on inappropriate charges.
Other Factors Delivering Benefit and Competition
The FCA also acknowledged additional areas for attention within the platform industry:
- Investing in securities – the FCA acknowledged the requirement for platforms to ensure their trading systems deliver best execution. The report noted that Retail Service Provider trading systems might restrict clients’ ability to trade in times of market distress, since market makers do not typically use these systems. The FCA highlighted its rules on best execution and noted that enforcement of these may be the appropriate solution.
- Holding large cash balances – large amounts of cash are held on platforms, constituting 8.8% of AUA on D2C platforms, and 3.9% on advisor platforms. The FCA found these are held mostly in pension wrappers, which will be addressed by a wider consultation on retirement outcomes and pension rules. Non-pension cash balances presented less risk as they were typically held through choice, and were rarely persistent, but the FCA hope new rules on unit class conversion will reduce the amount of cash brought onto platforms, and again acknowledged the work of industry bodies, stating an intention to re-review in 2020/21.
- Barriers to competition – the FCA noted that they only observed weak economies of scale which might restrict market entrants. Similarly it is not disproportionately costly for smaller firms to comply with regulation, and whilst technology costs tend not to fall with scale and can discourage expansion, new entrants can experience technology as a variable cost on entry. The biggest barrier to market entry observed by the FCA is the tendency for consumers to select large, established brands – but there are hopes that measures to tackle difficulty in switching will address this.