The FCA has recently published a Policy Statement and a Consultation Paper containing proposed remedies to the concerns first identified in its Asset Management Market Study (“AMMS”). These proposals apply to Authorised Fund Managers (“AFMs”) in respect of their management of authorised funds, such as UCITS. In this alert we summarise the FCA’s key measures and consider any longer term implications for the wholesale investment management sector.
One of the FCA’s core objectives is to promote competition in financial products and services, thus reducing potential harm to consumers. In its Final Report published in June 2017, the AMMS identified several drivers of weak price competition in the sector, alongside inadequate consideration to deliver value for money, and a lack of clarity regarding fund objectives. The concerns identified, alongside the FCA’s continued regulatory focus on fees and charges (also emphasised under MiFID II), have informed the approach taken in the Policy Statement and Consultation Paper.
Summary of Reforms
Policy Statement (PS18/8):
This Policy Statement contains the FCA’s final rules (following a previous consultation) focusing on the duties of AFMs to act as the agents of investors in their funds. These new rules (and effective from dates) are summarised below:
- Annual Assessment of Value – Effective 30 September 2019
AFMs must conduct an assessment of value using a new table of elements contained in COLL 6.6, including quality of service, performance, costs, economies of scale and comparable market rates. The table is non-exhaustive and AFMs must exercise their judgement about which other elements of their services are relevant. This can be included in the annual report or published separately, but in each case must be provided within four months of the end of the relevant annual accounting period.
- Independent Directors – Effective 30 September 2019
AFMs must now appoint a minimum of two independent directors who must comprise at least 25% of the total board membership. To qualify as “independent”, an individual must not have been paid by the AFM group for five years before their appointment, or had a material business relationship with it for the last three years. An independent director can serve a term of up to five years, which may be renewed once to a maximum of ten years, within one group. It is at the discretion of the AFM whether it will accept independent directors who also serve on other AFM boards.
- Prescribed responsibility (“PR”) – Effective under SMCR
This particular PR would require a Senior Manager (usually the Chair of the Board of the AFM) to take reasonable steps to ensure that the firm complies with its obligation to carry out the assessment of value, the requirement to recruit independent directors, and the requirement to act in the best interest of fund investors. Further detail on this proposal will be published in summer 2018 as part of the proposed extension of the Senior Managers and Certification Regime (“SMCR”) to all investment firms (expected to come into effect in late 2019).
- Moving Investors to Better Value Share Classes – Effective immediately
In an amendment to its previous non-Handbook guidance (FG14/4), the FCA now recommends that an AFM makes a one-off notification (without a requirement to respond) to investors a minimum of 60 days before mandatory conversion to an alternative share class occurs, rather than obtaining individual consent. The AFM must still ensure that mandatory conversions are consistent with investors’ best interests prior to the conversion.
- Fair Treatment of Box Dealing Profits – Effective 1 April 2019
The FCA identified that managers of some dual-priced authorised funds were making a risk-free profit on the difference between the dealing prices for matched transactions by matching the units of incoming and outgoing investors. The new rules prohibit the retention of such risk-free box profits and require them to be allocated in a way that is fair to all unit holders. Situations where box profits have been earned through “at risk” exposure, including where the dealing spread is narrower than the maximum permitted spread, will continue to be permitted.
Trail Commission & Extension of Governance Proposals to Other Investment Products
The FCA is still considering this issue and carrying out diagnostic work. It has confirmed it has no immediate plans to bring forward proposals for policy change.
- Consultation Paper (CP18/9):
The FCA is also consulting, until 5 July 2018, on further proposals to require AFMs to provide better information on what they are offering, as follows:
- Fund Objectives and Investment Policies
The FCA proposes to publish guidance setting out their expectations on fund objectives, including the aims of the fund and how it will achieve these. The objectives must be free from technical language or jargon and should explain any constraints on the fund. Any non-financial objectives should also be clearly explained in full, and these should be measured and reported on.
The FCA proposes to require AFMs to explain why they use particular benchmarks or, if they do not, how the investors should assess the performance of the fund. Where benchmarks are used, they must be referenced consistently across the fund’s documents. Where a fund is constrained by and/or targets a benchmark, that benchmark alone must be used as a comparator for past performance. Some inconsistencies between these requirements and those applying to UCITS KIIDs have been noted, which may create something of a headache until the KIID requirement is phased out from 31 December 2019.
- Performance Fees
The FCA proposes that all performance fees are calculated net of all other fees (currently this is expressed only as guidance). Hence, AFMs will no longer be able to charge performance fees on a gross basis.
- Impact on Authorised Fund Managers
For firms that fall under the AFM umbrella, these changes will, at the very least, require an assessment of their current systems and pricing models. Several of the new rules and proposals overlap with and extend other regulation, leading to an increased regulatory burden. In particular, firms must be aware of the increased responsibility falling on Fund Boards as a result of the new rules and Prescribed Responsibility.
The FCA’s continuing focus on value for money will almost certainly lead to great regulatory scrutiny and, potentially, thematic work in due course.
- Possible Implications for Wholesale Managers
The FCA will carry out thematic work to decide whether to extend any of the measures contained within the Policy Statement to with-profits and unit-linked products in H1 2019. The FCA does not have immediate plans to extend the rules to investment trusts or pensions.
While changes noted above currently only apply to AFMs, the remedies contained in these papers encapsulate the FCA’s approach to enhancing competition across the whole industry. Given the FCA’s track record of extending retail regulations to the wholesale and/or alternative sectors, it is not inconceivable that similar measures may be rolled out in due course.
 FCA Handbook definition: an authorised contractual scheme (ACS) manager or an authorised unit trust manager (AUT) or investment company with variable capital (ICVC) in respect of their management of authorised funds. These take the form of (UCITS), non-UCITS retail scheme (NURS) and qualified investor schemes (QIS)).