Authors: Simon Lovegrove, Mike Newell and Imogen Garner
On 5 April 2018, the FCA published its latest documents in response to the concerns the regulator previously identified in its asset management market study.
The documents, which together contain over 150 pages, comprise:
- Policy Statement 18/8: Asset Management Market Study remedies and changes to the Handbook – Feedback and final rules to CP17/18 (PS18/8);
- Consultation Paper 18/9: Consultation on further remedies – Asset Management Market Study (CP18/9); and
- Occasional Paper 32 – Now you see it: drawing attention to charges in the asset management industry (OP32).
PS18/8 follows Consultation Paper 17/18: Consultation on implementing asset management market study remedies and changes to Handbook (CP17/18) and sets out feedback and final rules and guidance.
Who is in scope of the new rules?
The new requirements in PS18/8 only apply to authorised fund managers (AFMs). AFMs include managers/operators of open-ended FCA-authorised funds (including ICVCs, Property Authorised Investment Funds, Co-Ownership Authorised Contractual Schemes and authorised unit trusts) which take the form of UCITS, NURSs and QISs. AIFMs of unregulated vehicles and other portfolio managers are not within scope irrespective of who those structures are targeted at.
Governance - Value for money
In CP17/18 the FCA consulted on proposals to strengthen and clarify an AFMs duty to act in the best interests of fund investors. Specifically, the FCA said that they must assess the value for money (VfM) of each fund against a non-exhaustive list of prescribed elements, conclude that each fund offers good VfM or take corrective action if it does not, and explain the assessment annually in a report made available to the public.
In PS18/8 the FCA reports that stakeholders agreed that value is at the heart of the asset management proposition but there were concerns over the regulator’s drafting. The FCA states that it has considered the feedback to CP17/18 carefully and still believes that the core of its policy is correct – that agents should be accountable to their underlying beneficiaries on how they deliver value. However, the FCA accepts that its draft rules could be seen as too focused on AFMs’ costs rather than the full value proposition of funds, which was not its intention. The FCA has therefore redrafted its final rules to clarify that fund charges should be assessed in the context of the overall value delivered, rather than using the term ‘value for money’. AFMs will have to publish an annual statement within 4 months of the relevant accounting period describing their value for money assessment. AFMs are not expected to disclose information which is commercially sensitive or anticompetitive but they must comply with the FCA requirement that communications are fair, clear and not misleading. The FCA has also decided to extend the implementation period for the value for money requirement from 12 to 18 months (30 September 2019).
Governance - Independent directors
In CP17/18 the FCA proposed rules requiring AFMs to appoint independent directors to their board. The FCA proposed that AFMs appoint a minimum of two independent directors and for them to comprise at least 25% of the total board membership. The FCA thinks that the introduction of independent members to AFM boards will lead to better outcomes for investors, so it has made final rules introducing this requirement as consulted on.
Which directors are considered to be independent will be an important question. The FCA rules set out detailed requirements on this issue and it is noteworthy that there is no obligation for the AFM’s chair to be independent (this is a decision left to the AFM itself). A director is unlikely to be independent where there is a monetary link with the AFM group, or where he/she has a close relative in a senior position in the AFM or a firm in its group. Significantly, independent directors can sit on more than one AFM within a group. However, time served will be calculated on a group basis. An independent director can serve a term of up to five years (renewed once to a maximum of ten years) within one group, starting from the time of the first appointment. The FCA has also clarified that a director, having already started to serve on the board of one AFM within a group, is not prevented from serving on another board within the same group, as long as the overall time limits are not breached.
The new requirements come into effect from 30 September 2019.
Governance - Senior managers’ regime
In CP17/18 the FCA consulted on a new prescribed responsibility that would make clear that a senior manager, usually the chair of the board of an AFM, must take reasonable steps to ensure that the firm complies with its obligation to carry out the assessment of value, the duty to recruit independent directors, and the duty to act in the best interests of fund investors.
The FCA reports that after considering the feedback it has decided to introduce the prescribed responsibility for AFMs as part of the extension of the senior managers’ and certification regime (SM&CR). The FCA intends to publish the final rules on the extended SM&CR during the summer. The FCA expects the prescribed rule to come into effect at the same time as the rules extending the SM&CR which is expected to be in mid to late 2019.
In CP17/18 the FCA consulted on changes to its guidance to make it easier for fund investors to be moved (converted) to cheaper but otherwise identical classes of the same fund. The FCA has now published final recast guidance which removes the need for the AFM to get individual consent from each investor before converting them. The recast guidance now recommends AFMs make a simple, one-off notification to investors, which does not require a response, a minimum of 60 days before a mandatory conversion. The recast of Final Guidance 14/4, now known as Final Guidance 18/3, is effective from the date of publication of PS18/8.
