Speech by Christopher Woolard, Director of Strategy and Competition at the FCA, delivered at the TISA Annual Conference.
Speaker: Christopher Woolard, Director of Strategy and Competition
Location: TISA Annual Conference, London
Delivered on: 24 November 2016
Highlights:
- The last couple of years have brought dramatic changes to the long term savings landscape. As a regulator, we are very aware of the amount of change this has resulted in for firms and appreciate the great efforts that have been made to accommodate and implement these initiatives.
- It is crucial that the asset management industry works well. We have found weak price competition which means investors are paying more than they should for services, which is in turn having a material impact on their investment returns.
- It is our job as the regulator to ensure that this market is efficient and effective, given the very clear social responsibility asset managers hold.
- We ask that the industry, consumers, government and other regulators to engage us in the asset management consultation, and all our consultations in this space, to improve markets for millions of everyday consumers. Together we can all play our part.
Note: this is the speech as drafted and may differ from delivered version.
Introduction: a period of change
Thank you Justin, and thank you to the Tax Incentivised Savings Association (TISA) for inviting me to speak at your annual conference. I want to use this opportunity to sketch out some of the challenges in the long term savings market and what role the regulator can play in them. In doing so, you will unsurprised I will use our latest market study on asset management as an illustration.
But before I do it’s almost 3 years to the day that I last spoke at this event. Few would have imagined at the time the dramatic changes that have taken place within the long term savings landscape since then.
Automatic enrolment has well and truly bedded in and is changing the way people save into their pensions.
The government's pension reforms have opened up to consumers a greater array of options for accessing their pension savings than ever before.
More recently, in the last couple of weeks we have published our approach to how we will regulate the Lifetime ISA – and have finalised our rules on capping early exit charges so that consumers eligible for the pension reforms can take advantage of them if they wish.
So I think if anything, ‘change’ and the need to adapt to change, has been the one constant in the market during this period.
And we as a regulator are very aware that this period of change has required a lot from firms. We appreciate the great efforts that have been made to accommodate and implement these initiatives.
The challenge: the state of the nation’s savings
The state of the nation’s savings is one of the most fundamental challenges we face
Turning to the theme of today’s conference - clearly there are significant challenges when we talk about the state of the nation’s savings.
Now, I don’t want to get too bogged down in statistics and numbers, but I do think it’s important to highlight a few facts that demonstrate the changing face and associated challenges to long-term savings in this country.
We all know that there is a substantial shift from DB scheme membership to DC scheme membership. But the scale bears mentioning.
Recent work by the Institute of Fiscal Studies tells us that in their early 30s, less than 10% of private sector employees born in the early 1980s were active members of a defined benefit scheme, compared with nearly 40% of those born in the 1960s.
We know that there are challenges to growing savings in a low-interest rate environment.
A recent estimate suggests that to provide yourself with 70% of your gross income for 25 years of retirement when real interest rates are zero requires setting aside 45% of gross income every year, which is obviously well above most achievable saving rates.
And we know that people are living longer and will enjoy longer retirements than any generation previous - yet as TISA’s research shows, by 2035, they will retire less well-off than the previous generation.
This is one of the most fundamental challenges we face.
The role of the regulator and the mission
A very important way that we can act in the interest of consumers is to use the tools available to us under our competition objective
So how do we as a regulator play our part in tackling some of these issues?
Last month we launched our Mission document. This sets out a series of questions about how the FCA should set its priorities – and the tools we should employ to carry out our work.
We think it's an important document and hope as many stakeholders as possible read it.
I’d like to encourage TISA and its members to get involved in the consultation process and to have your say on a number of critical regulatory questions that it raises.
We want that to be the start of a conversation about a range of topics, including how do we as a regulator play a role in public policy issues.
There are some things that are matters for the Government. For example, our role isn’t to encourage people to save – we can’t, for example, legislate to increase auto enrollment contribution rates.
But one way – and a very important way – that we can act in the interest of consumers is to use the tools available to us under our competition objective to look at markets as a whole – to give us a rounded view - and to ensure that they are working well.
We have done this in the retirement income space and are currently carrying out a review on retirement outcomes in the new decumulation landscape.
This work is looking at how firms and consumers are responding to the pension reforms and make sure that competition is working well. This is particularly important as we are seeing real growth in mass market non-advised drawdown.
The asset management market study
The top line finding of the asset management market study interim report is that there is weak price competition in a number of areas of the industry
Another important area where we have used our competition powers on the accumulation side is to look at the asset management industry.
I want to spend some time now to discuss in a bit more detail some of the aspects of the interim report – and I do stress the word interim because the findings and remedies we have published are just that and I’d encourage you to engage with and respond to the report.
We’ve seen a lot of comment analysis of the report over the last few days. And we fully understand we’ve raised a number of complex challenges.
But I think it’s important to remember that the guiding question behind the study was, and still is, a pretty simple one.
How do we make sure the asset management industry in this country works as well as it possibly can?
Now, one response to that question is that the market is already working pretty well. And up to a point, this is true.
The UK’s investment industry is the second largest in the world, managing almost £7 trillion of assets.
It’s also immensely important to the domestic economy.
But it is crucial that the market works well for everyone – particularly its end consumers.
It’s crucial because this is an industry that directly affects the lives of millions of investors. Three quarters of households rely on it in some way.
10 million saving for pensions.
11 million adults have some form of retail investment – many of these in stocks and shares ISAs – relying on asset managers to help them grow their savings.
So – in any discussion about the state of the nation’s savings – there is perhaps no more important and more influential industry that we should scrutinise.
And there is perhaps no more important time than now to do it.
Persistently low interest rates mean that it is vital that we do everything possible to ensure the market is working well. That it enables people to accumulate and earn returns on their savings which can meet their future needs.
