Speech by Martin Wheatley - Managing Director, FSA - at the FSA Asset Management Conference
Good morning, it is a pleasure to be here today. The breadth of today’s agenda reflects the variety of changes that affect asset managers at the moment.
Today you will hear the detail of that change from my colleagues Sheila Nicoll, Clive Adamson and Ed Harley,when they discuss policy and how we will supervise your firms.
And I look forward to also hearing from Professor Kay about his thought-provoking review. The review is both timely and welcome, and many of the broad themes line up with concerns that we have as a regulator. I am sure Professor Kay will offer robust challenge to my views.
Some of what Professor Kay highlights are issues that I would like to look at, but they go beyond my remit as a regulator and are really public policy issues which deserve wider debate. But it is clear that the long-term health of our equity market and its wider impact on UK plc and consumers remains relevant to us all. I am particularly interested in how asset managers respond to the idea of adopting a fiduciary duty to their investors, something that would offer an extra level of commitment beyond simply the letter of our rules.
And that commitment to your investors is something I want to focus on today, in particular how asset management fits in with the overall approach of the new FCA. We are going to have a renewed focus on getting a fair deal for consumers by making markets work well. I will look at some of how we are going to do this, and in particular, I will cover charging, competition and understanding consumer behaviour.
With this in mind, there are two clear themes that I want you to take away from my speech today:
- I would like to highlight some of the issues in the sector, notably, charges, competition and the gap between asset managers and the end consumer, which will be picked up by Professor Kay after me.
- And I would like to explain what changes we are going through in preparation to become the FCA – this change will mean a new type of regulator for your firms.
Important role of the asset management sector
There are many reasons why regulators, government and the EU are taking an interest in asset management at the moment – whether it is the vital role you play in our economy in terms of the jobs and wealth you build, or the influence you have as allocators of capital.
But, as a conduct regulator, I prefer to focus on your work managing the money of the millions of individual investors who place their trust and confidence in you.
In today’s world – with final salary pensions becoming a rarity and state support shrinking – those of working age have a huge degree of uncertainty around their financial futures.
Those of us fortunate enough to have pension and investment savings are hugely reliant on the investments that your firms select.
I am struck by the trust involved when we hand over our money to your firms to manage. We forgo pleasure and spending today to put money aside for tomorrow, in the hope that we have entrusted it to people who will help it to grow.
We do not know what we are going to get back – it is not like a bank account when we know the return we are going to get – even if it is a miserly one! We need to trust your firms’ integrity and character and your investment managers’ analysis, skill and judgement.
The good news is that we benefit here in the UK from huge expertise, and a world-leading industry. From firms with 200 years of heritage to new start-ups, we have a wide range of investment styles, asset classes and sectors to choose from.
But sometimes this choice can paralyse people – as I will explain later – and the variety does not always mean that what is on offer is completely clear.
Issues within the asset management sector
Charging
One of the things that Professor Kay highlights is the impact of charging, and I agree that this is something that we and the industry need to address.
Most of us are happy to pay a fee for a professional service, but that fee must be reasonable and we must know what we are paying for. As an investor I want to be reassured that asset managers are keeping my investment safe and growing, without fees taking out more than their fair share.
The question is, how can I be assured that this is the case? Most annual management charges are made clear nowadays – but how do I know if they are fair, and that there are not added hidden charges that I do not know about? And how do I know the impact those charges will having on the overall returns I will get?
These are valid questions that more and more people are asking. People want to be given a clear proposition about what they will be charged and why.
Another question is, how do I know the fund manager is looking after my best interests? Should I be concerned if the tracker fund I invest in is lending shares to short sellers, or that the managed fund I buy charges five times as much as that same tracker, but its holdings seem to be broadly the same?
These are questions that many ordinary investors may have.
This is about finding a way to make sure that people’s reasonable expectations are met, and that firms’ conduct allows for the fair treatment of customers.
We want you to be profitable, but what the FCA will be about is ensuring that the profits you make are based upon the fair treatment of your customers, rather than at their expense.
And we will look at how this fits in with our new objective to ensure effective competition.
