Getting the right investor outcomes

Speech by William Amos, Director of Wholesale Banking and Investment Management at the Investment Week Fund Management Summit, London. This is the text of the speech as drafted, which may differ from the delivered version.

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It’s a great pleasure to join everyone this morning and thank you for inviting me to speak at today’s summit, the FCA value opportunities to speak at such events so I do hope you all find this morning’s session valuable. As you know I’m going to spend some time talking about getting the right investor outcomes, but then, dig deeper in to the detail about what do right outcomes actually look like, why it is important to get the right outcomes for clients and why do we care? And finally, as you will recognise, the FCA approach is different so I will spend time on our Supervisory framework and our expectations of firms, cover some of the recent thematic findings in the asset management industry and finally talk to you about the role of our new fund authorisation and supervision team.

So, getting the right investor outcomes springs an immediate question to my mind, what is the right outcome? And by this I do not just mean ‘outcome’ as in profit. The right outcome for a client will be:

  • keeping costs reasonable
  • the right outcome will be within their risk tolerance
  • the right outcome will remain consistent with the original investment objectives
  • the right outcome will be when an investment manager treats a client fairly. The CEO of large Investment Bank has described this as, ‘treat customers as if they were a member of your own family’

And this is where the FCA’s expectations enter the picture.

As you know the FCA is nearly 18 months old, so we are continuing to engage and work closely with industry, continuing to listen and importantly continuing to learn.  Let me give you two very simple examples, simple but very effective examples of how we have worked with the firms.

Example one

A firm approached us with an idea for a new product which they considered to be innovative and which they felt presented a slightly different risk profile to their investors. The idea had received material scrutiny from the firm’s executive management, but the decision to launch had not yet been made. We worked with the firm to identify some of the relevant features of the fund which would help their investors to understand it. We agreed that given the nature of the current investors that disclosure of these issues was enough to facilitate the right outcomes, but this should be revisited if the distribution strategy changed. So, this shows us proactively working together, being transparent, and by both the regulator and the industry heading for the same goal, achieving the right investor outcome.

Example two

As part of our work we discussed with a firm the use of a proprietary trading desk on their trading floor. The arrangement appeared to indicate that the desk had potential access to confidential client information which could be used improperly.  We spoke to the firm; they understood our position and closed the desk just over a month after we raised the issue. This example, again, shows us proactively working with the firm, being transparent on our concerns and getting the right outcome.

These achievements are not only good examples of how we work with industry but are also examples of how firms can improve how their businesses are run and our expectations on specific issues. So this is therefore a good point remind you exactly what our objectives are.   

At its highest level, we have objectives to promote effective competition, protect customers and protect and enhance the integrity of the market. Our approach to these objectives is to be judgement based, forward looking and outcome focused.

In practice this means we will:

  • have a deeper understanding of the sectors we regulate, what customers are really experiencing and how markets operate
  • we will want to understand how a firm makes its money, how its business model operates now and what changes are planned, including where growth is forecast and where market pressures put growth at risk
  • importantly we will seek to understand a firm’s culture and how this impacts on how it actually carries out its business and we will be more focused on what the impact is on its clients, customers and whether the wider market outcomes are being achieved rather than if a firm is meeting individual rules

the business to be responsible for ensuring proper market behaviour all the way from the Board room through to the investment manager and trading desk.

This will mean we need to be transparent, and discuss issues; in particular, to understand firms’ reasons for conducting business in a certain way. This means we will spend more time than historically with the business, understanding what they do and, importantly, how they do it; how they think about risk, customers and the market; and how they identify, assess and control the risks in the business. We very much expect the business to be responsible for ensuring proper market behaviour all the way from the Board room through to the investment manager and trading desk. The reason for this is that recent history suggests that problems with retail and wholesale behaviour are the result of strategies or practices driven by and implemented by the business either from the Board, ExCo or in individual business lines rather than a flawed compliance or Internal Audit framework. Compliance and control functions are, of course, crucial to a business operating in its customer’s interests but this is not something they can achieve in isolation.  This increased focus on how the business is run, rather than how it is controlled, is a fundamental change and is directly linked to our forward looking outcome focused philosophy.

I would now like to explain further what I mean by outcome focused.

What it means is that we are fundamentally interested in what consumers actually experience and the impact of firms’ behaviour on the market.

This translates to a model which includes:

  • looking at individual firms to assess what drives potentially poor conduct behaviour including the culture and values of firms, and
  • at sectors where we use horizontal or thematic work to look at specific products or business lines to find out how customers or investors are being treated and to allow  us to understand better how firms and markets operate

So, I have mentioned culture, but what do I mean by it?

