Investor Outcomes: The supervision of costs in UCITS and AIFs
Further to the June publication of ESMA’s supervisory briefing on fund costs in UCITS and AIFs, this article explores what Irish Fund Management Companies can learn from the UK’s experience with Fund Value Assessments.
In June the European Securities and Markets Authority (ESMA) published a non-binding supervisory briefing on fund costs in UCITS and AIFs.
The guidance builds on the UK’s Value Assessments, enshrined in their Senior Manager and Certification Regime. It is likely that the Central Bank of Ireland (CBI) will regard the ESMA guidance as best practice; it builds on the CBI’s focus on Investor Outcomes, is a natural extension of the CBI’s CP86 Organisational Effectiveness thinking and will likely dovetail with the upcoming Senior Executive Accountability Regime.
It is worth noting that a number of Irish Fund Management Companies are already exploring whether to provide a voluntary attestation, perhaps in response to UK distributor pressure and/or to ensure that standards of governance across a firm’s UK and Irish fund ranges are consistent.
What can we learn from the UK’s experience with Fund Value Assessments?
What are fund value assessments and why have they been introduced?
UK consumers spend over £1bn each year buying investment management services from UK Authorised Fund Managers (AFMs). In its 2018 Asset Management Market Study (AMMS), the FCA reported that market forces in the industry are weak, leading to many overpriced and low-quality products. From the end of September 2019, AFM directors – known as Authorised Corporate Directors or ACDs – must now publicly attest that their funds offer value to investors or take corrective action if any do not.
What is the role of ACDs in fund value assessments?
The FCA sees fund value assessments as a catalyst for major change and not a ‘tick box’ exercise. The ACD must pay greater attention to the outcomes delivered to their customers. The new rules reinforce an existing duty to act on behalf of customers; and value attestations need to demonstrate high standards of board review and challenge. AFMs need to show they are trustworthy as well as competitive and the renewed focus on the agency responsibilities of AFMs is accompanied by new standards for personal accountability and independence for directors. This means that AFMs must change from supportive subsidiaries of asset managers into challenging clients.
What role does competition play in fund value assessments?
The FCA observed that one objective of the AMMS is to boost competition between firms. AFMs oversee the spending of consumers’ money and must now compete on the quality, cost and comparable prices of all services purchased on behalf of investors. Some services are highly standardised such as custody and fund accounting where AFMs need to show costs and service standards align with market norms. Others are highly differentiated such as customer support, the provision of advice and investment management - here asset managers must bring out what makes them different. Charging market prices does not amount to delivering value; what matters is how AFMs differentiate the services they provide.
What effect will fund value assessments have on different share classes?
The FCA found that new customers often pay less for the same service than established consumers; and that retail customers often pay more for the same investment service than comparable institutional customers. AFMs must ensure all services charged to customers pass the quality, cost and comparable market price tests discussed above: and the process of defining competitive features requires AFMs to justify any differential in costs; and address any that cannot be justified.
Why will fund value assessments lead to product rationalisation?
As agents acting for investors, AFMs must clearly define and describe the services offered to their investors. The FCA has identified major shortcomings in AFM’s descriptions of services, highlighting some as vague or unmeasurable and others as simply inaccurate. AFMs should now ask for regular confirmation from asset managers that each fund accurately describes an investment service that meets identified consumer needs. Over time, in response to changing circumstances and markets, creativity and innovation has resulted in a proliferation of funds and share classes. Because of the attestation requirements, asset managers should now provide AFMs with coherent product strategies which, when combined with an assessment of product line competitiveness, will result in rationalisation of many product lines. In addition, there are also increasing commercial drivers for rationalisation.
How should AFMs assess economies of scale?
Well established rules govern conflicts of interest between the asset manager and the customer; and the AMMS now requires AFMs to consider how efficiency savings from growing funds should be shared between customers and asset managers. At present, many asset managers argue they currently lack effective mechanisms to allocate costs to specific funds and therefore cannot accurately assess economies of scale. Pending resolution of this data problem, AFMs can still assess whether the allocation of risk and reward between consumers and the asset manager is fair - one interim solution is to measure, over a time period highlighted in the fund objectives, what proportion of the total return generated by a fund is allocated to the consumer and what proportion the industry keeps as fees and charges. If the split disproportionately favours industry, some adjustment may be appropriate.
What sort of information should a value attestation contain?
The attestations are aimed at consumers to help stimulate competition between AFMs. AFMs should not treat them as a tick box check list and can go further to highlight competitive features or the quality of governance arrangements. Comments from the FCA, early in the process, suggest that some of the initial fund value assessments may not have delivered what the FCA expects. While AFMs who have already published may simply be asked to resubmit better work next year, the remainder should not bank on similar forbearance. We have identified four topics that fund value attestations might usefully address:
- A description of the fund (or range if a composite report) setting out why the AFM considers it competitive.
- A description of the governance process setting out how the AFM as a trustworthy agent is acting in consumers best interests.
- A report summarising the status of the fund (or fund range) relative to the FCA criteria, perhaps in the form of a RAG report.
- A summary of the actions the AFM is taking to address any problem issues identified in the attestation process.
Firms may also usefully supplement the attestation with additional data on key points such as fund performance, fund size, fees etc.
What will be the long-term impact of value assessments?
Assessments of value are a harbinger of structural change for the UK funds industry and beyond. The first stages feel bureaucratic as AFMs recruit independent directors, request reports on value from asset managers and prepare public attestations. As a result of value assessments, asset managers have begun to address cases of poor value, in some cases reducing near term revenues. But looking forward, it is likely that competition to deliver value will require highly differentiated offerings, improved service levels and lower prices, and delivering these will need new business models with clear external propositions to customers and enhanced operational efficiency.
With the delegated model again under scrutiny from ESMA, and in order to get ahead of this guidance, it would be prudent to be able to evidence that your existing (delegated) operating model delivers both challenging oversight of the investment managers to the funds and positive investor outcomes. We’d be happy to share our learning gained from assisting UK AFMs put in place their Value Assessment processes – please reach out if you have a question.
Paul Traynor, Partner, EY