Asset Management Market Study: Final Report

Of Relevance to:
Asset management sector; retail intermediaries; providers of retail investment products

In November 2015 the FCA published its terms of reference (“TOR”) in relation to the intention to undertake a market study into asset management – a task which had been set out in the FCA’s Business Plan for 2015/16.

The TOR identified three main topics to be explored:

  • How do asset managers compete to deliver value;
  • Are asset managers willing and able to control costs and quality along the value chain; and
  • How do investment consultants affect competition for institutional asset management?

Almost a year to the day later, the FCA released its Interim Report (“Asset Management Market Study” – MS15/2.2) in November 2016. Findings within the Interim Report included, but were not limited to:

  • Little evidence of persistence in outperformance, but some evidence of persistence of relatively poor performance;
  • On average, active funds underperformed benchmarks after charges;
  • Investment consultants, on the whole, were not able to identify managers that offer better returns to investors, nor did they drive significant price competition between asset managers; and
  • In the investment consultancy sector there appeared to be a positive relationship between the number of high ratings given to an asset manager and the number of gifts and hospitality items recorded.

The Interim Report invited comments and feedback by 20 February 2017.

Please see Regulatory Roundup 82 for further details.

Having considered the feedback it received, the FCA published its Final Report into asset management on 28 June 2017 (MS15/2.3).

Final Report – Highlights

  • Requiring 25% of the board members of an authorised fund manager (“AFM”) to comprise of independent directors.
  • AFMs having to undertake, document and publish ‘value for money’ assessments.
  • When the Senior Managers and Certification Regime is rolled out to all firms, having an additional prescribed responsibility to act in the best interests of investors.
  • Possibility of extending the above to life insurers and with-profits business.
  • Risk-free box management profits to go to the fund rather than to the AFM.
  • AFMs having to publish their policy (in the prospectus) on box management.
  • Possible consideration to the ending of trail commission.
  • Restricting the basis upon which performance fees can be charged/calculated.

Final Report – The Detail

Whilst acknowledging the vital role that asset management plays in the UK’s economy – the UK’s asset management industry is the second largest in the world, managing around £6.9 trillion of assets – the paper provided what is described as a package of remedies split into three groupings:

  1. Those remedies which the FCA is consulting on alongside the Final Report (the FCA also issued on the same day CP17/18 “Consultation on implementing asset management market study remedies and changes to Handbook”);
  2. Final remedies which do not require further consultation; and
  3. Remedies for which the FCA provides initial views on its proposals and which will feature in a future consultation.

In addition to the above, the FCA is giving consideration to making a market investigation reference to the Competition and Markets Authority to further investigate investment consultancy services.  The three largest investment consultancies provided undertakings to the FCA in lieu of such a reference, although the FCA is minded to reject the undertakings in lieu – a final decision will be made in September 2017.

Grouping 1: Remedies the FCA is consulting on by way of CP17/18


The Handbook changes being consulted upon relate to the activities of AFMs which captures:

  • managers of authorised unit trusts;
  • authorised corporate directors; and
  • managers of authorised contractual schemes.

As a reminder, whilst an ‘authorised fund’ may bring to mind e.g. a UCITS, the Handbook definition is an:

  • investment company with variable capital (“ICVC”); or
  • authorised unit trust (“AUT”); or
  • authorised contractual scheme (“ACS”).

The proposed changes to the Handbook will apply equally to both ‘host’ AFMs as well as the traditional AFMs.

Any Handbook references below relate to the proposed rules as set out in CP17/18.  The consultation period closes 28 September 2017.

Fund Governance

The remedies proposed under this heading will apply to all UK-authorised AFMs for collective investment schemes that are authorised and domiciled in the UK as well as to UK UCITS management companies managing EEA UCITS schemes.  However they will not apply to EEA UCITS management companies accessing the UK market through the UCITS management passport nor to full-scope AIFMs that operate UK funds, or market EEA domiciled funds in the UK.

Independent Directors

  • At least one quarter of AFM board members must comprise of independent directors, with a minimum of two such independent directors (natural persons) where the governing body consists of less than eight members.
  • Independent members of the AFM governing body must be appointed for terms no longer than five years, and a maximum cumulative duration of ten years. No reappointment will be permitted until five years have elapsed after having served on the governing body for the maximum duration of ten years.
  • The Handbook will include guidance on persons that are unlikely to be considered ‘independent’.
  • The role of the independent members will include providing input and challenge to the ‘value for money assessment’ – see below.
  • The FCA recognises the challenge that will be faced in recruiting (at least two) independent directors per AFM and so propose an implementation period of 12 months following finalisation of the rules.

Value for money assessment

  • An AFM must carry out an assessment, at least annually, of whether each scheme it manages provides ‘good value for money’ for investors.
  • The assessment must (separately for each class of units in a scheme) at least consider:
  1. economies of scale
  2. charges and other payments
  3. quality of service provided
  4. classes of units (as in whether it is appropriate for investors to hold units in classes subject to higher charges than those applying to other classes of the same scheme).
  • The AFM must publish, at least annually, a report on the findings of the ‘value for money’ assessment. This can be done either as part of each fund’s annual report or through a separate dedicated report published by the AFM.

Future developments

  • The FCA will consider whether additional, specific, requirements should be imposed on the board e.g. how performance is measured and explained.
  • As part of the extension of the Senior Managers and Certification Regime, the FCA will consult on the introduction of a new prescribed responsibility on the chairman of the AFM board to act in the best interests of investors.
  • Chapter 6 of CP17/18 invites feedback on the possibility of applying the above governance reforms to life insurers, unit-linked funds, with-profits business and investment companies.

