On June 28, the Financial Conduct Authority (FCA) published its final report after its asset management market study (Study), which began in November 2015. Alongside the report, the first of a number of related consultation papers was also published. The report and consultation paper follow the FCA’s interim report published in November 2016, which had indicated many of the conclusions and proposed remedies of the report (for further information on the interim report, please see the Corporate & Financial Weekly Digest edition of December 2, 2016).
Hedge funds and private equity funds (alternative services) were originally largely out of scope for the purposes of the report, which focused primarily on non-alternative funds and segregated accounts (mainstream services). However, given some of the feedback received by the FCA during the course of the study relating to fees for such alternative services (highlighted in the report as being “particularly opaque”), the FCA has determined to include them in proposals relating to standardized disclosure of costs and charges to institutional investors (see below). To achieve this outcome, the FCA proposes to have an independent person to convene a group of relevant stakeholders to develop templates for the disclosure of costs and charges for both mainstream services and alternative services. While no timeline is given for this process, the FCA highlights that provision of accurate information on costs and charges is also required by the revised Markets in Financial Instruments Directive (MiFID II), which goes into effect for the European Union on January 3, 2018.
In terms of the matters included in the report itself, the FCA had several concerns relating to the asset management sector that it has now decided to target with a package of reform proposals. Such concerns included:
- price competition – weak price competition, particularly in relation to retail active funds, with a high level average profit margin of 36%;
- performance – the lack of clear relationship between charges and the gross performance of retail active funds in the UK;
- clarity of objectives and charges – how asset managers communicate their objectives, including the use of benchmarks and presentation of performance. Investors’ awareness and focus on charges is also mixed and often poor, including in relation to more complex structures such as alternative services; and
- investment consulting and other intermediaries – high and stable market shares for the three largest providers, a weak demand side, relatively low switching levels and conflicts of interest.
The report contains a number of proposed remedies that fall into three categories:
- To help provide protection for investors who are less able to find better value for money, the FCA proposes to:
- strengthen the duty on asset managers to act in the best interests of investors and establish independent scrutiny. The FCA hopes to increase suitability through the use of its Senior Managers and Certification Regime;
- require asset managers to return risk-free box profits to the fund and disclose box management practices to investors; and
- make it easier for asset managers to switch investors to cheaper share classes.
- To drive competitive pressure on asset managers, the FCA will:
- support the disclosure of a single, all-in-fee to investors;
- support the consistent and standardized disclosure of costs and charges to institutional investors, which will also apply to alternative services, as discussed above;
- chair a working group to focus on how to make fund objectives more useful and consult on how benchmarks are used and performance reported; and
- recommend that the Department for Work and Pensions remove barriers to pension scheme consolidation and pooling.
- To help improve the effectiveness of investment intermediaries, the FCA will:
- seek views on rejecting undertakings in lieu (UIL) of a market investigation reference regarding the institutional advice market to the Competition and Markets Authority (CMA) offered by investment consultancy firms. The firms offered undertakings to strengthen internal processes and address conflicts of interest, among other things, to the FCA in order to avoid an investigation into competitive practices by the CMA. The FCA expects to publish a final decision on whether to make a market investigation reference to the CMA in September 2017;
- recommend that HM Treasury consider bringing investment consultants into the FCA’s regulatory perimeter (i.e., whether such firms should be subject to authorization), depending on the outcome of the above decision; and
- launch a market study into investment platforms.
Most of these proposals were covered in the interim report and, therefore, should not come as a big surprise. Many changes also are included in incoming or current rules, such as MiFID II and the FCA’s Senior Managers Regime. Several of the above solutions are being consulted on in the consultation paper, including strengthening the duty on asset managers to act in the best interest of investors, facilitating switching investors to cheaper share classes and proposing to reject the UILs. Other measures, such as costs and charges disclosures to retail investors and benchmarks and performance reporting, will be consulted on later this year.
In terms of next steps, the FCA has stated that any new rules and guidance will be subject to cost benefit analysis and formal consultation. The closing date for responses to the Consultation Paper is September 28. The FCA expects to publish further consultation papers on most of the remaining solutions before the end of 2017.