“Where costs are less transparent, we have identified some specific examples where firms place less emphasis on controlling them”

FCA Asset management Market Study 7.54 (p135)

Yesterday I wrote about the savage treatment meeted out to Investment Consultants in the FCA’s Asset Management Market Study

Today I will focus on issues to do with value for money (VFM) and specifically on how the FCA want the “money” part of that equation to be better defined and communicated

The problem with getting value for other people’s money

The quote that opens this article, informs the sections of the Study which deal VFM.

Asset Managers are reckoned to manage around 80% of their costs in-house with around 20% outsourced to third party service providers. Some of the internal and external costs are met from within the Annual Management Charge (so diluting profitability to the asset manager), some met from the value of the fund (so diluting the performance of the fund to the consumer).

A simple analogy is the personal shopper, who finds limited numbers of bargains on the shelves of the supermarket, should the shopper put the bargains in his/her personal basket or in the person’s basket for whom he or she is shopping?

The conclusion from the FCA is repeatedly, that where scrutiny is off, malpractice creeps in

“However, we have concluded that most firms are still not applying the same rigour and oversight to the way in which they spend client’s research budgets as when they spend their own money”

The purchasing of research (especially “free research# paid for through higher trading costs) continues to be a thorny issue for the FCA but it is one that they are beginning to get on top of.

But there are areas where the Study finds new conflicts

The opacity of bond pricing where Over the Counter Pricing prevails.

Issues around Stock lending (despite its 2013 review) where losses are no indemnified and fees from the lending are retained by the asset manager (see my recnt blog on B&CE and State Street)

Similarly, some asset manager’s practice of profiting from Risk- Free Box management

As with Stock Lending, the payment of research costs and the execution of trades, Risk Free Box Management can substantially improve or diminish member outcomes.

What is clear is that

“Where costs are less transparent…… firms place less emphasis on controlling them”

Remedies for the consumer

The FCA divide the remedies for the current lack of transparency into two

Strengthening the independence and powers of fund governance

For fund governance bodies , there is no better sanction than this ongoing obligation

“to perform an annual, arm’s length reassessment and , where appropriate, renegotiation of the investment management agreement (IMA) with the asset management company”.  (10.10 -p 184)

Trustees’, IGCs and even the Authorised Fund Manager (AFM) Boards – were they to properly perform this function would become increasingly relevant to consumers. Charges that such fiduciaries are “paper tigers” only hold where the governance bodies are disinclined to exercise sanctions or not empowered to carry them out effectively.

Independence

The FCA are looking at the constitution of Authorised Fund Manager (AFM)  Boards ; making them proper fiduciary boards with a duty of care to the customer, thus realigning the needs of the customer against the needs of the shareholder.

I cannot see how this will be achieved without making AFMs independent of the Asset Manager’s management board (as IGCs are independent of contact based workplace pension providers. Reforming existing structures will rearrange the deckchairs but not save the ship.

Here are the options the FCA are considering to improve independence.

Powers

Here the FCA see the obligation to demonstrate that the fund is giving “value for money” as critical.

But here we get to the thorny question of measuring value for money; I’m pleased to say that the FCA do not duck this issue.

The “remedy” to ensure that both fiduciaries and consumers can see what they are paying for focusses on a single measure of charge that builds on the current OCF methodology

The first suggestion doesn’t give transparency and doesn’t seem to add greatly to customer outcomes and presents a maintenance of the status quo

I hope my reading of the rest of the paper suggests that maintaining the current status-quo is not the intention of the FCA; I am hopeful that one on the remaining options will be adopted.

The three options escalate the obligation on managers to the point in (D) where the manager is effectively underwriting all costs within the fund as part of the single charge. This actually happens in Turkey though it creates a very high ceiling for the charge which I doubt would be acceptable to many UK consumers or fiduciaries.

An interim solution for IGCs?

The final report from the FCA is due in Q2 2017, after the next round of  chair statements from the IGCs and workplace trustees.

So it looks like they will be left in limbo as to how to measure value for money till the April 2018 statements appear. This is a shame, but an accident of time.

It will be interesting whether the IGCs and Trustees are reactive , and simply wait to see what the FCA deliver, or proactive (and tell the FCA what they think best).

My view

In my view we need the highest level of independence and the strongest powers we as customers can get. I want to see more independence on fiduciary boards (especially AFMs). I would like to see option “C” implemented for the single charge, with “D” as a sanction against repeated over-spending where no value is forthcoming.

I would like to see an annual review of the IMA with a statement from the IGC/Trustee/AFM that it is still appropriate (or renegotiation).

Above all else, I would like to see Transparency and personal accountability in all things. For as the FCA points out

“Where costs are less transparent, we have identified some specific examples where firms place less emphasis on controlling them”

Personal accountability