Where can I find further information?

  • The relevant draft rules (Part 1 and Part 2) can be found in Appendix 1 of CP17/18.
  • COLL 6.6.25/26 re ‘independent directors’.
  • COLL 6.6.20 – 6.6.24 re the ‘value for money assessment’, including guidance on the appropriateness of ‘charges and other payments’ and ‘quality of service provided’.
  • COLL 4.5.7 re the publication of the ‘value for money’ assessment, including the minimum content.
  • COLL 8.3 & 8.5 re similar provisions in respect of qualified investor schemes.

Box management profits

  • The FCA has given consideration to the profits made from box management, both what it terms ‘risk-free’ box profits and ‘at-risk’ box profits.
  • Where, at the same valuation point, the AFM accepts instructions to both redeem and sell units and is able to match orders between those investors, then the resulting profit i.e. arising from the difference between the bid and offer prices is categorised as ‘risk-free’ (as the AFM’s own capital is never at risk) by the FCA.  In its view these profits should be passed on to the fund.
  • On the other hand, where the AFM carries such units over a valuation point then it could make a profit (or a loss) depending upon how the value of the units have moved over the valuation point. Any resulting profit is categorised as ‘at-risk’ (as the AFM’s own capital was at risk). These profits remain those of the AFM (although note that the draft guidance will not permit the AFM to profit from e.g. any situation from which it is not exposed to an equal risk of loss if the units fall in value).
  • AFMs will be required to explicitly state their policy on operating a box in the fund prospectus and whether they may retain any profits from it.
  • AFMs will have to account for the risk-free profits passed back to the fund, but will not have to disclose any at-risk profits made.

Where can I find further information?

  • The relevant draft rules (Part 1and Part 2) can be found in Appendix 1 of CP17/18.
  • COLL 4.2.5 re the prospectus and the need to include a statement on box management.
  • COLL 6.35 re profits from dealing as principal.
  • COLL 6.7.16 re exemptions from liability to account for profits.
  • COLL 8.3 & 8.5 re similar provisions in respect of qualified investor schemes.
  • COLL TP1.1 re transitional provisions delaying the need to update the prospectus for a limited time unless it is updated for other purposes.

Moving investors into better value share classes

  • There are concerns as to whether some retail investors (in authorised funds) were in more expensive share classes when cheaper, but otherwise identical, classes in the fund were available. At least one view expressed was to the effect that there may be an element of reluctance from advisers that receive trail commission (relevant to advice on investments sold before 2012) to advise investors to switch investments.
  • Of the firms surveyed as part of the market study, 21 asset management firms reported paying around £1.4bn in commission in 2015 with a separate report suggesting that 31% of all UK-domiciled fund assets (£245bn) remain in classes that can pay trail commission.
  • There was evidence that some investors remained in expensive share classes even though they no longer paid trail commission. AFMs claimed that this was as a result of FCA guidance that the express permission of investors must be sought before moving an investor to a different class – it is difficult to get such permission from every investor.
  • Some respondents to the interim report were ‘strongly recommending’ the FCA to introduce a phased sunset clause which would eventually lead the demise of trail commission.
  • The FCA recognises that the stopping of trail commission could have a significant impact on both product providers and on advisers (particularly those that are self-employed).
  • The market study did not specifically collect evidence around trail commission and therefore the FCA wishes to gather more evidence on the matter. The FCA welcomes information to help them understand the magnitude of the problem. The FCA recognises that trail commission is not restricted to the asset management sector and so also welcomes further information on the role it plays in other markets e.g. life assurance and the consequences of stopping trail commission.
  • Appendix 2 of CP17/18 includes draft guidance (which replaces guidance FG14/4 on the same subject) “Changing clients to post-RDR unit classes” and includes guidance on mandatory conversions.

Grouping 2: Remedies which require no further consultation

The FCA will:

  • Recommend that the Department for Work and Pensions remove barriers to pension scheme consolidation and pooling.
  • Recommend that the Treasury considers bringing investment consultants (as in firms which undertake due diligence on potential asset managers for a client) into the regulatory perimeter.
  • Recommend both industry and investor representatives agree standardised disclosure of costs and charges to institutional investors.
  • Launch a market study into investment platforms (Terms of Reference now published).

Grouping 3: Remedies which will feature in a future consultation

Costs and charges disclosure to retail investors

  • Performance fees only permitted above the fund’s most ambitious target (consistent with ‘performance reporting’ proposals – see below).
  • Performance fees only permitted above the fund’s most ambitious target on a net basis i.e. after deduction of ongoing fees.
  • Guidance on the wider use of pounds and pence (as opposed to a percentage) disclosure.

Benchmarks and performance reporting

  • Where the AFM has chosen a specific benchmark, comparator or numerical target for a fund, it should make the reasons for this clear to investors.
  • Where no specific benchmark, comparator or numerical target for a fund is chosen, then the reasons for this should be made clear to investors, and it would be prevented from using any other benchmarks or comparators in marketing material for that fund.
  • If AFMs choose to present past performance they must do so against the most ambitious returns target (if any) they hold out to investors.

Convening a working group on clarity of funds’ objectives and consulting on any proposed rule changes

  • The working group will also consider whether more information or additional metrics should be provided to help investors better understand the returns in relation to a fund’s objectives.
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