FCA outlines plans to tighten regulation in asset management industry

Out-Law News | 31 Oct 2013 | 2:57 pm | 3 min. read

The Financial Conduct Authority (FCA) is to conduct a review into the asset management industry in an effort to understand whether payment arrangements between asset managers and brokers give rise to conflicts of interest in the market.

At its asset management conference in London, the regulator also unveiled plans to launch a consultation in November on regulatory reforms in the market after it raised concerns about the "bundling" of services and the transparency of charges ultimately paid by retail investors.

"There are two persistent problems," the FCA's chief executive Martin Wheatley said in a speech at the conference. "Firstly, services are being ‘bundled’ together, with eligible and non-eligible services being mixed. Secondly, when this information is provided back to the client, there is a lack of clarity or adequate transparency around how their commissions have been spent."

The current regulatory regime allows asset managers to recover certain costs through the fees they charge investors. This includes being able to recover commission they pay companies to undertake independent research into the investment market.

Wheatley said that the FCA would seek to clarify how 'research' is defined and what costs can and cannot be passed on to clients from commissions in its November consultation paper. He said the "prevalence of bundled services" can "disguise overpayments for eligible services" and subsidise services asset managers should pay for themselves.

Brokers often provide a link between asset managers and the companies they want to invest in by facilitating meetings between asset managers and senior executives at companies. Wheatley said that although the FCA has "no particular concerns with the purchase of corporate access" he said it was wrong for asset managers to recover commission they pay brokers for this service from investors.

"Asset managers should be using their own funds if they wish to purchase access," Wheatley said. "This practice transfers the firm’s costs onto the client, which clearly works against the client’s interests. This raises a concern because asset managers do not control these costs with the same rigour as costs they incur directly. These costs are indirectly borne by the client and do not affect the manager’s profits."

"Likewise, on the other side of the transaction, chief executives and investor relations officers have learned, sometimes to their surprise, that their time is being billed to the industry by brokers," he added.

The payment arrangements also create a "potential conflict of interest" on the sell-side of the industry, Wheatley said. He said fund managers are "incentivised to spend" extra money gathered from research commissions "regardless of the added value of the services".

Wheatley said that the business model operating in the market was "unsustainable" amidst competition from investment markets based elsewhere in the world. He said that there was insufficient transparency regarding the bundling of charges and the use of commissions to buy research.

However, the industry was praised for how it had engaged with the FCA after the regulator sent letters to chief executives of companies operating in the sector asking them to confirm that they effectively manage conflicts of interest that can arise from the way services are paid for.

Wheatley called for the industry to help shape reforms to the regulatory regime and praised the resilience of the sector throughout the financial crisis. The industry is now a "driving component of the UK’s economy" with UK fund managers responsible for "a record £5.4 trillion in funds at the end of 2012, up 6.5% on the previous year", he said.

Financial regulation expert Monica Gogna of Pinsent Masons, the law firm behind Out-Law.com, said: "The FCA's announcement on the launch of a thematic review and consultation paper on broker commissions comes as no surprise. However, whilst it is of utmost importance to ensure transparency of costs and protect the consumer's interests, there is a real need for balance from the regulator to ensure that London's reputation as a pre-eminent powerhouse in the asset management industry is not eroded away with too much regulation."

"It is heartening to hear that the FCA proposes to engage with both the buy side and sell side when consulting on this issue and recognises that 'UK plc' is also part of a wider EU and global market and that any proposals will need to define a clear path as to how the UK will ensure that it takes into account its' position in the global framework," she added.

In another speech at the conference, the FCA's director of supervision Clive Adamson said an organisation's culture can help drive regulatory compliance. He stressed that the way that companies run their "product approval process" and whether they ensure products are sold in the markets they were designed for are factors the FCA take into account when assessing compliance.

Adamson also acknowledged the changes that businesses operating in the retail investment market have had to make to their business models as a result of the changes made to the regulation of the market via the Retail Distribution Review. He said that the regulator was "working hard" to ensure that work "leads to real changes in the market to benefit consumers".