It is my view that an important part of achieving the right outcomes is having the right culture. This means a culture which needs to be embedded throughout the business, thinks about the consumer and market integrity, and is used to drive long term growth.

The challenge for many firms is that culture is hard to change. We understand the time, dedication and persistent focus required over what may be a number of years to embed different approaches and ways of behaving.

We want a culture which is based on a concept of “should we do this?” with the business challenging itself on how it operates. If putting the client first is one of the firm’s core values, then how is this being implemented.  We expect to see firms ask themselves at all points in the product cycle, should we be doing this; specifically, does this fit with the values or culture of the company, is it in the interests of the client and will it enhance the reputation or integrity of the market? Or will it threaten it?  These are not questions that compliance should answer nor is it what the FCA handbook is for.  It is for those in the business.  Instead of this approach too often in the past we have seen a “can we” approach. This has resulted in passing responsibility into compliance or legal and asking is there a rule that stops us doing this. This can encourage a tick box approach, not taking into account properly the client, customer or wider market.

The challenge for many firms is that culture is hard to change. We understand the time, dedication and persistent focus required over what may be a number of years to embed different approaches and ways of behaving. We believe there are key drivers that reinforce the right culture or values. These are: clear and ongoing leadership from the top of the organisation, with constant reinforcement, incentive structures which support the messages from senior management and the board, effective performance management including penalties for not doing the right thing, and, importantly rewards for doing the right thing. For example, a promotion is more than career development for an individual. A promotion is where words become actions. Promotions say to others around you, these are the people who demonstrate our values; these are the behaviours we expect to see from you all.

I would like to share with you a quote I saw recently from the Harvard Business Review: “Thinking proactively about your company’s culture as an integral part of its business model is a good start. The next step is to actually start behaving in ways that make it a reality.” In summary this is saying don’t just talk about it, make every action reflect and reinforce the behaviour you want.

So let me move onto the detail of today and specifically talk about the wholesale industry.

In 2013 UK-managed assets stood at £5.2tn and generated £13bn in management fees. The UK ranked first in Europe and second worldwide, after the US, measured by assets under management (AUM). 8% of global financial assets and 36% of European financial assets under management were managed in the UK. This demonstrates to me the significant role the industry has in the UK economy and in ensuring effective allocation of capital and managing long term savings. It is therefore important we get regulation right and that the culture is right in the industry.

Our focus in wholesale is to look at two specific types of behaviours: those that impact on the integrity of the market; and those that impact on those who use the market i.e. the investors. In many ways our work on integrity corresponds to the reputation of the market. For example, where prices are manipulated, Money Laundering not prevented or fraudulent behaviour is allowed.  It is Important to note that this means we care even where there are not losses to other market uses or losses that flow through to retail customers. We are however, of course, concerned about how behaviour in the wholesale sector impacts on retail markets and we do not draw a hard line between retail and wholesale. The reason for this is that wholesale markets and behaviours can impact on retail markets. To give you some examples of the approach we take, I am going to spend some time talking through some recent work the FCA has published.

Last year our CEO, Martin Wheatley, launched our approach to Asset Management at our AM conference, which is that firms need to act as good agents at all times for their customers and I’d like to discuss further how this high level strategic aim leads to specific workstreams.

One area we have focussed on is looking at how asset managers spend clients’ money, where we have an expectation that the same rigor will be used when spending clients’ money as if the asset managers were spending their own. Our review on dealing commissions is an example of this – we are focusing on how firms act as good agents for their clients when spending dealing commissions. Connected to this is our Consultation Paper on the criteria for research which we published last year. UK investment managers pay an estimated £3bn of dealing commissions per year to brokers, with around £1.5bn of this spent on research. In our Consultation Paper we clarified the criteria for substantive research to help make sure that asset managers use dealing commissions in line with our requirements and investor expectations. This was a result of our conflicts of interest review in 2012 where we saw some asset managers using dealing commission to pay for services such as corporate access where investors’ money was used to buy access to company senior management.

As part of our wider work on dealing commissions, there have been significant discussions with firms on both the buy and sell side. We published a policy statement earlier this year followed by our recent thematic findings which found there were improvements made in the industry since November 2012; however, only 2 firms from a sample of 17 were operating at the level we expect. We found in 11 investment management firms that the amount of research purchased with dealing commissions remained linked to the volume of trades carried out, rather than on the value the research added to investment decision making. We also found 1 firm was using dealing commission to pay for market data (a practice we thought had stopped many years ago). We continue to work with industry on these issues to get the outcome we all want, which is the right one for the investors.