Competition
We could start by asking ourselves whether, in the words of Professor Kay, competition in the industry is ‘misdirected’, and, if so, why.
There are certainly more firms operating in asset management than retail banking or many other financial services industries where competition is seen to be weak. So on the face of it, having lots of choice would appear to be a good thing.
But has this seemingly competitive environment produced the type of competition we want to see? What we are aiming for is competition that either makes the industry more efficient or achieves a better deal for consumers.
We might ask ourselves whether it is a problem that the industry appears to compete predominantly on the aspirational aspect of its service – the future performance – when it is the one thing that cannot be compared and measured by potential investors.
Is it a problem that consumers are buying a service whose quality cannot be measured until much further in the future when it is often too late to realise the product was the wrong choice or excessively costly?
Some may say that is simply the nature of your business. But should we be concerned that asset managers compete less on the immediately measurable aspects of their offering such as fees?
It is clear there is price competition between active and passive approaches, but for actively managed products the levels of charging appear broadly similar.
If there is misdirected competition, there is scope for wide-scale consumer harm. Failures in competition impact us all as end-consumers because they reduce the investment returns that we rely on.
Even small differences in fees and charges can have large cumulative effects on returns over the life of an investment product, as we all know. Research from Which? shows that if you invested £10,000 in a fund with no charges, and you were fortunate enough for it to grow by 6% annually for 20 years, you would get a return of £32,071 – just over £22,000 growth.
However, if that fund had an total expense ratio of 1.67%, the industry average – your return would be reduced to £23,344 – meaning £9,000 of your growth would have gone on charges. If the TER was 2.5%, £12,000 would be paid out in charges. That does not even factor in other charges.
Our Retail Distribution Review aims to be a catalyst for the industry to look at charges again. It is clear that not all of the costs are down to you and we need to address why the overall costs of intermediation in the investment industry remain high.
How we view consumers
In thinking about our new objectives, we are improving our analysis by looking to understand why consumers behave in the way they do, a way that can often make problems worse, especially if these behavioural traits are exploited by firms.
We often think about this as just affecting retail consumers, but it does not just have to be them, and it is interesting that ‘consumer’ is defined widely in the Bill, from you and me buying a fund for our ISA, to other firms that you might do business with.
Consumers may be over-responsive to reported past performance; they may seek to avoid realising losses; and, they may anchor their thinking on irrelevant information. Barriers to switching and poor disclosure could lead consumers to take the wrong decisions, and may be examples of the industry not delivering what is in the interests of its customers.
And we now know there are limits to what disclosure and simply increasing the volume of information available to investors can do.
More information without regard to its relevance and quality, rarely leads to better decisions, particularly in a world where there is a bewildering choice.
I think back here to what is known as the ‘jam experiment’, where customers in a supermarket were offered the opportunity to taste six jams in one situation and 24 in the other.
Both groups were given discount vouchers to then buy a jar of jam after tasting them.
Although more people were attracted to the 24-jam stall, of those tasting the jam there, only 3% then bought some, while 30% bought a jar from the stall where they only had six to choose from.
This type of choice overload can happen in many types of market. And where consumers are unable to weigh up why they should choose one item over another, they may simply walk away, or opt to make a random selection.
In pensions and investments this may also come down to consumers sticking with default options or choices they made years earlier that may no longer be in their best interests.
While central government and regulators have a duty to educate consumers, it also falls to you and the intermediaries you work with to help consumers find investments that are likely to meet their needs.
This could be doing things like making it easier for consumers to make rational decisions, increasing transparency around fees and charges, and being competitive on these immediate, factual aspects like fees, rather than projected future performance.
Successful new entrants to the industry in recent years have recognised this, and have tried to draw a clear line between themselves and others in the industry. I would like to see the whole industry rising to this challenge.
At the FCA we will expect asset managers to work more closely with the intermediaries that sell their products. The truth is that asset managers can no longer distance themselves from the advice or sales process. Our view will be that the originators of products need to consider how they will distribute them as part of the design process.
This is something that we will expect from all financial services firms. We will ask firms to look at how they plan their products, how they plan their distribution and how they work once they are sold.
