As part of its asset management market study, the FCA has published:
- a policy statement on its measures on fund governance, moving investors to better value share classes, and treatment of dealing profits;
- a consultation paper on proposed measures on investor disclosures; and
- an occasional paper on costs and charges disclosures.
These papers follow the FCA's final report on its asset management market study which was published in June 2017 (see our blog). 1 Below we summarise the key rule changes and assess the implications for firms.
Final rules on fund governance, moving investors to better value share classes and dealing profits
- Value for money: the FCA had consulted on requiring authorised fund managers (AFMs) to assess the value for money of each fund against a non-exhaustive list of factors (including the costs incurred by the AFM, comparable products and services, economies of scale and differences between share classes). The AFM must then conclude that each fund offers good value for money or take corrective action if it does not, and explain the assessment annually in a report made available to the public. In its final rules, the FCA has added fund performance as a specific factor to be considered, to clarify that fund charges should be assessed in the context of the overall value delivered. It has also clarified that savings from economies of scale can be reinvested in the business where this is in the interests of investors. And it has extended the implementation period for this requirement from 12 to 18 months. In our view, it is likely that the assessments required in these final rules will not be sufficiently comparable to show clearly to investors which products offer the best value for money. However, firms offering products with particularly poor value for money may struggle to justify their offering and be put under pressure to reduce fees, improve the quality of service, or move investors into better value share classes.
- Independent directors: the FCA had consulted on requiring AFMs to appoint a minimum of two independent directors and for them to comprise at least 25% of the total board membership. The FCA has decided to require this for all AFMs, despite feedback asking the FCA to waive these requirements for smaller AFMs. As previously proposed, the FCA will not impose any restrictions on independent directors serving on multiple AFM Boards and the final rules include details on the length of term which independent directors can serve. The FCA has extended the implementation period for this requirement from 12 to 18 months. Currently, AFM Boards are generally staffed exclusively by executives of the firm, and portfolio manager appointments are usually longstanding. The presence of independent board members may put more pressure on AFM Boards to justify their choice of portfolio manager if they do not offer good value for money.
- Prescribed responsibility: the FCA had consulted on introducing a new specific prescribed responsibility for AFMs under the Senior Managers and Certification Regime (SM&CR), which is expected to be extended to almost all financial services firms in 2019. This would require a senior manager, usually the chair of the AFM board, to take reasonable steps to ensure that the firm complies with its obligation to carry out the assessment of value, the duty to recruit independent directors, and the duty to act in the best interests of fund investors. The FCA intends to proceed with this measure as consulted on. This will add weight to the FCA's requirements on assessing value for money and acting in the best interest of investors, as a senior individual will be held accountable.
- Share classes: the FCA had consulted on removing the need for an AFM to get consent from each investor before converting them to a cheaper but otherwise identical class of the same fund. The FCA has decided to proceed with this. Its updated finalised guidance also recommends that AFMs make a simple, one-off notification to investors, which does not require a response, a minimum of 60 days before a mandatory conversion. This will allow firms to close expensive share classes in which only a small number of investors remain. The FCA is still considering whether it should continue to allow the payment of trail commission and has no immediate plans to make rule changes on this.
- Dealing profits: the FCA had consulted on requiring that where managers of dual-priced authorised funds make a risk-free profit when dealing as principal in the units of their funds, these profits should be repaid to the fund. The FCA has decided to proceed with this, and has amended its final rules to take into account some technical concerns raised by stakeholders on the drafting. This remedy will reduce margins for some products.
- Scope: the FCA will carry out diagnostic work with a view to deciding whether to extend any of these measures to with-profits and unit-linked products in H1 2019. The FCA does not have immediate plans to extend the rules to investment trusts or pensions.
Proposed remedies on investor disclosures
- Costs and charges disclosures: in its market study, the FCA had highlighted the importance of clear disclosure of what asset management services cost through the presentation of an 'all-in fee'. Following the implementation of MiFID II and PRIIPS rules on costs and charges disclosures, the FCA does not have immediate plans to introduce new requirements in this area, but will consider mandating certain forms of disclosure as part of its ongoing investment platforms market study. It has published an occasional paper setting out the results of its behavioural testing on the effectiveness of costs and charges disclosures, which found that the prominence of costs and charges disclosures and the type of information displayed had a significant effect on decision-making. It urges firms to consider the results of this when thinking about how their disclosures are working. This approach is less interventionist than some of the options the FCA was previously considering, but leaves open the possibility of additional requirements at a later stage.
- Fund objectives and use of benchmarks: the FCA proposes to introduce new guidance on fund objectives, and a new requirement that if a fund has benchmarks, their use must be explained and referenced consistently in all consumer facing documents. This will make it harder for firms to change comparator benchmarks regularly or to carry out closet-tracking.
- Performance fees: the FCA proposes to require that performance fees must be calculated on performance net of other fees in all cases.
Implications for Firms
The new requirements on value for money assessments are likely be a particular focus for senior management within firms, especially given the new prescribed responsibility and the requirement to make the results of the assessments public. The requirement to introduce independent directors to AFM Boards (albeit that a majority of independents will not be required) is intended to bring about a significant change in governance arrangements through facilitating external perspectives and challenge. There will be significant demand in the market for credible independent directors, so firms should start their recruitment early.
The approach on "all-in" fee disclosures is less interventionist than some of the options the FCA was previously considering; however, new rules could yet be introduced in this area as part of the investment platforms market study.
Overall, this package of remedies is likely to increase significantly investor understanding and hence scrutiny of value for money in funds. That, coupled with competitive pressures, and heightened regulatory scrutiny, will generate continuing pressure on the margin between active and passive fund management costs, particularly for retail funds, and increase momentum towards industry consolidation.
The FCA's final remedies come into effect on the following dates:
- the requirements on value for money and independent directors come into effect on 30 September 2019;
- the requirements on the prescribed responsibility under the SM&CR will come into effect in mid to late 2019 (along with the rules for the extension of the SM&CR in general);
- the requirements on dealing profits will come into effect on 1 April 2019; and
- the updated guidance on transferring customers to better value share classes is immediately effective.
The FCA is asking for feedback on its proposed remedies on investor disclosures by 5 July 2018. The Institutional Disclosure Working Group of industry and investor representatives is also due to make recommendations on a template for the disclosure of costs and charges for institutional investors in the summer of 2018.
1This work is part of a broader regulatory and supervisory focus at both EU and UK level on the value for money provided to investors. For example, asset managers have recently had to implement rules in the revised Market in Financial Instruments Directive (MiFID II) on costs and charges disclosures, including payment for research, and rules in the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation on pre-sale disclosures. The European Securities and Markets Authority (ESMA) has also been coordinating work by national regulators to scrutinise "closet-tracking", which has resulted in several UK asset managers paying compensation to investors. Later this year, ESMA is also expected to publish the results of a large-scale study assessing the reporting of costs and past performance of retail investment products, as well as guidance on performance fees.
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