Asset managers under scrutiny: claims horizon scanning in 2017/18
The UK asset management industry is the second largest in the world, managing an estimated £6.9 trillion in assets for domestic and overseas clients.
In June 2017, the Financial Conduct Authority (FCA) published a report on asset managers, proposing significant reform.
Meanwhile, asset managers also face significant regulatory changes as a result of the:
- Implementation of the Markets in Financial Instruments Directive II (MiFID II).
- Implementation of regulations concerning Packaged Retail and Insurance-based Investment Products (PRIIPs) with its heightened investor protection regime.
- Scope of the Senior Managers and Certification Regime (SM&CR) being extended to include asset managers from 2018 onwards.
2017 and 2018 appear likely to be challenging years for asset managers and their insurers.
The new regulatory burdens on asset managers will increase the risk of regulatory sanction and, potentially also, the increased risk of investor claims.
FCA Asset Managers Report
In June 2017, the FCA published an Asset Managers Report (the Report), summarising the findings of its asset management market study, which launched in November 2015.
The Report included a package of reforms and remedies intended to address its concerns within the industry. In particular, the Report flagged concerns regarding:
- Weak price competition. Average profit margins of 36%, clustered pricing and prices remaining broadly stable over time are all factors which have caused concern around excessive profit margins and a lack of competition in the asset manager market.
- Performance. The Report found there is no clear relationship between the fees associated with a fund and the fund’s performance. Indeed some evidence indicated a negative relationship (i.e. higher fees and worse performance). Further, the Report identified difficulties for consumers in comparing past performance, and a trend for poorly performing funds to be closed or merged with other funds. However, mergers in some cases took a considerable time to happen, and merger appeared to correlate with poorer performance of the merged fund, although it is unclear whether this is a direct result of the merger.
- Issues with Investment Consultants and Other Intermediaries. Concerns were identified in the investment consulting market as a result of weak demand, relatively low switching levels, and conflicts of interest.
The remedies proposed are said to form a “consistent and coherent framework of interventions”, and are focused on strengthening protections, driving competition and improving the effectiveness of intermediaries.
Specifically, asset managers will find themselves:
- Under a strengthened duty to act in the best interests of investors, with increased accountability coming in under the SM&CR and new independence requirements in governance structures.
- Under pressure to switch to single all-in fee structures to improve transparency. The FCA are also looking to standardise the terms of disclosure of costs and charges to institutional investors.
- Meanwhile, investment consultants remain potentially subject to a Competition and Markets Authority investigation of the sector in September 2017. Such an investigation would be in addition to a further FCA market study which was announced in the Report, and is also intended to explore how competition is working in the investment platform market.
The FCA terms of reference did not include alternative asset classes, such as private equity and hedge funds, which are now likely to be subject to scrutiny.
Other regulatory changes
There are a number of other regulatory regime changes on the horizon which impact upon asset managers.
- MiFID II. From 3 January 2018, MiFID II will impose new requirements concerning transparency and transaction reporting.
- The PRIIPs regulation. From 1 January 2018, this will require firms to produce a PRIIP Key Information Document (KID) for each PRIIP that they make available. These short summary documents have closely prescribed content, and whilst they are able to refer to prospectuses, they must meet the necessary standards as a standalone document. Failure to produce a KID will expose managers to potential regulatory sanction. Equally, managers may face a new exposure to damages claims from investors alleging reliance on inaccurate or misleading KIDs.
- The SM&CR is coming into force for asset managers (as well as insurers, investment firms, insurance and mortgage brokers and consumer credit firms) during 2018, although no date has yet been fixed. With an increased focus on individual accountability within asset managers, we anticipate an increased uptake in D&O insurance and a greater focus on the terms of cover.
The next 18 months appear likely to be challenging for asset managers as they grapple with the new regulatory requirements being imposed on them and we await what further consultations may bring.
The potential for regulatory sanction, or investor claims founded on breach of regulatory requirements, will no doubt be a concern for asset managers and consequently for their insurers.
When pricing the risk of cover, insurers will wish to hear that firm’s seeking cover are taking active steps to respond and implement changes which address the changing regulatory landscape, to ensure the firm does not attract the attention of the FCA enforcement team.