Speech by Andrew Bailey, Chief Executive of the FCA, at the Investment Association Annual Dinner 2017.
Speaker: Andrew Bailey, Chief Executive
Event: Investment Association Annual Dinner 2017, Mansion House, London
Delivered: 17 October 2017
Note: this is the speech as drafted and may differ from the delivered version
- We are ready to roll our sleeves up and continue to make open markets work effectively.
- Our recommendations on fund governance and the effectiveness of boards and the role of independent directors are an important part of ensuring the interests of investors.
- We have established our new Asset Management Authorisations Hub, designed to ease what we recognise can be a complicated process of seeking authorisation for new asset managers.
It is a pleasure to be here at Mansion House tonight. I spoke here two weeks ago at the annual Regulators' dinner, but unfortunately that evening I forgot to bring most of my voice with me. I was struck by the Prime Minister's problem – of the voice that is – on the same day. But I had the good fortune of the Lord Mayor’s solution, the magic Mansion House potion of whisky with small amounts of other things added. And, when the first one ran out and I was speaking, another duly appeared. It’s one of those things you could dream about – here I am at Mansion House making a speech, holding a glass of whisky, and then another. Tonight, the good news is that there is only one regulator to speak before you can enjoy yourselves, but I’m afraid it’s me, and I have a voice and no whisky.
I don’t know whether it’s a real sign that you have made it when you have a dinner at the Mansion House. If so, the Investment Association has impressively done so in double quick time, because I thought it was supposed to take a few centuries to get here. It’s well deserved, and a reflection of the importance of investment management. My plan tonight is to start by saying a bit about the importance of investment management, and what defines the public policy interest in it today. I will then briefly say something about the FCA and our role. And then I will end by setting out a number of big issues that we face together, and I can tell you that when it came to selecting the big issues, they were not hard to find.
The role of investment management
Investment management is, of course, crucial to the effective provision and management of the deep pools of long-term capital – patient capital as it is also called – which are essential for well-functioning capital markets which in turn support investment, and thus productivity growth and thus the expansion of economies and living standards. The last decade, which has been turbulent at times has seen around a 30% growth in global assets under management. Interestingly, and impressive though this is, it actually represents a decline – not a major one – as a percentage of global GDP from just over 100% to around 92%. There is a trick question here – but one for which the answer is nonetheless interesting and important. If I asked the same question about aggregate bank assets for the largest 1,000 banks in the world, I would guess that many people would say that they too have gone down as a share of global GDP. And, they would be wrong: they went up from around 145% of global GDP to 150%. The reason lies in regions. In 2006, US banks had a 13% share of total bank assets for the top 1,000, European banks 58% and Asian banks 22%. In 2016 those shares were 14% for the US, 32% for Europe and 44% for Asia. For assets under management, in 2006 US firms had a 42% share, European firms 45% and Asian firms 8%. In 2016 those numbers were 53% for the US, 33% for European firms and 9% for Asian firms.
This tells us something about the world and financial systems. Bank assets in Asia have expanded rapidly in the last decade, most obviously in China. Assets under management in Asia have not expanded at anything like the same rate. Bear in mind also that Asian GDP has grown more rapidly. US firms have expanded their share of assets under management at the expense of European firms. But this has not affected the position of London as a financial centre. In the last decade the assets managed by North American fund managers based in the UK have risen from 25% to 45% of total UK assets under management. We are open for business.
In the last decade the assets managed by North American fund managers based in the UK have risen from 25% to 45% of total UK assets under management. We are open for business.
I want now to move on to the role of investment management. Again, it is useful to draw a contrast with banks, and also traditional life insurance. There is a bit here of “thank you for stating the blinding obvious” but it matters. Banks act as principal by taking customer funds onto their own balance sheets as deposits. They make a commitment to provide liquidity to depositors (the availability of money from the deposit) and a commitment to return the full value of the deposit plus any interest. Those commitments are backed by the bank’s own capital and by deposit insurance. Banks have to cover their cost of capital. Depositors should expect to receive a rate of return that takes this into account. They should also hold assets which on average are more liquid in all circumstances, again consistent with their commitments. Not all their assets need to be liquid at all times, but a larger proportion should be. Before the global financial crisis many banks expanded very rapidly by backing deposits with assets which were illiquid and hard to value. This was inconsistent with their commitments. We know what happened. It is a salutary lesson for any country with rapidly growing bank assets.
Investment management is different. It is an agent not principal relationship with the investor. The commitments are not the same; they are to return the results of an investment strategy, and they are longer-term strategies. Of course, such strategies are exposed to macroeconomic and other events, and thus to movements in asset values. The investor bears that risk, though they will hope to benefit from the quality of decisions made by the investment manager. But there is no commitment of a formal nature. With more risk should come higher rates of return, and losses are not buffered by the capital of the asset manager.
