There are strong forces of change affecting asset management in the UK, some of which are global in nature, others are UK specific. Among these forces, let me start with Brexit.
There are a number of possible outcomes from the EU withdrawal negotiations. For asset managers the key issues are delegation of activity, passporting of funds and segregated account arrangements for EU clients. I start from the position that today we have arrangements in place which work well for the benefit of all clients, and there is every reason for all parties involved to seek to put in place arrangements post-Brexit which preserve the benefits.
As in any other global industry, asset management supply chains are international. Few would argue nowadays that all of the parts of an automobile should be sourced solely within the country where it is ultimately assembled. I do not believe it would be any more sensible to require a fund to be managed solely within its domicile. The truth is that delegation is a well-established global norm, underpinned by strong standards and regulatory cooperation. It is not dependent on EU membership. There is no reason to disrupt a system that clearly works effectively.
There is, of course, a more general point here which is important. Financial markets are by nature global not regional in form, and there is a very long history to this. Likewise, we tend naturally to think in terms of global regulatory approaches wherever possible. We are a very active participant in, and supporter of, the work of IOSCO. We work closely with other European Union authorities in this endeavour, and I am sure we will continue to do that post Brexit. Our common interests in effective markets and outcomes for consumers will not suddenly vanish. Moreover, global arrangements like delegation provide ready evidence that the basis exists for a successful model of mutual recognition of regulatory standards which supports continued open markets. As a public official, I take no position on the pros and cons of Brexit. But I do take a strong position that Brexit does not need to be an excuse to restrict trade in financial services, and that to do so would be a mistake for all sides.
Moving on, the next big issue on the landscape concerns changing demographic patterns and the interaction with macroeconomic conditions. I quite often say that if I could put Brexit to one side, hypothetically to be clear, this is the biggest issue that we face at the FCA. And that is because it pulls together a number of very big trends, namely an ageing population, persistent very low or negative long-term real interest rates, and increased costs of care in old age, to name three. Asset managers are very much in the forefront of these issues because increasingly you are providing the means of saving for old age, and the choices for consumers are becoming more complex at a time when – over quite a long period now – the responsibility for those choices has been increasingly transferred to consumers. This is an important reason why at the FCA we have a strong focus on the conduct issues that can arise.
To give a prime example of an issue that we face, the growing number of people reaching retirement could lead to a shift in the balance of assets under management from accumulation–orientated products to decumulation products, including a variety of income drawdown strategies, some of which are likely to be relatively complex.
Closely allied to these demographic trends is the decline of defined benefit pensions and the growth of defined contribution schemes and other retirement income products. This is leading to a range of changes in the sector. The big point that I would draw out is that there continues to be a major shift towards placing more responsibility for decision making onto individuals. We have seen that happening for some time in the accumulation phase of saving for retirement. Now, we are seeing the similar change in the decumulation phase as people exercise choices over when and how they draw pensions. Given the implications of an ageing population, low real interest rates and the cost of old age, it seems to me that greater choice makes sense in terms of individual circumstances and preferences. But it places a responsibility on industry to provide products and the regulator to establish conditions in which those choices can be made securely and confidently.
Developments in regulation
The Market Study was conducted under the FCA’s powers as a competition regulator. These are quite unusual powers for a financial regulator by international standards, but I regard it as something where the UK has set a very good example, and we take competition very seriously. We have identified several drivers of weak competition in a number of areas of the asset management sector. Some investors are not well placed to find better value for themselves, and can be relatively insensitive to the price of asset management products and services. Such investors struggle to protect their own interests and through this to drive competitive pressure on asset managers to deliver good products and services at competitive prices. To help mitigate this, we have issued final rules on governance remedies focused on asset managers as agents of their underlying investors. The proposed changes strengthen the duty on asset managers to act in the best interests of investors.
We have issued final rules on requiring asset managers to pay any profits they may earn when dealing as principal in the units of dual-prices fund without putting their own capital at risk (so-called ‘risk-free box profits’) back into the fund. We have also revised guidance published on changes to make it easier for asset managers to move investors from more expensive share classes to cheaper but otherwise identical classes.
