Make no mistake – the FCA’s final report on competition in the asset management industry contains some of the biggest potential changes to UK fund governance since Open Ended Investment Companies were introduced in 1997, writes Kevin Tomlin, senior product manager at BNP Paribas Securities Services.
June’s publication was the conclusion of a review by the Financial Conduct Authority (FCA) of the competitiveness of the asset management industry. It followed an interim report issued last November which, among other things, described the asset management industry as “particularly weak in achieving value for money for investors”.
The FCA suggested this weakness was partly because there is currently no person or body challenging asset managers on whether value for money is being delivered. The regulator’s proposed solution is twofold.
First, the watchdog recommends the appointment of independent directors. It has specifically proposed a minimum of two independent directors, or 25% of the FCA authorised fund manager’s Board membership. This is intended to give the value-for-money assessment teeth (see point two). Furthermore, the chairman of the Board will be personally responsible for ensuring that the new responsibilities are undertaken.
Second, Boards will be required to address value for money as part of their ongoing assessment. The FCA has also proposed a number of criteria that must be addressed by Boards as part of their ongoing assessment, in respect of every fund managed, namely:
- Fees and charges – whether these are reasonable, taking into account market rates. This will include third-party provider costs
- Economies of scale – the extent to which such benefits (for example, from increased fund values) have been passed onto investors
- Share classes – whether it is appropriate that some investors are in more expensive share classes than others (this will be easier to satisfy once the FCA has amended rules to make it easier to switch investors into share classes that are more advantageous to them)
- Service quality – costs of service will need to be justified. This reflects comment from some that the FCA should not focus on costs and charges alone when considering value for money
While helpful to Boards in undertaking value-for-money assessments these criteria are not exhaustive. Fund managers will want to ensure they are following common processes and using similar indicators to determine how they deal with each of the criteria.
Value-for-money assessments will need to be published annually, and we can expect them to be subject to regulatory and, potentially, public scrutiny.
The FCA has published draft rules on all of the above and has requested comments by September 28.
A sharp boost
As part of the debate about whether having independent directors or “statutory” value-for-money assessments is the right way forward there are at least two other issues that will generate much discussion.
The FCA has proposed that the new rules will come into force within a year of being instated. If we assume the rules are in place by the end of 2018, this will mean the industry needs to find nearly 500 independent directors by January 2019. This may prove difficult, particularly as the FCA plans to stipulate that an independent director cannot have been employed by or have had a major contractual relationship with the company for which it acts in the previous five years.
The new requirements will apply to domestic funds only, not to those marketing here from the European Union under the Ucits passporting regime. There is therefore a danger that firms will re-locate and manage their funds in other jurisdictions. The FCA takes the view such regulatory arbitrage is unlikely and that the costs of its proposals (which will fall on the fund investors) are outweighed by the benefits of making the UK more attractive for investors.
Much remains on the FCA’s agenda for improving competition in the asset management sector, but these proposals will already revolutionise the way funds are governed.
A significant amount of work will be needed, probably by the industry, in interpreting and developing guidelines to comply with the value-for-money requirements.
And while the post-Brexit world for funds is unclear, the UK will find some benefit in being able to argue its corporate governance regime and associated investor protection friendliness has been given a sharp boost.
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