Also, the meaning of liquidity differs between banks and investment managers. I described the commitment for banks earlier. For investment managers the commitment must be fully transparent too, but it is feasible for some investments for redemption of funds to be suspended where this is consistent with the illiquidity of the assets and market conditions. We saw this safety valve at work last year following the Referendum in the case of open-ended property funds. We are consulting on some areas of improvement to the process, but it has been proved to work provided that investors really do understand the terms and are therefore not surprised when it happens.
I want briefly to mention another big development that frames quite a bit of our interest in investment management as regulators. Over the last few decades we have seen a big shift in responsibility for long-term saving, notably for retirement, from the state and employers to individuals. This has in the last decade been accompanied by conditions of very low real interest rates which have substantially increased the cost of long-term saving and led to conditions where there is real concern that for many people, and particularly younger people, the retirement saving rate is too low. But, to be very clear, this is not a criticism of younger people. We have a substantial inter-generational saving and asset-ownership issue on our hands today.
The transfer of responsibility for saving decisions to individuals took place first in the saving or accumulation phase, but more recently with the introduction of pension freedoms it has come in the decumulation phase. This all makes sense, because with the added issues of greater longevity and an ageing population, more freedom in working lives and retirement decisions is entirely sensible. But it does create some very big public policy challenges.
Another important, and again logical, development has been the decline in more traditional life insurance products and the growth of the role of investment management in this area of long-term saving. This represents a shift away from products provided by firms acting as principal (life insurers) with some forms of commitments or guarantees in the contracts towards asset management contracts of an agency sort.
I would draw two major conclusions from these changes. First, the changes and the challenges are fundamental to society, and thus they inevitably engage public policy. In a way, they pitch investment management into the world of public policy far more than before. And, therefore, second, when you see the things that governments do, and we as regulators do, it’s worth remembering that there is a reason why we are showing so much more interest.
The Role of the FCA
On that note, let me briefly describe the role of the FCA as financial conduct regulator, drawing on the Mission Statement we published earlier this year. The FCA has an overriding strategic objective set by Parliament to ensure that relevant markets function well. In addition, we have three operational objectives with which to deliver our strategic objectives; to protect consumers, protect the integrity of UK markets, and enhance competition in the interests of consumers.
It is not possible, or desirable, to create markets and firms which never fail. To do so would involve a cost of regulation which would substantially exceed the benefits, and even then provide no guarantee. Our approach is to create a framework of rules to govern the operation of markets and then apply a combination of forward and backward looking judgement. All of this is done to support the public interest as set out in our objectives from Parliament. And, to do this, we need to ensure that we are a proportionate and effective regulator as financial services adapt to meet new needs in different ways.
Issues of today
That’s about the briefest description of the FCA I can come up with. I want to use my remaining time to cover three issues of the day which are highly relevant for investment management, namely: Brexit; the Asset Management Market Study; and innovation and how we can support it. This is going to be at a pace I’m afraid.
Let’s start with Brexit and investment management. The UK has around a one-third share of EU assets under management. It is the largest market in Europe with around £8 trillion of assets, representing more than the next three countries combined. Investment managers in the UK manage just over £1 trillion on behalf of overseas authorised funds. Over 80% of those funds are domiciled in either Luxembourg or Dublin. This requires co-operative arrangements which are well established. Let’s not beat about the bush, this model works – it works well for investors and for investment managers. So, why disrupt it, or put another way, must it be disrupted?
This requires co-operative arrangements which are well established. Let’s not beat about the bush, this model works – it works well for investors and for investment managers. So, why disrupt it, or put another way, must it be disrupted?
This is a global issue and we are not the only ones asking this question. As my fellow-regulator in Luxembourg suggested last week, EU rules on delegation arrangements are already strict and no further strengthening of them is necessary. This is a commendable statement. Of course it will be criticised by others, as will everything I say, as a product of self-interest. Actually, what we have done is to help to put into effect, with firms, a system that serves the public interest. Does it require membership of the EU to make this system work? No it does not.
So, what does it require? Two things are above all else necessary. First, that we recognise the principles for open financial markets which have long been recognised in goods trade, namely the Most Favoured Nation Principle, which has a very long history in Europe. It means not restricting free trade to regional trade blocs and not discriminating in the trade terms offered to other countries. To make that work for financial services like investment management requires regulation in the public interest which delivers equivalent outcomes and protection and embodies close co-operation and information exchange between the regulatory authorities.
We have this now with EU partners, including through the common regulatory framework that has been put in place, but we also have it with other countries. We are ready to roll our sleeves up and continue to make open markets work effectively.