A further piece of work where the FCA has worked with industry is on the communication of fund charges and I’d now like to talk you through some of our findings from the work. The FCA reviewed the marketing information made available to UK retail consumers by 11 firms. We found good examples of firms who provided their customers a consistent, combined charge figure across all relevant documents and platforms, but there were still examples of firms referring to different charges figures in different documents, making  comparisons difficult. It is not only our detailed rules which mean firms must present their fund charges clearly and consistently, but it is in the interests of a competitive market so that retail investors are able to better compare charges before making decision on where to invest. This is important so investors can understand and compare charges across the market as this, together with fund performance and risk profile, are the key areas that they should look at.  This does not mean the lowest charge is the right answer but clarity of charges helps customers find value in the market, which should promote efficiency and ultimately a stronger industry to meet long term savings needs.  This is central to our statutory objective to secure appropriate protection for consumers and requirements for firms to communicate with investors in a way that is clear, fair and not misleading.

We have established a new centre of excellence for investment funds which will oversee the cradle-to-grave lifecycle of UK investment funds. 

So now let me move on to something new. Those who attended the FCA’s Asset Management Conference last October may remember that we made a number of commitments with regard to our supervisory approach in the funds sector. We spoke about striking a proportionate and measured regulatory approach in this area, which encouraged opportunities for entry and innovation so that we continue to help to enhance the UK’s position as a global leader in this important industry.

Part of achieving this balance has come through changes we have made to the fund authorisation process and in setting up an enhanced fund supervision approach. This is a new direction for the FCA, complementing and aligned to firm supervision.

We have established a new centre of excellence for investment funds which will oversee the cradle-to-grave lifecycle of UK investment funds.  The new Fund Authorisation and Supervision Team are responsible for regulated funds from their point of entry into the UK market at the authorisation stage, monitoring and supervision all the way through to the fund’s termination or closure.  By aligning the authorisation and supervision functions in this way we can ensure that a consistent focus on investor outcomes will run throughout the product's life.

I’m sure you’re wondering “how is the FCA going to supervise funds?”  And before I get into the detail, let me add some context for fund supervision. So, why in particular do we need to directly supervise investment funds?

Well, we are all aware of recent failures in the sector. It is worth reminding ourselves of some of those recent examples that underline why we are enhancing our approach.

The Arch Cru Funds that were wound up in 2009 after dealing in the funds was suspended due to liquidity problems were initially valued at over £400 million. When the investments went bad and the fund collapsed some 20,000 retail investors across the UK were affected. Even after compensation, many of these investors lost up to 40% of the initial value of their investment.

After that, the Arc European Property Fund was the first UK regulated fund to go into liquidation in January 2010.  This fund had approximately £4 million invested via some 300 UK investors. Most of these investors had invested through SIPPs and lost a substantial part of their retirement savings.

So – our aim is to identify at the earliest possible stage where risks in certain funds exist and to take pre-emptive action where appropriate so that we can limit the potential and actual loss to investors.  We believe that the direct supervision of UK funds complements our existing firm supervisory model and will support and enhance investor confidence in funds domiciled in the UK.  While we cannot, of course, guarantee that our new approach will prevent any future fund collapse, we will continue to work with operators in the funds sector to ensure that as agents they are acting in the best interest of the investor and focussing on protecting their investments.

While we are not a backward looking regulator, there is a precedent for taking this approach. In the days of self regulation, some of you will remember that the Investment Management Regulatory Organisation (IMRO) took a focused approach towards scrutinising the products being offered by their managers. We have studied this approach and think that our new method builds and enhances on this and other approaches we have studied.

Our peer regulators in Europe in fund-focused jurisdictions such as Luxembourg and Ireland, as well as our bigger counterparts such as France and Germany, operate approaches that look at both the managers of funds, the operators of funds and the products themselves.  We have taken steps to understand good practice from Europe and beyond and will align that to the FCA’s firm supervisory approach.

So let’s talk about the enhanced approach and in particular the remit of the FCA’s Fund Authorisation and Supervision Team

Our task is two-fold.

  • to improve our internal systems and processes to be more efficient in delivering high quality scrutiny of new funds and changes to existing funds at the gateway
  • to enhance that protection to investors throughout the fund’s lifecycle

Let’s address first the Authorisation of new funds.

How do you produce the right outcomes for investors through the fund authorisation process? 

