Following its interim report last November the FCA’s long awaited final report on competition in the asset management sector was published earlier this week together with an initial consultation paper on certain aspects (CP17/18). The initial reaction has been mixed with some commentators describing it as a radical shake up and watershed moment for the industry and others saying it does not go far enough (and is likely to be watered down further in due course). So who is right? As always the devil is in the detail and both papers warrant close reading by those affected. However, the key points for authorised fund managers (AFMs) to be aware of are as follows:
1. Fund governance and value for money
This is perhaps the area of greatest medium term impact for AFMs and where the FCA’s proposals are most developed. FCA are proposing to strengthen the requirements for AFMs to act in the best interests of investors by specific reference to value for money considerations. This is through a combination of clarifying expectations, introducing independence on governance boards and introducing a prescribed responsibility under the Senior Management & Certification Regime.
They are now consulting (in CP17/18) on the following proposals:
- A new value for money (VFM) rule – the AFM will be required to assess whether VFM has been provided to fund investors. The assessment must take place on an ongoing basis and must be formally documented at least once a year. The assessment must consider at least whether economies of scale are being shared with investors, whether charges are reasonable based on costs incurred, the quality of service investors are receiving and whether different share classes offer VFM – including assessing and explaining why some investors are in more expensive unit classes with substantially similar rights and conditions as other classes (where this is the case). AFMs will be required to publish, at least annually, a report on the findings of their VFM assessment.
- A prescribed responsibility to act in the best interests of investors to be allocated to the chair of the AFM board who will therefore be personally accountable and will need to assess the provision of value for money in accordance with the FCA rules (the scope/applicability of this responsibility will be further consulted on later this year as part of the FCA’s wider consultation to extend the SNSC to all FSMA firms).
- A rule requiring independent directors of the AFM board – AFMs will be required to appoint a minimum of two, and at least 25% of the total board membership, independent directors who meet specified requirements of independence. This will mean most AFMs needing to recruit two or three independent directors. Based on its proposals the FCA expects approximately 480 independent directors to be required across the industry and recognises that it may be challenging to appoint suitable candidates with the right skills and expertise.
2. Transparency of fees and charges
This was an area of much focus and anticipation as the interim report had proposed the introduction of a single all-in-fee with four potential options, one of which would involve the inclusion of a single charge to cover all charges taken from the fund (including transaction costs) with the AFM bearing the risk of any overspend. However, following a number of well-reasoned objections it does not appear that the FCA will be introducing any model that goes substantially beyond the changes that are due to come into force at the start of 2018 under PRIIPs and MiFID II – which will require all costs and charges to be shown as a single disclosure (including asset management charges and indirect costs such as transaction charges). Instead, the FCA’s focus will be on testing ways to improve the effectiveness of any forthcoming disclosure to understand how factors such as formatting and prominence encourage investors to focus on the impact charges have on their investments. The FCA says that this will inform the development of any future remedies in this area.
For institutional investors, FCA will ask an independent person to take forward the possibility of standardising costs and charges disclosure with the relevant industry stakeholders. FCA is also considering consulting on rules so that performance fees are only permitted above the fund’s most ambitious target and are only permitted on net returns.
3. Risk-free box profits
As widely predicted the FCA proposes to prohibit the retention of risk-free box profits by AFMs and is consulting on the most pragmatic means to end this practice – which is likely to involve such profits being passed to the fund and a disclosure in the prospectus of the AFM’s policy on operating a box and how any profits will be treated. Taking risk-free profits is not considered to be a widespread norm so it is not expected that this will have a significant impact on the industry as a whole. The FCA has clarified that it does not propose to prohibit the retention of profits made by AFMs from holding positions between pricing points when using their own capital (‘at risk profits’).
4. Objectives, benchmarks and performance reporting
The FCA wants to improve the usefulness of objectives for investors, but rather than rule making at this stage it intends to chair a working group (comprising consumer and industry stakeholders) following which it will consider whether the group’s output should be turned into new rules in this area.
Following consideration the FCA does not think all funds should have to use a specific benchmark or comparator in its objectives (or otherwise). However, it intends to consult on an approach so that an AFM must explain to investors why it has - or has not - chosen to set a benchmark. The FCA is also considering introducing rules and/or guidance to clarify that where AFMs present their past performance they must do so against the most ambitious returns target they hold out to investors.
5. Easier switching between share classes
In CP17/18, FCA consults on removing barriers to firms moving investors to cheaper share classes without express consent where this is in investors’ best interests. FCA propose to clarify that the AFM can undertake a mandatory conversion if the required conditions are met i.e.:
- the power to undertake a mandatory conversion is set out in the prospectus
- the AFM must have made all reasonable attempts to inform unitholders to enable them to give alternative instructions, and
- the AFM is satisfied on reasonable grounds that the change will not result in detriment to investors.
The FCA is also asking for views on whether the payment of trail commission should be ended and, if so, over what time period.
In summary
On its face the final report confirms many of the key findings in the interim report, in particular that there is weak competition in a number of areas of the asset management industry and firms do not typically compete on price, particularly for retail active management services. The package of remedies (some of which are outlined above) is also relatively interventionist in terms of the FCA pushing the asset management industry in a way that goes beyond what we have seen before in this area. However, on delving into some of the detail the proposed reforms are not as radical for AFMs as they might have been. As outlined above, the key exception to this is likely to be around governance where the proposed enhanced requirements will involve significant change and potentially provide a springboard for the FCA to challenge firms on their pricing strategies, cost control, performance and (ultimately) profitability.
What’s next?
Responses on CP17/18 are due by 28 September 2017 with final rules likely to come into force during 2018 (subject to transitional provisions).
FCA will consult on costs and charges disclosure and the use of benchmarks and past performance, later this year. Watch this space.
The next FCA market study in this arena will concern platforms; the study will consider how D2C and adviser investment platforms (and firms offering similar services in adjacent markets) compete to win new customers and retain existing customers and whether they enable investors to access investment products that offer value for money. The FCA has made it clear that it has concerns about this aspect of the value chain.
We can advise on the issues raised in this article and the implementation of any changes resulting from the FCA’s final report and CP 17/18. If you would like to discuss further please contact Tom Dunn or your usual Burges Salmon lawyer.