In CP17/18 the FCA asked questions for discussion about whether it should continue to allow the payment of trail commission. The FCA reports that it is still considering the issue and has no immediate plans to bring forward proposals for policy change.
The FCA found that the managers of some dual-priced authorised funds were making a risk-free profit when dealing as principal in the units of their funds. In CP17/18 the FCA proposed that these profits should be repaid to the fund, for the benefit of investors. The FCA has proceeded with its proposal while making some technical changes to the rules and guidance. It is also allowing some flexibility in how risk-free profits should be allocated fairly and in the interests of investors. The rules on box profits will come into effect on 1 April 2019.
Extending the governance proposals to other investment products
In PS18/8 the FCA reports that views were mixed as regards extending the governance proposals for the authorised funds market to other investment products and investment trusts. The FCA has planned diagnostic work into with-profits and unit-linked products that will improve its view of any harm that exists in these markets. The FCA expects to reach a view on whether further intervention is required in the first half of 2019. The FCA is also keeping the possibility of further changes to investment trust governance arrangements under review, but is not planning any immediate action. Consistent with its earlier consultation, the FCA is not bringing forward proposals on extending the governance proposals to pensions at this time.
CP18/9 is the FCA’s second consultation paper proposing changes following the regulator’s asset management market study. As before the proposals in CP18/9 apply to UK AFMs.
CP18/9 proposes measures to improve the quality, comparability and robustness of information available to investors. They seek to address the regulator’s concern that fund objectives are not as clear or specific as they could or should be. The FCA is also consulting on proposals to ensure that benchmarks are used appropriately. The FCA proposes that if a fund has benchmarks, their use must be explained and referenced consistently in consumer facing documents. This includes a proposal to ensure that benchmarks are shown appropriately and consistently against fund past performance.
To deliver improved fund disclosures the FCA proposes to:
- publish guidance reminding AFMs how they should express fund objectives and investment policies to make them more useful to investors. Firms should, when describing the objectives of their funds: (i) explain clearly what they are looking to achieve and how; (ii) explain the constraints that the fund’s portfolio construction may be under; and (iii) explain any non-financial objectives they have, for example the environmental or social objectives of an investment, and how they will measure and report progress against these objectives;
- make new rules so that AFMs must explain why they use benchmarks, or if they do not, how investors should assess the performance of the fund;
- require that, if an AFM uses benchmarks, the benchmarks must be referenced consistently across the fund’s documents and, wherever the AFM presents the fund’s past performance, benchmarks used as a constraint on portfolio construction or as a target must be presented alongside the past performance; and
- amend its performance fees rules to provide that performance fees must be calculated on performance net of other fees in all cases.
The deadline for responding to CP18/9 is 5 July 2018.
CP18/9 does not cover the all-in fee and the possible standardisation of disclosure of fees and charges. On the latter, the FCA has published an Occasional Paper (OP32), which considers the impact of different ways of presenting information on investors’ decision making and understanding. OP32 does not put forward any specific policy proposals but is designed to encourage debate and inform the FCA’s next steps.
Some aspects of PS18/8 have generated concerns in the industry, including how the delivery of overall value to investors will be benchmarked. A key challenge for the industry will now be to try to establish consistent ways of delivering compliance with these new requirements and to avoid a plethora of different approaches being taken. The possibility of extension of the rules to cover listed investment companies and insurance products has been ruled out for now but still remains a possibility for the future. Certainly ensuring that the new requirements to act in the best interests of investors and consider that overall value is being delivered are now prescribed responsibilities for senior management should give the new rules proper “bite”.
The requirement for managers to appoint independent directors is also considered relatively onerous, presents logistical issues in sourcing suitable persons and there is no dispensation for smaller firms. Managers will need to carefully review the composition of their boards and assess the independence of their existing non-executive directors. It’s helpful that managers have an 18 month timescale in which to become compliant, but even so this may be difficult to achieve given the challenges.
Another key change which has provoked discussion is the proposal to enable investors to be switched to better performing funds without the requirement to obtain investor approval. Whilst this undoubtedly reduces the administrative burden, issues such as the onus of responsibility on managers to consider making these changes (together with possible legal complexities) needs to be fully assessed. The proposals on box profits are generally considered to be uncontentious as many managers have already stopped such practices.
CP18/9 is also initially focused on AFMs and areas on which the asset management market study highlighted difficulties in comparing retail funds, particularly funds having seemingly very similar investment objectives and the manner in which historical performance data and performance fee data is disclosed, but again the FCA is considering the possible extension of the rules to insurers and listed investment companies. Given the extension of KIIDs across such products, it seems somewhat anomalous that investment objective and benchmarking disclosure would not be aligned. At this stage the FCA appear not to wish to change the rules on prospectus disclosure but rather to ensure consistent but helpful disclosure in KIIDs and other marketing literature.