UK: Costs And Charges In The Asset Management Market Study: The FCA Goes All-In For Transparency

The FCA recently published its final report on the asset management market study (see our briefing here). One of the headline features was the proposed "all-in" fee. There has, however, been some uncertainty on where the FCA's proposals stand in relation to forthcoming EU legislation which will, in any case, require an aggregated fee disclosure. This brief aims to shed light on this where possible.

In the final report, the FCA decided that it will supplement forthcoming Markets in Financial Instruments Directive II (MiFID II) and Packaged Retail Insurance and Investment Products Regulation (PRIIPs) requirements on the disclosure of costs and charges for retail funds, rather than immediately introduce its own rules. Instead, the FCA plans to consult on additional guidance around how this information should be presented to customers. Details have not yet been announced and it is yet to be seen whether the FCA will propose new formats for disclosure, whether tabular or linguistic. But the direction of travel is clear: the FCA wants greater transparency and true comparability of costs which retail investors can understand. In the light of the FCA's findings (see below), firms should consider their current approaches to consumer engagement and the ways in which they can improve the clarity and effectiveness of their communications. This could be achieved through consumer testing and examining the language and formats used in communications. Such analysis/re-assessment would put firms in a stronger positon in advance of the FCA's consultation paper later this year.

What is the FCA's "all-in" fee?

A proposal for new guidance to ensure charges are presented in a way which investors can easily understand, is not misleading and is comparable. Aggregation of costs and charges will already be required under MiFID II and PRIIPs.

The final report restates the FCA's support for the all-in fee, a key component of which is the asset management charge which, following the application of MiFID II, will include an estimate of transaction costs. This means that the FCA will not be imposing its fee transparency "remedies" through new rules. Rather, the all-in fee topic will be subject to further consultation, and details of how the all-in fee will work in practice will likely be clarified at this stage.

Are there existing requirements on aggregating costs and charges?

Yes, MiFID II and the PRIIPs set out requirements on aggregating costs and charges (see Annex below for a summary of the key provisions). Asset managers will need to comply with these rules from January 2018. The rules will require firms to provide aggregated information to their clients on a regular basis, for the lifetime of the investment. Furthermore, firms must provide an itemised breakdown of costs if the client requests this. Disclosures will include the asset management charge, an estimate of transaction costs and any intermediary fees.

How does the FCA's approach fit with this?

The final report acknowledges that there are significant imminent changes, with the application of MiFID II and PRIIPs fast approaching. These will require firms to calculate and disclose indirect costs such as estimated transaction costs, and present charges as cash amount in cost disclosure documents. The FCA's on-going concern, however, is that this information may still be presented in a way that is not entirely clear to consumers, thereby hindering true comparability of fund charges. The FCA undertook research (as part of its Smarter Consumer Communications initiative) to examine consumer engagement in this sector. Results from the FCA's "clickstream data" showed that of all the visits to the website to look at funds, fewer than 9% looked at charges and under 3% looked at documents (including the Key Investor Document). Furthermore, customers only sorted lists of funds by charge – a strong indicator of engagement with charges, according to the FCA – during 0.1% of visits.

This explains why the FCA is proposing to supplement existing (MiFID) and incoming (MiFID II and PRIIPs) legislation. It intends to test ways to improve the effectiveness of any forthcoming disclosures in order to understand the role played by the prominence and presentation of charges to encourage investors to focus on the impact charges have on their investments, and to enable effective price comparison. The FCA's findings from this work will inform the development of any future "remedies". For example, the Regulator is considering whether to consult on guidance in areas such as the wider use of pounds and pence disclosure on "other information sources". As part of this, the benefits to consumers of consistency between point-of-sale disclosures and on-going disclosures mandated by MiFID II and PRIIPs will be examined.

Overall, it is clear that the FCA is keen for fund managers to disclose one set of total charges, which is simple to understand, cannot easily be made misleading, and can be compared across the industry. The FCA will draw upon its Smarter Consumer Communications work in delivering its proposed measures.

Performance disclosures and fees

The FCA is also considering whether additional policy action is required to make UK domiciled funds' performance fee structures more equitable and review fees which do not align investor and manager incentives. The FCA plans to consult on rules for performance fees to be permitted only when the fund's most ambitious target has been exceeded, after ongoing fees.

As part of its initiative on ensuring investors understand that past performance is not a reliable indicator of future results, the FCA is also considering new rules for where an AFM does not set a specific benchmark, comparator or numerical target return for a fund.

What are the considerations for firms?

