EBCs face an unprecedented level of upheaval if the FCA goes ahead and refers investment consultants to the CMA and recommends regulation of pension consultants. John Greenwood examines where a referral could take the sector
The FCA’s momentous decision on whether to refer employee benefit consultants to the Competition and Markets Authority is expected in a matter of days. Its concerns over conflicts of interest in the delivery of investment consultancy services could lead to a wholesale restructuring of the £120bn fiduciary management sector and looks likely to bring EBCs under FCA regulation for the very first time.
So sensitive is the subject, with such a massive pile of fiduciary management assets at stake, that few industry players are prepared to talk on the record about what is arguably the biggest issue facing the pension consultancy sector for years. Several industry stakeholders who have spoken to Corporate Adviser have said the impact on the EBC sector is likely to be on a par with the upheaval the Retail Distribution Review inflicted on IFAs and the retail advice sector.
The FCA’s decision on whether to refer investment consultants to the CMA, having rejected undertakings in lieu of referral the ‘big three’ investment consultancies – Aon, Mercer and Willis Towers Watson – is believed to be made public at the end of next week. Nobody Corporate Adviser spoke to is expecting there not to be a referral, which the FCA has said may be needed because of concerns over the relatively high and stable market shares for the three largest providers, a weak demand side, relatively low switching levels and conflicts of interest. It is also widely expected to recommend to the Treasury that it should in future regulate employee benefits consultants.
One life office source told Corporate Adviser that it expects the request to the Treasury for FCA regulation of EBCs to come quickly, with the CMA investigation more likely to go quiet for a lengthy period while investigations are carried out.
“FCA regulation will make current practices, where EBCs advise clients and then recommend their own products, harder to justify, he argues.
“Retail advisors struggled to recommend the own products and you would expect a similar effect in the corporate space,” the source says. “This will have an impact on the scale of the Retail Distribution Review, which created severe market disruption, with the banks pulling out and the advice gap widening. We don’t exactly know how it will impact the market, but there will be disruption.”
The prospect of referral has come from the FCA’s Asset Management Market Study, a massive piece of work that is targeting transparency across all stages of the investment management value chain.
“I suspect the FCA’s concerns over EBCs stem from the KPMG research two years ago that showed the vast majority of fiduciary mandates were converted without a competitive tender,” says PTL Trustees managing director Richard Butcher.
The 2015 KPMG fiduciary management market survey, which took data from 13 of the biggest fiduciary managers found that 75 per cent of mandates were awarded without a fully competitive tender in 2014. Yet the 2016 version of that survey showed that appetite for the product is continuing to grow with £123bn of assets under fiduciary management in 2016, more than double the £59bn in 2013.
KPMG’s 2016 report also showed some improvements in terms of competitive tenders, with 33 per cent of new appointments advised by an independent third party in 2016, compared to 23 per cent in 2015, but that appears unlikely to stop the regulatory train.
“The review will clearly have more impact with consultants that are providing a vertically integrated fiduciary management service. But I think it will be good for them, it will be cathartic in the long run,” says Butcher. “The concern with the FCA is that the big three firms offer a full management service. But it is not just them – smaller firms will also be impacted by any change to the rules. The referral to the Competition and Markets Authority will I am sure happen and there will be changes, but it will leave the industry in a better position in the long run.”
What future for investment consultants as fiduciary managers?
So is this the end of the consultant-led fiduciary management model as we know it? “The CMA may end up saying that you can be an investment adviser and fiduciary manager on the basis that you follow certain requirements, for example on the basis that the reward of the contract is reviewed every three years, or that there is a competitive tender for each mandate,” says Butcher.
This is precisely what the ‘big three’ should have offered in the undertakings in lieu they offered earlier this year, says one senior figure at an EBC outside the big three, who says his firm also now faces FCA regulation and potential significant market upheaval as a result of the failure of the undertakings to satisfy the regulator first time around. He says: “I am not surprised that the FCA rejected the undertakings in lieu offered by the big three. What they offered was not a lot. Have they offered more of what the FCA were looking for then there was a possibility that we would not get the referral to the CMA. They should have offered things such as competitive tendering for all fiduciary mandates and regular oversight of all mandates. Have they gone this far, we may not have got a referral to the CMA. I do not think there should be a referral, I think the regulator should have said that we have done the work, and these are the principles that we are going to build on.”
