In June the U.K. Financial Conduct Authority (FCA) published its review of the country’s mainstream asset management market. Its report highlights areas of concern and proposes new rules and guidance to address them with a relatively rapid consultation timetable.
Despite the stated limited focus of the report, it is expected that it will influence practices across the market, including those of private equity and other alternative fund managers, who would be wise to pay close attention to the coming consultations.
The U.K.’s asset management industry is the second largest in the world (behind the U.S. market), managing approximately 6.9 trillion euros of assets. The FCA launched its market study in November 2015 to investigate how well the market works generally and whether the investment products consumers invest in offer good value. The review was intended to focus on mainstream asset managers (not alternative asset managers), pooled investment funds, insurance-based investment products and segregated mandates (bespoke investments where funds are not pooled with those of other investors).
Findings and Proposals
The FCA’s final report identifies three key areas of concern: 1) a lack of investor protection; 2) a lack of competitive pressure; and 3) regulation of intermediaries (such as investment platforms and investment consultants).
Investor Protection: The FCA proposes to strengthen the duty of asset managers to act in the best interests of investors and to use the senior managers’ regulatory responsibilities to bring individual focus and accountability. The proposals (which are subject to further consultation) include a requirement that asset managers appoint at least two independent directors to their boards. They would also include changes that make it simpler for managers to switch investors into cheaper share classes, where applicable. There’s a requirement for better disclosure of box management practices (which allow asset managers to profit from the spread on client trading without risking their own capital) and a return of risk-free box profits to investors. The FCA will also chair a working group to focus on how to make fund objectives more useful, and it will consult on how benchmarks are used and performance is reported.
Competitive Pressure: The FCA identified a lack of pricing competition among asset managers. To increase competitive pressure, the regulator proposes to introduce a requirement that managers disclose a single, all-in fee (including asset management fees and an estimate of transaction costs and any intermediary fees) to investors. In addition, the FCA supports calls for consistent and standardized disclosures of costs and charges to institutional investors and recommends that both industry and investor representatives agree on a standardized template of costs and charges. The FCA proposes to appoint an independent third party to convene a stakeholder group to develop these proposals further, for both mainstream and alternative asset classes.
Regulating Intermediaries: The agency will seek views from interested parties on whether to ask the U.K. competition authority to investigate investment consultancy services. Subject to such a referral, the regulator recommends that the U.K. Treasury consider bringing investment consultants into the regulatory perimeter.
Private Equity and Alternative Funds
While alternative asset managers were excluded from the focus of the FCA’s review, there will be a question over whether the FCA’s revised approach might be brought to bear on managers of private equity, hedge and other alternative asset funds in the future. Given that the FCA is a principles-based regulator, it is likely that the current proposals reflect the FCA’s perception of best practices toward investors in any asset class.
Indeed, its director of competition reportedly stated: “The focus of the study has been on the mainstream asset management community. Broadly, do we think some of the same principles apply to hedge funds? Yes.”
Furthermore, the FCA has specifically indicated that it will include private equity and hedge fund managers in its transparency drive, despite the fact that they were not a focus of the study. Although it is also reported that the FCA has no immediate plans to look at these firms, we would not rule out future action or impact.
Finally, investors may seek to apply any changes in approach that they adopt as a consequence of the FCA’s findings and recommendations to their alternative investments, particularly with respect to transparency issues, which could bring pressure on alternative asset managers to change as well.
Any new rules and guidance will be subject to a cost-benefit analysis and formal consultation. The FCA has published a consultation paper setting out its proposals in relation to fund governance, risk-free box profits and share-class switching. The closing date for responses is September 28.
The FCA expects to publish further consultation papers on most of the remaining reform proposals before December. Given the relative speed at which it is acting, we will continue to monitor the proposals closely and continue to provide updates on the rapidly evolving regulatory landscape.
Nikesh Pandit in Jones Day’s London office assisted in the preparation of this article.
Note: The views expressed are the personal views of the lawyers and do not necessarily reflect those of the law firm with which they are associated.
Published August 25, 2017.