Speed read

The Financial Conduct Authority (FCA) published the Terms of Reference for its asset management market study on 18 November 2015.  The study follows a wider review of competition in the wholesale sector launched in July 2014.

According to the FCA, the aim of the study is to “understand whether competition is working effectively to enable investors to get value for money when purchasing asset management services”.  The study will cover both retail and institutional investors and will seek to understand how asset managers compete, whether they are willing and able to control costs and quality, and how investment consultants affect competition.  It will also look at barriers to innovation.

The FCA will shortly be approaching market participants to request information and data and discuss the issues raised, and aims to publish an interim report in the summer of 2016.

Background

The FCA launched a review of competition in the wholesale sector in July 2014, and in a feedback statement issued on 19 February 2015, identified a number of areas within the asset management sector where competition may not be working effectively.  The FCA suggested that it was likely to wish to consider this further, and subsequently confirmed its intention to undertake a market study into asset management. The publication of the Terms of Reference on 18 November 2015 marks the beginning of the market study.

Focus of the market study

According to the FCA, the aim of the study is to “understand whether competition is working effectively to enable both institutional and retail investors to get value for money when purchasing asset management services”.  The study covers both retail and institutional investors and is broad in scope, reflecting a wide range of issues identified in the feedback to the FCA’s 2014-2015 wholesale sector competition review.

The market study will focus on asset managers who manage funds and segregated mandates, in the UK, for retail investors (including high net worth individuals) and/or most types of institutional investors (including pension funds and insurance companies).  Most importantly, the study also covers ancillary and third party service providers, particularly where they are paid out of the assets of the relevant fund or client.

In terms of scope:

• Tracker funds, ETFs, multi-manager funds, funds of funds and platforms are within scope;
• Private equity and venture capital funds are outside scope, and hedge funds are only within scope where they offer products that compete with the products listed above;
• Wealth management firms and stockbrokers are only in scope where they provide or distribute asset management products or services;
• Investment consultants for institutional investors are within scope; and
• Financial advice per se is out of scope.

Key issues

In summary, the FCA is looking to understand:

• how asset managers compete to deliver value;
• whether asset managers are willing and able to control costs and quality along the value chain; and
• how investment consultants affect competition for institutional asset management.

In addressing these three main questions, the FCA will also consider whether there are any barriers to innovation or technological advances which may be preventing new ways of doing business that could benefit clients or investors.

The FCA accepts that there are a large number of asset managers in the market, and that they compete against each other.  The focus of the study appears to be on how clients and investors choose asset and fund managers and how such asset and fund managers compete.  The FCA questions whether clients and investors do not focus enough on:

• Management fees: the FCA’s Terms of Reference comment on the difference between active and passive management fees and the “clustering” of active management fees at 1.5%, and refer to reports of a 35% operating profit margin among asset managers.  The FCA plans to carry out a profitability analysis as part of the study; and
• Fund costs: how closely asset managers are controlling the costs of services incurred by funds and clients (including custody, administration, risk services, investment and portfolio management systems, stock lending and benchmarking data services).  The FCA’s question here is whether there is an “agency problem”, i.e. whether asset managers have sufficient incentives to constrain the costs of such services and to choose between services based on what is in the interests of relevant clients or investors.

The concern is that, if clients or investors do not focus sufficiently on these matters (either because they lack the information to do so or for some other reason), then competition may not be working well and asset managers and/or their service providers may be earning higher returns than they otherwise would.

The FCA also plans to consider:

• whether, in certain niche areas of the market, there is sufficient competition – the FCA refers to LDI mandates and the size of the leading retail investment platform providers;
• whether investment consultants may have conflicts of interest;
• whether vertical integration of some providers distorts competition or creates conflicts; and
• the extent of barriers to entry and switching, and whether there are barriers to certain kinds of innovation that would deliver better results for clients and investors.

Recommendations

In terms of what firms should be doing now:

• Review the Terms of Reference and understand the potential impact at both a firm and industry wide level.
• Ensure you are “plugged in” to industry work on the market study.
• Consider how you would resource and respond to an information request – the FCA will soon issue information requests to asset managers and other relevant market participants. Based on the requests in recent FCA market studies, we anticipate that these will involve both a lengthy questionnaire and a large data request, and require significant dedication of resources to answer.  As the FCA plans to look at asset managers’ profitability, the data request is likely to require significant information on revenues, costs and cost allocations, and it may be worth giving detailed consideration to how the questionnaire and data responses are presented.
• Consider if you also wish to make your own firm specific submission.

Next steps

FCA to approach market participants to request data  -  Shortly

Deadline for submissions on the Terms of Reference  -  18 December 2015

FCA to publish interim report with preliminary findings  -  Summer 2016

FCA to publish final report  -  Early 2017

For further information please see the Terms of Reference for the asset management market study.

For information and documents relevant to the FCA's wholesale sector competition review please see the FCA's review and feedback statements.