The authorisation stage is the gateway for collective investment schemes that want to be promoted to UK investors and as such investors’ expectations must be aligned with the fund’s own stated investment objectives.  Fund structures must be clearly set out in language the investor can understand how they are to operate, what the investment strategy is and what are the risks involved. Investors must be able to clearly understand the charges associated with their investment. 

After consultation with the industry, we have taken steps to ensure that our fund authorisation process has been made more efficient and robust and compares favourably to other jurisdictions

Since April 2014, we have met our new  objective to reduce new fund authorisation timelines for all Alternative investment Funds (AIFs) from the previous 6 month  deadline to a maximum of 3 months – and this will reduce further – down to under 2 months from April next year for all schemes, whether they are UCITS or AIFs. For qualified investor funds we will process applications within one month. Our aim is to further cut any unnecessary delay in the process and we are already making great strides in this direction.

We are, for example, already processing UCITS applications typically in under 6 weeks which is 2 weeks inside the UCITS timeline. In addition, we are investing in new technologies to enable us by 2016 to facilitate faster online fund applications.

To be more efficient, the FCA also needs you in the industry to play your part.  Documents submitted to us need to be accurate and unambiguous, which is not always the case - and any concerns we raise will have to be promptly addressed. Where we find this not to be the case we are starting to be more proactive in following up directly with both the fund manager and its legal representative.  We are not taking this more interventionist approach for some bureaucratic reason; instead it is to allow you, the industry, to speed up your business, which you tell us matters.

Now let’s go into a little more detail about our fund supervision approach.

In the post-authorisation phase of the life of an investment fund, what matters is the delivery of the stated investment objectives for the investor and how you as operators and managers of funds go about doing this. Managers of funds and those with an oversight responsibility in the Authorised Corporate Director (ACD) or depositary or trustee should be constantly checking to see:

  • is the fund compliant with the investment mandate
  • is there the appropriate transparency and disclosure to investors
  • are the investors interests being best served throughout the fund life-cycle
  • are all the decisions you are making done managing any conflict of interest and producing the best possible outcomes for investors

If you are doing all of this, our fund supervision will not have any material impact.

The new unit will focus on UK authorised funds – both UCITS and AIF, with a particular interest in retail-focused funds and as I mentioned earlier the approach is aligned to the FCA’s firm supervisory model that most of you will be familiar with already - pre-emptive, reactive and thematic. 

Our pre-emptive approach will be data-driven, using new data streams to identify outlier funds for supervisory follow-up work. We have significant new data coming in to us as part of the AIFMD, but we are also working with industry to extract more use from existing data and building new capabilities to focus our analysis of market data. Our aim is to identify issues early and put in place mitigation tools to minimise any potential detriment to investors.  We will do this by continuing to work closely with authorised fund managers (AFMs), Authorised Corporate Directors (ACDs), trustees and depositaries. 

Our reactive work will be driven by problems that have already crystallised in funds, or have been identified from customer complaints, internal FCA firm supervisory reviews or whistleblowers. We will operate a rapid response process to determine the extent of the risk and any detriment, and to work on an immediate resolution that minimises customer detriment and the likelihood of recurrence.

We will also focus on potential high-risk areas.  The areas could be based on, information from data or market trends identified by our analysis. 

One current area of interest is valuation and liquidity management.  We are therefore using property funds as case studies to explore how firms deal with assets that can be difficult to value and where fund liquidity needs to be carefully monitored and managed.

So what does this all mean for the industry and how will you be affected?

From your perspective, fund supervision will complement existing FCA firm supervision. The team will have its own supervisory mandate as I have mentioned but will also operate with   existing supervision teams such as the team focused on client assets and asset managers. As such you may see the funds team assisting firm supervisors in or you may interact with them as part of a specific piece of fund supervision work.

Ultimately, we want to see firms operating as good agents and with the client or investor interests being served in all areas of your business. This is no different when we focus on the fund product itself, but it may be that you need to consider whether your internal processes adequately cover all the way through a fund product life-cycle.

In conclusion, I hope today has given you a better understanding of our expectations and approach, particularly on fund authorisation and supervision. As always, there is a key message I would like you to take away from today. This is the need to act as good agents for your customers and ensure throughout your business that the decisions and actions you take are in the best interests of your customers. For our part, the FCA will be both on the side of the consumer but also as a constructive regulator so that we can continue to have the debates we are increasingly having with firms and collectively re-build the trust in financial services.

So, now let me end with a thank you again for inviting me to speak here today and many thanks for listening. I hope you all enjoy the rest of your day.