Remedies for a Healthy Patient

One thing that FCA is good at is trailing its views. So it is that the Asset Management Market Study Final Report contains no real surprises. But lack of surprise does not mean lack of impact. These measures will certainly have that, especially on the pockets of fund managers. And not so much as a pause for breath before going into rule-making mode. CP 17/18 (CP17/18: Consultation on implementing asset management market study remedies and changes to our Handbook | FCA) is the start of the implementation process.

What we have here are measures for enhanced fund governance, value for money assessments, reviews of expensive share classes and box management intervention. And there is much more promised, especially ‘single all-in fees’ and other transparency requirements, due ‘later in the year’.

As we know, all of this is driven by FCA’s conclusion that competition is not effective in the investment funds market. We do not disagree with that view, but it is not news and there are no silver bullets to remove the inability of investors to discriminate between funds that are good for them and funds that are not. What is more troubling is FCA’s dislike of profitability.

It is fair to assume that the head-hunters will not object, not strongly anyway, to the proposal for independent directors. If FCA is right and the industry now needs 480 additional directors at a cost of £27m each year, that should keep them busy for a while. Flexible as the regulator might be about the background of IDs, if these directors are to provide value for money, they will need to have a good understanding of the structure of the funds they are selling to the world. Some would say that without that knowledge they would be exposing themselves to unacceptable risk. Remuneration can reward the expertise or address the risk; firms will have that choice to make.

And where the IDs must provide value for money is in considering whether the AFM is providing the same to unitholders. That judgement must be informed by a real understanding of what is and is not important for investors – not always the same as what is and is not important to investors. What proportion of unitholders’ complaints cited split infinitives in the managers’ report? To properly assess is to clearly add value. They will need also to understand the FCA’s logic that it is possible to act in the interests of the company’s shareholders, as required by company law, while acting (also) “solely in the interests of unitholders”.

Will the value for money assessment be good value for money? The definition of value will shortly rule the world of investment funds. FCA has made its pitch; if the industry is unconvinced, now is the time to speak.

Let us also note, since FCA chooses not to, the spill-over effect where AFMs carry out additional activities, such as management of unregulated schemes and of segregated portfolios. The same independent directors will be responsible for all of the company’s activities, even when only the authorised funds require their appointment. More risk, more expertise.

Then there is the matter of the box, where the industry gets a good ticking-off. FCA has convinced itself that riskless box profits are evidence of failed competition. Unwelcome as the comparison might be, if you ask the requisite salesman to find you a second-hand car, you might not be surprised if, when delivering, he marked up the price to make it worth his while. And that would likely remain true, notwithstanding his contract to maintain the new motor for you. The regulator admits that its solution – to hand over the profits to the fund – is no more than pragmatism, albeit performance enhancing.

And what of share classes? It would be a brave firm that openly complained that it will be increasingly difficult to keep investors strapped into share classes with premium charges. As FCA contemplates cutting off the trail commission pensions of scores of retired IFAs, the pressure to release the investors that have funded the cashflow will be overwhelming. This could be the next compensation leviathan.

So, what have they not discussed? A passing mention there may be, but certainly no discussion of the role of the depositary. Many people would say that a key aspect of their role was to look after the interests of unitholders. Where the depositaries have the added lustre of trusteeship, the fiduciary element is hard to miss. Nevertheless, it takes FCA just two sentences to dismiss their capacity to take on tasks so closely related to that cause. With their snide allusion to conflicts of interest, FCA dismisses the whole depositary tribe…. but leaves them firmly in situ. It is hard to escape the belief that this is a bullet unbitten.

Posted in: Asset Management Market Study, FCA, Value for money assessment
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Inflaming June

As temperatures soar around the country and June looks as though it might at last live up to its reputation, the investment industry waits with bated breath for two documents that will be key to life in 2018.