I will move on to the Asset Management Market Study. In June we published the final report. It contained significant proposals relating to giving protection to investors who are less able to find better value for money, remedies to increase competitive pressure, and proposals to improve the effectiveness of intermediaries including making a market investigation reference to the Competition and Markets Authority to investigate consultancy services.
Now, I am aware that there has been a certain amount of interest in the study. Tonight I want to make a few points which underpin how I think about the recommendations. First, our recommendations on fund governance and the effectiveness of boards and the role of independent directors are an important part of ensuring the interests of investors. “Strong boards are more likely to align business interests with those of investors”. Who said this? Well, I think it is what the investment management industry frequently and correctly says about the firms in which it invests, and it’s what you demand. It’s a general principle.
Turning to value for money and fees. We are asking management and boards to assess whether funds offer value for money for investors, and to do so on an annual basis. Likewise, we have asked for greater transparency and clarity of fees and performance objectives, with good quality disclosure to investors on a regular basis. I think this should be part of ensuring that fee structures contain sensible incentives for managers. We see that there are big changes already happening in the world of fees, and now seems like the correct time to make sure what emerges is sensible and fit for purpose. But we do recognise the challenges and where more work is needed. We have further work under way on disclosure templates for institutional investors, for instance. And we want to continue the dialogue on value for money, and on what questions we should all be asking to assess whether what's being delivered does represent good value. We do not, for instance, want to incentivise short-termism or fail to recognise the value of effective stewardship.
Third, innovation, and what we can do in the future. Since 2014, the FCA has developed Project Innovate, with three themes: an Innovation Hub which enables new and established businesses to be able to produce innovative financial services and products; an Advice Unit, which provides feedback from us to firms; and our Sandbox, which is a safe place where firms can test innovative products. Alongside these initiatives, in 2016 we introduced with the PRA a New Banks Start-up Unit which is designed to assist new banks to get going, including through the authorisation process. Project Innovate is open to all FCA regulated firms, and anyone who wants to start-up and become one. It has had substantial use, and we are pleased to see that other countries are introducing similar initiatives. We thought we would take another step, and so recently we have announced another initiative, to create a start-up unit for new investment managers.
We want a dynamic, vibrant sector with an engaged customer base and firms competing effectively to deliver value for their customers. A key feature of vibrant, competitive markets is ease of entry for new participants. In the regulated space, that means ensuring the regulator strikes the right balance between ensuring only fit and proper firms are able to conduct regulated business with ensuring that barriers to entry do not deter well-governed, innovative firms. This is key to our vision of competitiveness. We believe the FCA can do more here. We have therefore established our new Asset Management Authorisations Hub, designed to ease what we recognise can be a complicated process of seeking authorisation for new asset managers.
We want a dynamic, vibrant sector with an engaged customer base and firms competing effectively to deliver value for their customers.
Before and during that process, we will make the range of information we need clearer and easier to manage, we will give new asset managers their own case officers and access to a dedicated website portal, and we will help newly-authorised firms navigated their early stages of their regulated lives through closer engagement with supervisors. This is not about reducing regulation; it is about promoting a vibrant, well-functioning industry that helps to provide for the critical long-term savings.
We are excited about the new unit and looking forward to seeing many new initiatives and innovations.
In conclusion, over the last nearly eighteen months we have spent a lot of time at the FCA working on our Mission. What lies behind this is our commitment to explain how we put into effect the objectives given to us by Parliament – effective markets, appropriate consumer protection, market integrity and competition in markets. We are deeply committed to open markets. We believe that consumer protection and market integrity can be effectively achieved with open markets. And, we believe that strong competition at home is the best way to support international competitiveness. These are very strongly held principles.
Our approach to three areas on which I have focused - Brexit, the Market Study and the new hub at the FCA and more broadly our Project Innovate and the Sandbox to support innovation as well as new investment management firms - is anchored in these principles.
These principles also shape our proposals on the listing rules. I believe that our proposals create a sensible balance between open markets and integrity. I am more than happy to discuss the substance of the proposals in terms of those principles and our statutory objectives, about which we have been transparent. Let me add that with clear principles, objectives and explanation of our proposals, to pick an argument about whether we should or should not meet people who want to operate within the UK regime is in my view to pick the wrong argument. The right debate is surely around the substance of how to get the appropriate balance between open markets and the integrity of these markets.
The challenges are all around us, whether it is Brexit, long-term saving and retirement provision or adjusting to the pace of innovation. We can handle these challenges, I firmly believe that, but to do so we need to be very well anchored to the principles of open markets, strong competition and a willingness to embrace change.
Brexit is, of course, a challenge. But it is important that we are very robust in supporting what works today, and in doing so rejecting the case that Brexit must mean a weaker European investment management sector because there is a failure of the imagination required to preserve and develop what works today.