The top line finding of the report is that there is weak price competition in a number of areas of the industry.
And the result of this weak competition means that investors are paying more than they should for asset management services, which in turn is having a material impact on their investment returns.
Our evidence falls into three broad categories – the way asset managers compete, our understanding of consumer behaviour, and the role of intermediaries in helping investors choose between providers.
How asset managers compete
In terms of how asset managers compete – we found that while fund charges have, on average, fallen for passive funds over the last 5 years – they have stayed broadly the same in actively managed funds in the last decade.
Alongside this, we found considerable price clustering for active equity funds. Many funds are priced at 1 and 0.75% which suggests that there is a ‘going rate’ for much of the industry.
As the report sets out, the average operating margin of firms was some 36% across the six-year sample we took. By comparison, the average across all firms in the FTSE all share was 16%; only property investment performed better.
Now of course high returns are not necessarily troubling, in themselves, to competition regulators. If a service or skill is not easily replicable it will be well rewarded.
But the persistent nature of these levels of profit raises concern that price competition is not as strong and effective as it should be.
Taken together, this tells us that there is limited competitive pressure on prices for these funds. From our perspective, this all points to the fact that there is greater room for efficiency and value for investors.
As well as looking at how asset managers compete – we looked at the relationship between price and performance.
What we found was that there was no clear relationship between the two – in essence the most expensive funds do not appear to perform better than other funds before or after costs.
We also found that there is around £109 billion invested in expensive ‘active’ funds which closely mirror the performance of the benchmark.
What we are talking about is a significant number of funds who take only modest positions yet charge a high price for them. These funds are advertised as ‘active’ funds, but in effect perform quite closely like passive funds – delivering similar results.
We are also not advocating one type of investment strategy over another. This is not a case of active vs passive.
But what we are saying is that investors should get what they pay for – or to put it another way, they shouldn’t overpay for what they receive.
Investor behaviour
In addition we have also found that past performance is often used as a marketing tool – used as a key indicator for retail, and to some extent institutional investors in their choice of fund.
This is problematic for two reasons – first past performance is inconsistently presented, making it difficult to interpret and therefore compare funds.
Second, although the warnings have been part of our handbook and advertisements for years, the study shows past performance really has limited value as an indicator of future performance.
Coupled with a focus on past performance was a general lack of focus – especially among retail investors – on what they are actually paying for the service that they receive - around 50% of retail investors were not aware or were unsure whether they were paying fund charges. Many asset managers told us they did not lower prices to compete.
Clearly this is troubling, especially as the impact of charges and getting what you pay for is particularly crucial in this market.
As these are long-term products, even a small reduction in charges can have a material impact on the amount of money consumers will have in their savings and pension pots.
As the report sets out, if you assume a growth rate in line with the FTSE all-share average, an investor paying 0.25% in disclosed charges on a £20,000 investment would earn over £9,000 more, over a 20 year period, than an investor paying 1.0%. This has the potential to rise to over £14,000 when undisclosed transaction costs are taken into account.
Role of intermediaries
The third issue we looked at was how intermediaries help institutional investors identify good asset managers and the impact they have on competition between asset managers.
In the institutional market we see a wide range of investors. There are a number of large, sophisticated institutional investors who are able to negotiate good deals with their asset managers.
However, there is also a long tail of smaller institutional investors – mainly 32,000 small pension schemes – who behave much more like retail investors and achieve similar outcomes.
These smaller fund trustees are particularly dependant on the advice they receive from investment consultants.
We have identified a number of concerns about the way in which the investment consultancy market is operating.
The market is relatively concentrated and switching rates are low.
Our evidence suggests that investment consultants, on average, are not able to identify managers who offer better returns to investors.
And that it is difficult for pension funds to assess whether the advice provided by investment consultants adds any value.
We also have concerns about whether the interests of investment consultants are in line with investors’ interests.
In response to the issues identified in the report, we have designed a package of proposed remedies that are intended to:
First, bring much greater transparency and clarity to pricing – through the introduction of an all-in charge and standardised disclosures.
Second, bring greater clarity to the duties of fund managers to act in the best interests of investors, and hold them to account for this.
And third, give both consumers and institutional investors a much clearer sense of the strategy they are investing in.
We have also made a number of recommendations to government regarding the benefits of smaller pension schemes pooling assets and whether investment consultants should come within our regulatory perimeter.
Finally, we are for the first time proposing to use our powers to make a market investigation reference under the Enterprise Act to the Competition and Markets Authority on the institutional investment advice market.
This is probably the most significant piece of competition work the FCA has undertaken to date. Its findings point to a need for reform.
For asset managers, we understand the report and its interim findings are challenging.
We also appreciate the commercial complexity they are operating under. And the complexity of the policy environment.
So one point I want to stress is that we see the report as indicative, first and foremost, of a market failure in the economic sense.
This has been about observing competition, not searching for rule-breakers.
I also need to make it clear though that we expect the industry to engage positively with the analysis.
Asset managers are entrusted with a very clear social responsibility to the nations’ savers – our job as the regulator is to make sure that it is an efficient and effective market that serves the interests of these savers.
Conclusion
Let me conclude by saying this.
Many challenges lay ahead in ensuring adequate levels of long term savings in the UK - both in a social policy context and in regulatory terms.
These challenges are in accumulation and decumulation. As a regulator, we have an overarching duty to make markets work well.
Our asset management work should be seen as indicative of our willingness to look hard at how markets are working and propose action.
Implementing the right actions needs dialogue across industry, consumers, government and regulators. Please engage with us on the interim findings on the asset management study and with our wider work on the Mission.
Together we can all play our part.