In this article, I argue that until those who manage funds and assets are held responsible to the end consumer we will not see effective enforcement of reforms.
The central thrust of the FCA’s Asset Management Market Study (interim) is that the investor is being let down by an inefficient active management industry, poor fiduciary controls and by advisers who are complicit with and adding to the misery,
The remedies put forward are sensible; tighter measurement of the leakage to third parties resulting from transactions, strengthening the fiduciary responsibilities of fund managers and referring the Investment Consultancy practices to the Competition and Market Authority.
Of these remedies, easily the most important would be the benefits resulting from asset managers exercising a duty of care to their customers, the unit holders of the fund (ultimately the beneficial owners – you and me).
It is easy to miss this , when reading reports of the paper. These tend to focus on the more sensational aspects of the study (the strongly worded criticisms of bad practice), but these bad practices are symptoms not the cause of the malady; the cause of the malady is that those entrusted with our money, are not showing they are capable of being trustworthy.
This Government’s chosen weapon to improve the consumer’s lot is not prescriptive legislation. It is instead a strengthening of the fiduciary framework so that strong the various bodies that have oversight of the management of business, are effective.
As regards pensions, it works like this. At the top of the chain are the Regulators (FCA, tPR in terms of pension funds), below them, the super fiduciaries (IGCs master trustee’s and large employer sponsored trustee boards). Below them are the trustees of small occupational pension schemes.
Fund managers, are not generally considered a part of this fiduciary framework. The Asset Management Market Study , sets out to change this. It calls for “a strengthened duty on asset managers to act in the best interests of investors”. This may not sound much but it explicitly states that the reforms would hold asset manages accountable for how they deliver value for money, an introduce independence on fund oversight committees.
The key word is “accountable”. That word should be causing concern among asset managers and those that manage funds, fund of funds and fiduciary management arrangements. Critically , these managers must be accountable for the outcomes to the beneficial owners.
Ultimately, every decision taken by a manager that involves costs to the member, should carry risk not just to the member, but the manager. The areas explored by the FCA in the study show that this is not the case. Managers can ratchet up the costs but are not accountable for the value for the money spent. Since , in many cases, the money spent reverts directly or indirectly to the manager’s pocket, it is easy for the FCA to charge managers with conflicts of interest. But there is little that can be done to hold such managers to account.
I work in a business that is dominated by a code of practice. The institute and Faculty of Actuaries demand a high standard of behaviour from its members and when it does not get it , it takes action. This makes the term “actuary” – meaningful. The same cannot be said of the managers of the money within our pension funds.
Whether the management is for retail SIPPs or for the largest funded DB plans, there is a lack of accountability for the delivery of outcomes. SIPP managers should be accountable to their IGCs (or GAAs), the CIOs of the big pension funds are accountable to their trustees. These relationships are in place and their is direct oversite and accountability
But those who are actually managing the assets and creating the fund structures are not accountable – other than as service providers. They have no direct accountability to the beneficial owners because the law of Privity prevents it.
The law of Privity means an individual cannot sue on a contract to which one was not a party. A common example of the principle in operation is that if A (a consumer) buys goods from B (a retailer) and B had originally bought them from C (the manufacturer). If the goods turn out to be faulty, A cannot sue C in contract law because A has no contract with C. B would have to sue C for the faulty goods to establish immunity from A’s lawsuit against B.
Take the trustees of the People’s Pension. They employ B&CE to create funds for them and those funds are managed by State Street. The Trustees are a customer of B&CE and B&CE a customer of State Street but People’s can only hire or fire B&CE. They may seek to influence the choice of managers employed by B&CE but they have no direct control. The law of Privity prevents this.
Even if you are in a Legal and General workplace pension, your fund managers have no direct accountability to you. Your fund managers are Legal and general Investment Managers, you contract with Legal and General Assurance. Your intermediary is the L&G IGC.
The end product of this is confusion. Throughout 2016, I’ve been trying to find out the true cost of passive management through my L&G Worksave plan, compared to the costs through a People’s master trust. The law of Privity is against me.
I need to go straight to the source, I need access to the fiduciaries of the asset manager itself. This I currently do not have (in any approachable way).
The benefits of the FCA’s approach
My hope is that by making the asset manager generally accountable (not just to the customer), I will be able to clearly understand what is happening to my money. More importantly, I can use independent consultants/advisers – to seek redress for me when something goes wrong.
Much is made of the negative impact of ambulance chasing in the US, but what is not said is that the fear of being directly accountable to consumers (albeit though class actions) has made the American asset manager and fund fiduciary a lot more energetic in control of costs and in demonstrating the value of the costs incurred.
If we are to make asset managers and fund managers and fiduciary managers accountable, then the Authorised Fund Manager (as a fiduciary concept), must be held to account for the value for money delivered to investors.
Weaknesses of the FCA’s approach
The FCA in it Market Study recognises the need for reform of the AFMs to be more accountable. It suggests that either it imposes a duty of care on the AFM ‘to demonstrate how it has complied with the duty to act in investor’s best interests. Or require all board members to be covered by the Senior Managers and Certification Regime (SM & CR).
Frankly, neither approach will do much to change asset manager or fund manager’s behaviours. Nor will it empower advisers and consultants , nor will it strengthen the hand of trustees and IGCs.
The weakness of these approaches is that they rely on an arcane governance chain that protects asset managers rather than holding them to account.
There are better suggestions from the FCA as “alternatives”, though the implications of ideas such as to “replace existing governance structures with (a) new body” sounds promising. This new body might be an independent board similar to the US Mutual Fund structure, with responsibilities underpinned by the SM &CR.
But even here, the difficulty is in how to make such a board accountable, the IGCs and trustees are full of independents but “independent” does not mean “effective”.
The weakness in all the proposals, as I read them, is that they do not address the issues of Privity raised in this blog. To be clear, they do not render the behaviour and performance of fund and asset managers directly accountable to members. They do not lay senior managers and ultimately shareholders open to commercial sanctions from members via class action law suits.
The nuclear button
Banks have learned the hard way, how bad behaviour leads to fines and worse- to compensation claims to individual customers. Asset and Fund managers have not had to learn these lessons. They have been protected by Privity , by trustees and latterly by IGCs.
The nuclear button is put in the consumer’s hand by setting up AFMs (or similar) within fund managers and asset managers ,which are directly accountable to the beneficial owner of the funds.
Establishing a system where consumers can sue the asset manager directly, would strengthen the entire chain of governance. IGCs and Trustees would be a lot warier of hiring managers who were targeted by consumers for bad practice, fiduciary managers and SIPP platforms would similarly run from such managers.
I appreciate that my suggestions will be countered by those within the funds industry (including many on trust and IGC boards) as advocating “mob rule”. So be it. My suggestion to make fund managers directly accountable to consumers is the only way that the excellent micro matters of the FCA Market Study, will be enforced. If that means setting the lawyers to work – so be it.