The FCA’s provisional decision to refer the market for investment consultancy services to the Competition and Markets Authority (“CMA”) – is it time for a detailed market investigation?
On 18 November 2016 the FCA released its Interim Report for the Asset Management Market Study. The Interim Report sets out the FCA’s concerns arising from evidence of weak competition in a number of areas in the asset management industry, together with a set of proposed remedies to address these concerns.
In addition to issues identified by the FCA as to how investment consultants affect competition between asset managers, the FCA identified specific issues relating to the market for the provision of investment consultancy services. As a result, for the first time in any FCA market study, the FCA has come to the view that this market needs further investigation by the CMA.
The FCA has the power to make a market investigation reference (“MIR”) to the CMA where it has reasonable grounds to suspect that any feature, or combination of features, of a market restricts or distorts competition.
The purpose of an MIR is for the CMA to investigate the market more deeply where it appears that competition is adversely affected by the structure of a market, by the firms operating in the market or by conduct of the firms’ customers or suppliers.
When the FCA wants to make such a MIR, it must consult any persons whose interests may be substantially impacted by this proposed decision. This is likely to include the consultancies themselves, and also their clients (which will include pension plans).
If the reference goes ahead, the CMA will have 18 months in which to conduct an in-depth review of the market. If the CMA finds that there are features of the market that, in its view, restrict or distort competition it has strong and wide-ranging powers to address any adverse effects on competition it identifies, including structural and behavioural remedies.
Why has the FCA decided to make a MIR?
The FCA has identified a number of market features it considers could give rise to competition issues. The FCA has also considered the scale of these issues, the size of the market, the proportion of the market affected by the features, the persistence of those features, the availability of appropriate remedies by the CMA and whether alternative powers are available to the FCA to address the features which it has identified. The FCA has concluded that it would not be able to use its regulatory powers to address the concerns identified effectively.
Some of the conduct of concern relates to unregulated activity. The FCA has therefore also recommended that HM Treasury consider bringing the provision of institutional investment advice within the FCA’s regulatory perimeter so that the FCA can then be in a position to take forward any recommendations put forward by the CMA should it do so at the end of a market investigation.
The issues identified by the FCA include:
- weak demand side – the FCA found that pension plan trustees sometimes accept investment advice with little scrutiny. Levels of switching between investment consultants are low;
- inability to assess quality of advice from investment consultants and employee benefit consultants (“EBCs”) - there is limited availability of transparent and comparable data on the performance of investment consultants’ advice. Due to difficulties with evaluating advice, institutional investors tend to focus on the service provided, rather than quality of advice, and firms therefore compete on quality of service rather than quality of advice;
- persistent levels of concentration and relatively stable market shares among investment consultants – the three main investment consultant firms have an estimated combined market share of 60%, the FCA claims that market shares of EBCs are likely to mirror those of the investment consultants;
- barriers to entry and expansion – barriers to entry for investment consultants or EBCs are not particularly high. However, expansion for smaller firms is more difficult as brand and reputation within the market is very important; and
- vertically integrated business models – some consultants are now offering products traditionally offered by asset managers. The FCA has identified that this may mean that investment consultants and EBCs may offer their own products, as opposed to referring a client to a third party, and this can give rise to conflicts of interest.
If the reference goes ahead, what does this mean for the parties involved?
The CMA must decide whether there is an adverse effect on competition, i.e. whether any feature, or combination of features in the market for investment consultancy services prevents, restricts or distorts competition. If it finds there is an adverse effect on competition, the CMA has a wide range of remedial powers 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).
The FCA has set out some potential remedies that the CMA could consider including: requiring consultants to provide more standardise performance information to their clients, to publish their performance and fee information, to prohibit certain fee structures and requiring trustees to periodically review and retender contracts with their investment consultants.
What do institutional investors need to do now?
Institutional investors – including pension plan trustees - should consider whether they agree with the concerns raised by the FCA. If there are issues they would like to be considered as part of the market investigation, they should raise these with the FCA, in order that they can be reflected in the reference made to the CMA. Representations must be made to the FCA by 20 February 2017 and should include comments and views of the respondents, supported by evidence where possible.
What do investment consultants need to do now?
Firms in the investment consultancy sector can expect in-depth, lengthy and intense scrutiny of their business and practices by the CMA if the market investigation goes ahead. The MIR must be completed, and a report published, within 18 months. Firms may need to be involved in responding to detailed requests for information, providing representations and substantial amounts of evidence, as well as meeting with the CMA to explain business models and practices, the market and aspects of competition within it.
Investment consultants should consider whether they agree that a MIR is necessary and appropriate, and whether there are any aspects of the FCA’s findings that they wish to challenge. In addition, they should ask themselves whether there are undertakings that the sector could give to address the FCA’s concerns thereby avoiding the need for a reference. Representations must be made to the FCA by 20 February 2017 and will need to be supported by evidence where possible.