Asset managers’ profits are too high according to the FCA. That’s the clear message in the Asset Management Market Study Final Report that the regulator published this week. The question is will their proposals make much of a difference? At Platforum’s D2C & Digital Investing conference yesterday, Daniel Godfrey declared that he thought the FCA had bottled it. But we think that, in some areas, the FCA’s plans have teeth.
The FCA reported that the managers they surveyed enjoy an average of 36% operating margins and 20% to 45% return on capital employed. The regulator is proposing ways to change this – using both indirect methods to encourage competition and direct actions to improve practices and governance.
Promoting competition is one of its strategic objectives – which its predecessors didn’t have. So it seems determined to pull as many competition-encouraging levers as it can to drive down charges. This has led it to making lots of laudable proposals – the key question is whether competition in this market will in fact drive down fund charges.
Nevertheless, at Platforum we think it will help investors and advisers for funds to disclose a single all-in fee for funds, despite the imperfections of any such approach. But kicking it into the MIFID II/PRIIPS long grass could be seen as a classic example of regulatory pussyfooting.
Initial reactions from active fund managers suggest that they have been given confidence by the FCA’s response to the challenge of reporting variable transaction costs in an all-in-fee. The FCA has indicated that it will allow fund groups to calculate the fee using the previous year’s transaction costs and to report the final transaction costs to investors at the end of the year in an annual statement. However, one active manager felt that active houses need to do more to communicate the value of transactions in improving fund performance.
Our conversations also indicate that the smaller active fund houses unable to absorb research costs might be hard hit by an all-in-fee: but of course, they will be expensive. The emphasis on costs will hand an advantage to asset managers with scale.
We like the idea of funds providing investors with clearer and more useful objectives, although we will reserve final judgment until we see the practical outcomes. And we think that performance measurement and benchmarking could be improved and made easier for investors to understand.
Making it easier for firms to move investors to cheaper share classes is also really good news: fund groups with legacy books often need a wet signature. But it’s still a significant programme of work for some. The indications are that the FCA will introduce a sunset clause: the timescales could make a significant difference to certain fund managers and advisers. In 2016, commission made up 26% of investment revenues to advice firms.
We agree that investment consultants should be brought under FCA regulation. Bringing consultants into the regulatory perimeter could be welcome news for the manufacturers of target date funds. We reported on conflicts of interest in our workplace savings report.
More disclosure and transparency are always welcome. But we are sceptical that they will kick off a revolution in the competitiveness of the asset management sector – especially in the retail space. After all, if it has proved tough to persuade lots of advisers of the benefits of keeping down asset management charges, then how much harder will it be to get the message across to retail investors? And it is only once the importance of charges is more widely accepted that providing even more information about them will have much effect on buying habits.
But we think that the FCA’s proposals for more direct actions could have the greater impact.
We welcome the requirement for fund managers to return risk-free box profits to their funds and to disclose their box management practices to investors. The late and very much missed Paul Bradshaw, whose finger was very much on the pulse of the industry, was heard to report that at least one fund management house he knew about made more money out of its box profits than any other of its activities. It is perhaps a wonder the regulator hasn’t identified these problems before.
But the proposal that looks as if it could have the biggest impact on charges is the use of the senior managers’ regime – that’s just about to hit non-banking financial services – to act in the best interests of clients. Of course they should be doing that already. But the FCA found that fund management boards generally tend to lack independence and don’t consider value for money for investors. Fund management business need strong governance – but they mostly don’t get it.
So the FCA proposed much clearer regulatory expectations, more independence of the boards – along US lines – and an extension of a prescribed responsibility for value for money for investors under the senior managers’ regime – although it stopped short of giving them fiduciary duties. There will be increased costs, as with many of the other proposals. And it looks as if the managers will have to pay them.
Improving governance could turn out to be a damp squib, or it could make all the difference.