The Asset Management Market Study in UK
A wave of sweeping changes for the asset management industry in the UK is at the horizon, with some of those kicking in very soon. These come with the implementation of a packet of measures part of a recent endeavour of the FCA called the Asset Management Market Study in UK.
Amongst the various measures proposed, this brief article will focus on the governance reform element of the proposal, with the introduction of a value for money assessment and non-executive independent directors’ requirement, effective as of 30 September 2019.
Overview and Final Findings
The Asset Management industry plays a vital role in the UK and global economy for a variety of reasons. Asset managers are in charge of managing the savings of a large multitude of retail investors and their decisions affect the financial wellbeing of these investors. Asset managers channel the funding from their investors into supporting a wide variety of both UK and international enterprises, which in turn create jobs and drive growth.
The Asset Management Market Study in UK was necessitated to ensure that this segment of the market works well and investment products are able to deliver value for money to investors. At the end of the initial consultation phase it emerged clearly, amongst other things, that in a number of areas there were inefficiencies in the asset management industry due to a weak price competition. In simple terms, the FCA found that there was no competition on price particularly for retail active asset management service when compared to institutional investor mandates, where typically the costs tend to fall as mandates increase in size. Asset managers do not adopt any price reduction technique to win new retail clients and these very retail clients are not always in a position to ascertain and understand value for their investment and find a better value.
Measures to improve fund governance
Some of the remedies suggested by the FCA are proposed at governance level, with the idea to strengthen the duty of asset managers to act in the best interest of their investors. In essence, a governance reform to increase the level of scrutiny carried out by boards of fund management firms, with the introduction of yearly assessment on the value for money and a minimum number of non-executive independent directors.
Further to consultation with industry participants, the FCA acknowledged that the assessment of value for money, whilst not considered sufficiently so far by asset management firms, should not only be focused on costs charged to funds by their managers, rather on the overall service delivered to investors. Accordingly, value for money shall be assessed on the basis of a list of prescribed elements, including quality of services as well as fund performance.
However, as far as costs are concerned, the assessment still requires a comparison between the costs charged in the fund product versus the cost of a similar strategy offered in a different product, like segregated mandates. This comparison, will possibly help to strengthen the competition on price also for retail products, where the initial findings of the study showed weaknesses.
As part of the same measure, it is also proposed to introduce the requirement to disclose the yearly assessment in a report. This requirement will help with transparency at industry level and eventually will also serve as a tool to better explain the performance of a fund at a specific point in time to retail investors.
The package of measures introduced by the FCA dovetails with the initiatives of investor protection at European level and also places the UK in line with the regime introduced in some other European domiciles, like Ireland and Luxembourg, well known hubs for fund formation and establishment. This is particularly the case for the introduction of the requirement to appointing non-executive directors to the board of investment funds, which is customarily imposed on fund boards in Ireland and Luxembourg for quite some time now.
It is interesting to see that, when defining the eligibility criteria of independent directors, the FCA does not seem to be concerned with setting a limit of directorships per individual, which instead is a consolidated practice both in Ireland and Luxembourg, nor to require any specific prior fund experience, which should be helpful to discharge the task of an independent director. The FCA seems to emphasise and be concerned mostly with the element of independence, making sure that independent directors have no prior ties of any sort with asset management firms.
Cost of Implementing the Measures
No doubt that the proposed remedies will benefit retail investors, but these will come with a price. The FCA study comes with a very detailed costs analysis for the implementation both of the value for money assessment and the non-executive independent directors. The question is who will ultimately bear the final cost of implementing these new measures? Will it be the managers or the investors?
It was lately clarified by the FCA that, at least for the non-executive independent directors’ requirement, the related cost will have to pass through the fund managers to the funds and ultimately investors and not directly charged to the funds. In essence, non-executive directors will be a cost of the manager, who will then have discretion to decide whether to pass it on to investors via an increase of the management fee or any other fee or not.
We will see what market practice will develop on this topic and whether fund managers will decide to bear the cost of the independent directors or pass those to investors, similar to what happened in the recent past for the costs of investment research under MiFID II.