Dear Clients and Friends,
The FCA’s recent publication of its Asset Management Market Study Final Report sees a continuation – and even arguably a heightening – of the recent regulatory focus on fees and charges, both in terms of the transparency of their disclosure to investors, but also as to whether the fees themselves are justified and represent fair value for money when considered in the context of the performance of the fund to which they relate. The impact on asset managers will vary depending on the nature of the funds they manage and the clients they serve (with some doubt over the exact scope of the FCA’s recommendations adding complexity to the mix), but it is likely that for many firms, the proposals will require potential systems work at a minimum, and could even force a re-evaluation of their pricing models.
An Old Debate
The debate regarding fees and charges in respect of financial services products is nothing new. A tension has always existed in this respect between the providers of financial services products and their consumers, and the asset management sector is in many ways merely representative of this debate. However the debate is likely to prove particularly challenging for asset managers for a variety of reasons.
The Scope of the FCA’s Proposals Remains Unclear
The original scope of the FCA’s review didn’t extend to private equity, hedge funds and other alternative asset managers. However the FCA’s director of competition has expressed the view that some of the same principles should apply to hedge funds (whilst being silent on other sectors), whilst the report itself notes that the FCA “will consider whether any remedies [in respect of transparency of charges] should apply in this sector”. For firms already grappling with a considerable volume of regulatory change, coupled with uncertainty as a result of Brexit, this lack of clarity is unhelpful, to say the least.
Existing Regulatory Initiatives Have Already Increased the Focus in this Area
MiFID II, PRIIPS and UCITS V have all made (or will make) changes to the nature and content of information disclosed to clients. The FCA’s new proposals, although subject to further consultation and written in the context of those further changes, will only serve to increase the existing regulatory burden faced by firms in this respect.
For example, many firms will already be implementing significant systems changes in order to enable them to comply with enhanced requirements regarding ex ante and ex post disclosure of fees and charges as required under MiFID II. The potential creation of an industry standard template for disclosure of costs and charges to institutional investors could lead to further work on those same systems.
Further, the proposed creation of a single “all-in fee” for retail investors will force those firms who deal with retail clients to re-evaluate their pricing models, whilst also potentially requiring yet more systems work. (And of course it is not inconceivable that the FCA may look to extend at least the principles behind the idea of a single “all-in fee” beyond the retail world at some point.)
The FCA’s Concerns Go Beyond Disclosure, Raising Questions about Fairness, and Value for Money
As noted above, the FCA’s concerns go beyond simply whether fees and charges disclosure is sufficiently transparent (albeit that this is in itself a significant concern on the FCA’s part) and relate, in no small part, to whether fees and charges are justified and represent fair value when considered in the context of the performance of the fund to which they relate.
For example, the FCA has questioned the extent to which actively managed funds actually outperform passively managed funds to such an extent as to justify the higher fees typically associated with the former (although it should be noted that the FCA’s concerns regarding value for money are not limited purely to actively managed funds).
Further, the FCA has indicated that it has significant concerns over whether performance fees can be justified, and specifically whether firms may be using incorrect benchmarks when calculating fund performance. The FCA plans to consult on a requirement that fund performance should only be shown against the fund’s most ambitious performance targets, with a similar requirement in respect of the calculation of performance fees (which would also need to be calculated against performance net of ongoing fees).
At the heart of the FCA’s concerns regarding fees and charges are the FCA’s beliefs that competition – certainly in respect of price – is weak in the asset management sector, that profitability may be too high, and that there is an imbalance between the fees charged by asset managers relative to the returns they generate for investors. Given the nature of these concerns and the specific proposals put forward by the FCA to address them, it seems almost inevitable that asset managers will face significant pressure on their margins and may be forced to re-evaluate their pricing models and even close or merge funds.
These pressures come at a time when the asset management industry has faced and continues to face a significant volume of regulatory change, with AIFMD, UCITS V, MiFID II and PRIIPS all requiring firms to make significant changes to their business models, governance arrangements, systems and controls – all with potentially considerable cost implications, both at point of implementation and on an ongoing basis.
A specific FCA proposal (already being consulted on in CP 17/18, published alongside the final report) is the potential introduction of a rule requiring funds’ Boards to consider and assess the “value for money” offered by their funds. Taken together with the forthcoming extension of the FCA’s Senior Managers and Certification Regime into the asset management sector, this change will place an increased responsibility on the shoulders of Fund Boards, and given the pressures and challenges fund pricing models are likely to face, this challenge is not one that should be underestimated.