Asset Management Market Study: Clarity of charges – but a transfer of risk?
09 December 2016
Even before the Financial Conduct Authority’s (FCA) recent asset management market study there was much debate about the communication of charges to investors. The FCA's 2014 Clarity of Fund Charges review drove a focus on the ongoing charges figure (OCF) as a single charge figure, to allow investors to easily compare fund charges. Pressure from the EU led to the packaged retail and insurance-based investment products (PRIIPs) regulation, requiring transaction costs to be disclosed in addition to ongoing charges.
Charges under both the current and PRIIPs regimes are estimates based on previous years and the investor bears the risk of paying of any difference between the estimated and actual charge. A further limitation of the OCF is that it does not include other charges such as transaction costs, which can make up a significant proportion of the costs to a fund. Explicit transaction costs such as broker costs are less difficult to estimate than implicit charges such as the bid/offer spread.
The FCA’s greater focus on best execution, and the changes under MiFID II, are driving a need for more complex analysis. Some firms are developing more sophisticated analysis in response, which will also help meet the new disclosure requirements under PRIIPs and any changes required as a result of the final market study remedies.
The FCA’s market study proposes four options to further improve clarity of charges. All also represent a transfer of risk to firms, the only debate being the extent of this risk transfer. The most ambitious option requires asset managers to use a single charge for all costs, including transaction costs, and puts the risk of any difference between the estimated and actual charge on to the asset manager. The least onerous option would see today’s estimated OCF become the actual fund cost.
Practically, the classification of the charge will impact the ease with which it can be changed. If classed as the annual management charge, increasing it would require a change to the fund prospectus, with change also needed to the associated communication to investors and the regulator. A single charge would need to be set at an appropriate level to cover all costs and the FCA will expect robust governance to ensure this provides value for money for investors. If the charge is set too high, to minimise risk to the firm, the unintended consequence could be clients unnecessarily paying more. An overestimate also raises the question of what firms should do with the ‘profit’.
The FCA also deploys demand-side levers in the market study. A single charge for all costs is likely to be the easiest for investors to understand, though the variability in transaction costs from year to year may make the charge estimate less accurate, or increase the risk to the firm if it cannot recover these differences.
So what can firms do? Aside from the wider governance implications of the market study, the potential for the risk of costs being left for the manager to bear should lead firms to consider in detail the relevant costs. Modelling and analysis of these costs is a first step. Not only is this important for the FCA and for consumers, but there are clear competitive advantages for firms in their preparedness.
I hope that the remedies make the UK market more competitive, but I am concerned that a single charge could make UK funds look more expensive than their EU competitors, particularly undertakings for collective investment in transferable securities (UCITS) funds which will continue to use the OCF for the first five years of PRIIPs. Accurate and detailed cost modelling may not fix this, but it’s a sensible first step.