The original undertakings in lieu included an offer not to give investment services to clients that had not appointed a consultant under a competitive tender process in the previous 10 years and a pledge to notify clients every five years that they should review the service contract with the EBC.
The original undertakings also offered to end contracts entered into more than 20 years ago where there had been no competitive tender for a consultant appointment.
Aon, Mercer and WTW’s proposal also offered to provide clients with detailed information on performance of highly-rated investment manager strategies over consistent time periods and over comparable mandates and to adopt standards to present and calculate the performance of fiduciary management whole-fund solutions to enable comparison of different fiduciary managers’ track records, and also to present fees in a standardised format.
The undertakings in lieu also included measures designed to stop conflicts through gifts and corporate hospitality. They also contained a measure stopping consultants from recommending their own master trust to a client, although they could introduce them to it.
“Now there is probably going to be a referral and there is a risk that the CMA will recommend the dismantling of the entire industry as we know it,” says the anonymous EBC source. “The Armageddon outcome is that they say that you can’t do both consultancy and investment advisory. I don’t think that is too likely, I would rate the chances of that at around 40 per cent. But it is still a possibility.”
New market opportunities?
While those outside the big three may be upset at the prospect of FCA regulation and other potential regulatory changes, some predict they will be able to increase their market share in the pension investment management space off the back of the sector shake-up.
That anonymous EBC source says: “There will be winners and losers from these changes. I cannot see the big three losing half of their current market share as a result of any changes that may be introduced, but them losing a quarter of their market share is a possibility.
“Most of the big firms will not be frightened at the prospect of regulation. They are pretty much running on that basis already. But for the smaller firms this will be an intimidating prospect.”
Another life office source, who also wished to remain anonymous, says: “This will be good for independents. It could lead to a big change in business and may even change the way that they will charge for work. Typically in the corporate world people have charged on a per hour basis. Will this change to a percentage basis? If the big firms are not making as much money of investments will they focus on larger companies who are happy to pay their fees?”
This life office source also points out a strain between providers and EBCs that the asset management market study has highlighted. “We have an issue with running contract-based schemes where someone else, ie the EBC, is choosing the investments. If that contract is challenged because the charges are too high, we are the people the individual member has the contract with, yet the EBC has decided on the higher charging funds. Providers are stupid to have accepted this, but it feels wrong. In future these decisions will be more down to IGCs rather than consultants.”
Sources have suggested that corporate advisers outside the big three that concentrate on digital, technical and engagement will see the CMA referral as an opportunity to come to the market, preying on the reputational damage that a referral could do to the big three. “If there is a competition referral I would be surprised if the independent firms are not there saying ‘do you really want to be associated with these organisations that are currently under investigation’”, said one senior life office source.
Butcher says: “There will be more money moving around the market, otherwise the whole thing will have been a failure. But the problem with fiduciaries mandate models is that no two are the same. Different consultants do it in different ways. So the eventual outcome for each firm will depend on the detail of what the CMA comes up with.
“Every single product is unique in its own way. Some fiduciary manager models have the consultant tied to one asset manager, others cover the complete market. There are also various variations in has the mandate is constructed, for example Aon Hewitt contract with the underlying fund managers, whereas with Willis Towers Watson, the contract is for service, but they have power of attorney to appoint managers on the trustees’ behalf. So there are different legal relationships for different models. What is more important for the trustees is deciding which of the 20 or so providers out there ticks the most boxes for them,” says Butcher.
“The review will be a game changer for the entire asset management industry, not just for investment consultants,” adds Butcher. “Ultimately it will be to the benefit of recipients. This is designed in part to shine a light on the underlined costs in the whole process. What the FCA didn’t write in the report was “you lot are making too much profit”.