Most important is that firms are not required to take immediate action. But, the FCA commitment to all-in fee disclosures, together with other "remedies" in the final report and FCA consultation, will lead to enhanced scrutiny of charges and may prompt pressure on fees for active retail funds as firms seek to explain the fairness of their charging structures to the FCA.

For example, other FCA "remedies" include reforms for governance bodies to consider value for money. These reforms are intended to enhance scrutiny on costs and charges as well as the disclosure thereof. Furthermore, reforms under MiFID II will result in a "step up" of work, analysis and transparency on costs and charges as there will be greater obligations around best execution which will strengthen the content and quality of disclosure to clients.

Firms should recognise the underlying FCA expectation that they take more responsibility for any lack of customer engagement with charges, and consider any read across to other areas of the business. To drive further competition on retail fees, the FCA suggests explicit disclosures alone are insufficient. Disclosures must be clear and comparable so as to engage consumers; the FCA wants firms to take responsibility for these changes and see them through.

In the short term, the disclosure changes under MiFID II will provide greater transparency for investors because a key component (and variable element) of total charges is transaction costs and an estimate of these will in future be mandatory. Similarly, the use of pounds and pence rather than relying on just percentages for fees should aid consumers in understanding charges. Nevertheless, the transaction costs element will be an estimate and possible costs, such as dilution levies and adjustments, will not be disclosed. As a result, completely accurate comparability on total charges for all retail funds may not be achieved.

In the medium term, the FCA initiatives requiring a formal consideration of value for money to include fees and charges, as well as the yet to be published proposals on clearer communication, should further assist investors wishing to compare the true costs of similar funds and it is clear that the FCA is committed to its all-in one fee. This suggests firms will need re-visit their charging structures as well as how effective their explanations of these charges are to retail investors.

ANNEX

Summary of cost disclosures required under MiFID II and PRIIPs

MIFID II PRIIPs (KID)
Format Expressed in monetary and percentage terms Expressed in monetary and percentage terms
Methodology Ex-ante and ex-post Ex-ante and ex-post
One-off charges To be disclosed To be disclosed
All costs related to the transactions To be disclosed To be disclosed
Incidental costs To be disclosed To be disclosed
Costs and charges to be aggregated All costs mentioned above All costs mentioned above
Cumulative effect of costs on the return To be disclosed To be disclosed

MiFID II

Article 24(4) of MiFID II requires MiFID firms to provide appropriate information in good time to potential clients with regard to (among other things) all costs and related charges. This requires that all costs and associated charges related to investment/ancillary services and financial instruments be disclosed to clients. This encompasses a wider range of costs than are currently required under MiFID.

Clients should be provided with an aggregated overview of all costs and charges of the investment, including, where the client requests (as provided under Article 24(4)), an itemised breakdown.

Article 50(2) of the MiFID II Delegated Regulation states that firms are required to aggregate all costs and associated charges for both investment and ancillary services charged by the firm (or other parties where the client has been directed to such parties), and all costs and associated charges associated with the manufacturing and managing of the financial instruments.

The information provided to the client should allow him/her to understand the cumulative effect of costs and charges on the return on investment.

Annex II to the MiFID II Delegated Regulation sets out tables of the costs that should be disclosed. There are separate tables for costs associated with the service and costs associated with the financial instrument. Costs associated with the service to be disclosed include:

  • One-off charges related to the provision of an investment service (e.g. deposit fees, termination fees and switching costs)
  • Ongoing charges
  • All costs related to transactions initiated in the course of the provision of an investment service (e.g. broker commissions, entry and exit charges to be paid to fund managers)
  • Any charges that are related to the ancillary services
  • Incidental costs (performance fees)

Costs and charges related to the financial instrument (examples are provided in the table in Annex II of the Delegated Regulation) include:

  • One-off charges, ongoing charges
  • All costs related to the transactions
  • Incidental costs

PRIIPs

Costs are to be included in the "What are the costs?" section of the KID - this must provide costs associated with the investment in the PRIIP, comprising both direct and indirect costs (including one-off and recurring costs). To ensure comparability, total aggregated costs expressed in monetary and percentage terms must be provided to show the compound effects of the total costs on investment (as set out in Article 8(3)(f) of the Regulation).

The Delegated Regulation provides more detail on costs which need to be disclosed. This includes "costs over time" and "composition of costs" (see Article 5 and Article 13 of Delegated Regulation).

Annex VI of the Delegated Regulation sets out the methodology for the calculation of costs.

Firms must provide "costs over time" which specify the "summary cost indicator" of the total aggregated costs of the PRIIP as a single number in monetary and percentage terms (the table for this is provided at Annex VII to the Delegated Regulation).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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