As part of an overall package, we have also published a consultation paper with proposals to improve clarity over what a fund is offering (what it aims to do, how it intends to do it, and how performance is shown) as we believe that a lack of clarity is another reason for weak competition. The proposals aim to help investors, and their advisers, make use of better information to choose the right funds. This incorporates the work of our fund objectives working group. The group has included a wide range of stakeholders including asset management firms and investor groups. We are grateful for the time and expert input of this group.
Taken together, our remedies seek to address both demand and supply side problems in the asset management market which, if addressed, should lead to greater competition and innovation in this market in the interests of the consumers it serves.
The market study also highlighted the importance of clear disclosure of what asset management services cost through the presentation of a ‘single charge’. MiFID II and the Packaged Retail and Insurance based Investment Products Regulation (PRIIPS) have recently introduced greater disclosure of all costs and charges, including transaction costs. Consumers should now see the full costs and charges, expressed as a single fee, for most transactions in investment products. This is a significant step forward, though we will be conducting some work to evaluate how effective these measures have proved in practice. In any case, how the new information is presented will be as important as the disclosure itself if it is to help consumers make more informed choices. To better understand this, we conducted behavioural testing. We have published the results of the testing. The findings show that different disclosure techniques yield meaningfully different outcomes for consumer engagement. Firms should consider the results when thinking about how their disclosures are working.
In response to other concerns highlighted by the market study, we are supporting an independent Institutional Disclosure Working Group (IDWG). The group is seeking to agree a disclosure framework to support consistent disclosure of costs and charges to institutional investors.
The market study also highlighted issues of conflicts of interest, ineffective competition and a lack of transparency on fiduciary management performance and fees in the investment consulting market. These could result in: inappropriate purchase decisions and possibly too high prices being paid for fiduciary management services; and poor service levels and too high fees for investment consultancy services as a result of ineffective competition. We have referred investment consultants to the CMA, and now await the outcome of their investigation.
As I hope you can tell, this is a very important package of measures which is designed to reflect the importance of asset management to long-term savings in this country.
As I mentioned earlier, in EU regulations we saw a major change in the landscape at the start of this year with the introduction of MiFID II and PRIIPS.
MiFID II is probably the largest single change ever in European financial market regulation. Our initial priority, to be very clear because I know this attracts attention in some quarters, was to implement MiFID II in a way that did not stop the effective functioning of markets. I want to be very clear on that. It does not mean that we disregard rules, but it does recognise that implementing rules in a market that wasn’t functioning would be – at its kindest – getting the cart before the horse. Our supervisors have a programme of work to assess the state of compliance and to evaluate how effective the regulations have been in meeting their aims. In order to undertake that work properly, it is appropriate, as we generally do following major pieces of regulatory change, to allow the market time to evolve and to allow an adequate period of time to pass to make meaningful observations of trends and patterns.
PRIIPS, meanwhile, establishes standard disclosure obligations, including a requirement to disclose transaction costs for retail products under scope. It also introduced a requirement for firms to produce, publish and provide a standardised key information document (KID) for PRIIPS. This was so that investors can make better informed decisions by being able to compare key features, risks and rewards of PRIIPS.
Some firms have told us they have concerns about this directly applicable EU regulation. In response, in January we published a statement clarifying some of our views on the KID. We will continue to engage with firms and their trade associations to consider how their concerns may be resolved so that investors get the full benefit of the Regulation. We will also continue to work with the European Supervisory Authorities, and contribute to the European Commission’s post-implementation review of the PRIIPS Regulation.
I want to be clear that I am concerned about PRIIPS, and I know I am not alone. It carries a risk that it is leading to literally accurate disclosure which is not providing useful context, and there is evidence that funds, for instance from the US, are withdrawing from Europe to avoid the burden. I have also heard concerns about performance projections. We all have to take this seriously.
This is an edited version of a speech given to the London Business School