As all except the hermit community are aware, MiFID II comes into force on 3rd January 2018 and the EU instructs all countries in the Union to have firm requirements for the implementation of MiFID II in place by 3rd July. As such requirements are not yet published in the UK, two weeks remain for FCA to comply, as it has undertaken to do. This will provide the industry with six months in which to make an extensive series of changes to its working practices, some large, some small. Among the larger and more fundamental changes is the obligation to price and supply execution and research services separately. It remains open to some doubt whether bond market practitioners will be able to meet this requirement by year end. The Policy Statement, when published, will, in theory at least, be the last regulatory word on the matter, prior to implementation. The industry may be able to contain its excitement while it waits; we will have to wait to see whether it can contain its exasperation once the requirements are set in stone.

The other source of anorak frisson is the impending extension of the Senior Managers and Certification Regime to all sectors of the industry. This regulatory measure, driven unusually by Parliament itself, will shift the balance of responsibility for compliance with regulations from corporate entities, including boards, to individual senior managers. That shift will take place on an unspecified date in 2018, but the draft requirements have been promised by FCA in Q2 – that is to say, any time in the forthcoming fortnight. The regime, we are promised, will be clear, simple and proportionate. The question is what will proportionality look like. We do not have long to wait before we find out.


Posted in: FCA, MiFID, Senior Managers Regime
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Best Execution – Again

It would not be entirely fair to accuse the Regulator of banging-on endlessly about best execution. Until the publication of the Thematic Review in 2014 (TR 14/13), it had said nothing about it for years. And there was precious little evidence that they were looking seriously at it on supervision visits. So what has changed? Well, just about everything, really.

You will have noticed, I am sure, that FCA published a press release in March to which they gave the less than endearing title of ‘Investment managers still failing to ensure effective oversight of best execution’. Investment managers still failing to ensure effective oversight of best execution | FCA And on the same day they published a similarly entitled press release about firms’ inadequacies over use of commission. This is not entirely normal; when FCA wants to comment on standards of compliance it usually uses a TR, so why the change?

Let me reassure you that this is not just anorak analysis – there is a significance in this that transcends the train-spotter comments. First, we have some changes of style resulting from the still fairly recent arrival of Andrew Bailey. Although a measured man, the length of fuse is limited and he is rather more politically astute than most of his predecessors. Pre-empting criticism is a clear trait that we should expect to go on seeing from a Bailey-led regulator. But why this and why now?

One reason is the link between best execution and use of commission. However poorly explained the FCA’s concern on this might be, the forthcoming purification of execution charges under MiFID II, refocuses attention on commission rates and so should enhance competition, which is becoming a major theme of FCA’s, as you will have spotted. Add to that the need to see execution charges fall when research must be separately paid for – unless FCA is to be seen to have done little but to raise costs for consumers.

Anyway, MiFID II is supposed to improve the effectiveness of the best execution regime. Insignificant as the forthcoming rule changes might seem, their intention is to oblige firms to adopt order execution policies that are more than platitudes and good intentions and cease to be diluted to the point of meaninglessness by exceptions, discretions and record regimes that provide no explanation of decisions made.

And then there is ESMA. Never will FCA admit that its supervision policy is driven by anything other than its own risk assessment. However, when ESMA publishes league tables of the activity of national regulators, FCA has no wish to have to explain to parliamentary committees or anyone else why it has ignored long-standing and pivotal requirements. The 2014 TR was inspired by the knowledge that ESMA would shortly publish and the pressure remains. As we said in our comments that year, what the regulator starts it will have to finish.

So much for the motivation; what about the substance? With MiFID II in force in eight months’ time, the FCA wants to see preparation on the go. Here is an area where firms need to be seen to be completely on top of the requirements, including being able to show that the matters raised in TR 14/13 have been reviewed. Most firms will have gaps to fill when the analysis is done and many will have yet to complete that analysis. Overstretch is a wide-spread and long-standing problem for compliance teams, but they should have no difficulty in proving that this is a task that has to be done. On looking at best execution, the first demand of the regulator will be to see the gap analysis work. Where finding none, it will do it itself, but by no means free of charge.

Striking also are the questions posed in the press release. The first says it all: “who would the FCA hold responsible if the firm fails in its obligation to ensure it consistently achieves best execution?” Let it not be you.


Posted in: Best Execution, Competition, ESMA, FCA, MiFID
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