While fund managers might be well used to inspection and review by the authorities, consultants, who until recently played a purely advisory role, have tended to get off more lightly.
Consultants were caught up in the FCA’s dragnet in November 2015 as part of the regulator’s market study into the asset management industry. The authority said it wanted to understand how consultants’ advice affected competition between fund managers, and whether they had any conflicts of interest.
The regulator’s interest appears to be a real attempt to get to know the market better, according to senior consultants who have been involved in discussions with the FCA. Practical matters such as the efficacy of consultants’ recommendations, whether the ‘big three’ have an excessive dominance of the market, and even whether going out for drinks at fund managers’ expense really leads to better client performance, are under examination. But there have been few hints as to whether the regulator thinks there are any problems, or what it might do to fix them.
In common with their peers in asset management, the consultants report a data trawl of quite challenging proportions. Bobby Riddaway, head of investment consulting at Capita, a smaller player in the market, said: “They wanted to know absolutely everything – clients, fees, assets under management, number of reviews, absolutely loads. They are trying to get a handle on how much advice is given to schemes of different sizes and what they are getting for their money.”
According to one senior consultant, the FCA has been “putting a lot of energy” into examining performance track records – keen to look at which fund managers get picked by consultants and how they perform afterwards. It has also been running a rule over consultants’ revenue figures and operating margins. In particular, the FCA’s attention has been attracted by fiduciary management, a new hands-on, and higher-revenue service that consultants have begun to offer in recent years.
Fiduciary management, largely a preserve of the big three consultancies, Aon Hewitt, Mercer and Willis Towers Watson, has achieved good results and proved increasingly popular with pension funds. But it has been beset by accusations of conflicts of interest, a lack of transparency and unfair competition.
For years, consultants have found themselves denying that they encourage their pension fund clients to privately choose their fiduciary operations rather than running a wider tender process for the services. In its terms of reference document from November, the FCA itself observed: “Mandates for these services are often awarded without a tender process.”
Celene Lee, head of investment consulting at Xerox HR Consulting, a mid-market consultancy that does not offer fiduciary services, said: “The fiduciary managers who are still consultancies do have this inherent conflict of interest which is very hard for them to deny, and has caused concern. The FCA is asking a lot of questions about this”.
Cox said: “People are lobbing little grenades into the fiduciary model, without thinking ‘this is a whole industry and that’s just one way of delivering a service’. Has the FCA found something that says there is a big rip-off model? I suspect they haven’t.”
His colleague Tim Giles, head of the UK investment consulting practice, said: “From the information we have provided [to the FCA], profit margins in our fiduciary business are no greater than for the advisory business. The fees might go up for fiduciary, but clients are getting more for their money.”
Nevertheless, action by the FCA remains a possibility. Simeon Willis, head of investment strategy at KPMG, which also doesn’t offer fiduciary, said: “The FCA has been quite clear on the potential routes of action it has, such as best-practice guidance or specific new regulations, but they are also aware that some aspects might be covered by other regulations already in the pipeline.”
Xerox’s Lee, whose firm offers to select and monitor fiduciary managers on clients’ behalf, said changes in the market might make regulatory action less likely: “In the past 12 to 18 months, we have actually seen an improvement, compared to the period when the consultants first turned themselves into fiduciary managers.”
Pension funds new to the concept are hiring “fiduciary selectors” to find the best one, she said, and those that appointed their consultant as a fiduciary in the “first wave” are now undertaking their first reviews.
While the consultants all publish figures claiming that 70%, 80% or even 100% of their fiduciary contracts come through open-market processes, they are extremely keen to head off any possibility the regulator might enforce such beauty parades and reviews.
Giles said: “Every survey you look at, you see more competitors, rather than less. We really think if people want to use third-party evaluators, let them. But if you make it statutory, then the costs go up; and you want this evaluation process to be as competitive as possible.”
Other ideas to come out of discussions with the regulator include a requirement or guidance to structure fiduciary businesses as separate entities from consulting arms, perhaps with a certain number of independent board directors.
The fiduciary question could, however, be solved perhaps more simply by colouring in one of the investment industry’s grey areas.
While investment consultants and consulting firms are FCA regulated, the actual provision of advice is only subject to oversight if it leads to a specific recommendation of a fund manager or a fund.
Strategic advice on asset allocation, however, does not fall within FCA rules.
This might mean, in theory, a consultant offering fiduciary management could deliver a strongly favourable verdict on fiduciary management as a concept, under the guise of general advice.
KPMG’s Willis said: “In terms of how they might address the conflicts of interest in fiduciary management, I suspect they might simply tighten up the current requirement to take independent advice when making investments.
“We do have this loophole at the moment where a fiduciary manager provides some services that could be regarded as fund management services and others that are regarded as advice.”
This issue was examined by the Law Commission in 2014; respondents to its consultation at the time called the loophole “anomalous”.
But the Commission did not end up recommending the regulation of generic advice.