Culture Change – Early Judgement
We will be given new powers to intervene and stop problems with products sooner and more effectively – with bans and sales restrictions without having to wait for a consultation.
This will mean that we can act more decisively than we do now. For example, last month we proposed to ban the sale of high-risk unregulated collective investment products to most consumers. In future, we will be able to do the ban first, then consult.
This is not going to be about us being restrictive or heavy-handed. We will only use this new power in the worst cases, where we have to step in to stop people being ripped off.
So, in the example I have just given, we found that three-quarters of sales made on these unregulated schemes by financial advisers were unsuitable. When there is that level of poor practice out there, we will not stand by and let it continue.
But we acknowledge that these schemes will be right for some people, so even in this case we are not stopping everyone from being able to buy them. If you have a large, well-diversified portfolio, you are welcome to invest.
The point is that we are ensuring the firms that sell these products really think about who they are appropriate for, and only sell them to those people. What will no longer happen is people being persuaded to cash in their final salary pension and invest it through a self-invested pension in schemes based on off-plan property in eastern Europe or golf courses in Mexico – which is what has been happening up until now.
We have been clear with firms here, and that is going to be a feature of the FCA. We are going to communicate with you and with consumers in a way that you will understand. We will move away from jargon and regulatory speak. When we consult you on rule changes, we will try to do things face-to-face, we will issue fewer consultations and when we do, they will be more concise and to the point.
Our supervision of your firms will be more focused on your conduct. In particular, this will be about the conduct at the very top of your firms. Senior management teams set the culture of their organisations so we must ensure that the targets and aspirations set there turn into good outcomes for consumers.
Clive will go on to explain how our supervision will work in detail, but the main thrust is that we will move from an approach that was broadly reactive to one that is more forward-looking and that is better than before at spotting and dealing with risks.
We will look to intervene earlier to stop issues developing into major harm for consumers and risks to market integrity.
This will see us have fewer supervisors attached to particular firms, but supervisors more able to spend time dealing with emerging problems and specific issues or products that have the potential to cause consumer harm or are already doing so.
At the heart of the FCA will be a new department that acts as the radar of our new organisation – combining research into what is happening in the market and to consumers, and better analysis of the risks out there. They will then feed that in to our policymaking and our supervision of firms. We want to really understand what is happening to your customers, the deal they are getting and the issues they face.
All of this will be delivered by a new culture in the FCA. We will encourage our staff to be more confident in making bold, firm and predictable decisions.
We are working through that change now. It will not be instant, as it is at least six months before the new FCA is up and running, and even then it will take time to bed down all of the changes.
What we are doing at the moment is developing how our approach will work in practice, and we will set out our latest thinking in the approach document that we publish next month.
We encourage you to read this and come along to the events that we are going to hold around the country where we explain what the FCA will mean for firms. We want to get your views on the way of working that we set out because getting regulation right will be a two-way process.
The success of the FCA will also depend on us achieving the right balance between consumers’ and firms’ responsibility. While it is reasonable for consumers to take responsibility for the decisions they make, a balance must be struck.
Consumers cannot always be expected to have the financial knowledge, information and understanding of complex products and risks to make informed decisions; so all parties – consumers and firms alike – must take responsibility for their part in transactions.
Meeting fair and reasonable expectations like these should be at the centre of how firms operate and they should see it as their responsibility in the first instance, not the responsibility of the regulator. This should be demonstrated through how they treat their customers, and their conduct towards each other.
Conclusion
I hope this speech has provided a little more clarity around what our expectations are. As I mentioned, both Clive and Sheila will be able to provide more detail on our new FCA supervisory and policy approach respectively. I hope I am clear that:
- I appreciate the very important role of the asset management sector.
- There are issues in the sector that we all need to address.
- We are changing as we prepare to become the FCA – this will mean new expectations on you, and a new challenge, but I believe it is a change that is needed and that will help to enhance consumer confidence in financial services as a whole.
I am looking forward to our next speaker, Professor Kay, to hear his take on some of the key issues long-term investors and the asset management industry face.
