Monday, 20 March 2017 | Prepared by Rajiv Jaitly, Managing Partner of Jaitly LLP
Although there are opinions by the yard as to what Brexit will mean – whether for financial services or otherwise – it is essentially nothing more than speculation on what might be – however educated or well informed. In the UK there was life before passporting and, believe it or not, life would continue if passporting were to come to an end.
Theresa May’s January speech at Lancaster House did give one crumb of comfort, which was that the City of London would not be required to make cliff-edge changes and that any changes would have a suitable transitional period for change; and, let’s face it, asset management firms have had to adjust to many regulatory changes over recent years and they have shown a resilience and ability to weather many of the political and regulatory storms. After all, isn’t that what stress testing is all about?
Perhaps of more significance to wealth managers and asset managers in the face of Brexit is the publication of the interim report on the FCA market study on Asset Management (MS15/2.2). One may wonder if it provides the product development teams at Wealth Managers, who are facing the uncertainties of Brexit, a real opportunity to design and present a disruptor model that might grab the attention of investors anywhere in the world and cause them to beat a path to the door of that UK investment manager.
One of the problems with regulation in asset management has been the lobbyists acting on behalf of European asset management to erode the dominance of the City of London. Brexit gives the City an opportunity to look at the regulatory model again and make it fit for the 21st century by transforming the way that it serves the interests of the City of London and its investors. But I have already talked about the futility of speculating on something for which there is no precedent. Is there something that firms should be thinking about in the cold hard light of day that would create opportunities whatever Brexit looks like or means?
MS 15/2.2, in my view, gives some very firm indications on the direction of travel that are worth considering and which would apply regardless of the form Brexit takes.
So for the specialists looking to increase distribution for a product that would have investors beating a path to their door, here is what I think that product would need to look like to be consistent with what the FCA appears to have in mind:
- It would need to have a governance model with a strengthened duty to act in the best interests of investors. This is something I have proposed ever since I got involved with advising the regulators on pension and investment products and their associated costs. Current proposals are exploring this possibility because Treating Customers Fairly (TCF), it is generally felt, does not go far enough. The existing product models are arguably designed to cater primarily to the interests of the investment managers and not necessarily those of the investors. Of course we need to be pragmatic – no one would wish to spend money on a model where they, as investment manager, could potentially be fired if they were not delivering for their investors. But here is the challenge – if you were to act in the interests of investors and were transparent about what the manager got out of it – it would be a product like nothing the City of London had ever seen before, and why would the investment manager ever be fired for acting in that way? I believe the investment managers need to have a duty akin to a fiduciary duty to their investors to manage the all too evident conflicts of interest that exist when handling money for others. That requires a truly independent governance structure that does not comprise the ‘old boys network’ on boards and where that structure is not dependent on a single asset manager. If you are squirming already – hold tight.
- It would introduce an all-in fee to the product – so that any investor can see and compare the costs of investment. No hiding behind bundling charges, research fees, spreads or mid prices, behind-the-scenes arrangements on credit facilities for the asset management firm, or taking expenses out of the assets under management to preserve your own bottom line. So a very clear separation between investors’ money and what the investment manager incurs as costs for providing their investment management expertise – an opportunity to tell investors what it really costs to manage their money and why that investment manager is the right person for them to do it.
- The manager would agree to help investors identify what is the best fund for them against the objectives of the fund. In doing this, the manager would use both absolute and relative measures, enabling the investor to identify underperformance and the options available to them without penalizing that decision-making process – it would allow the investor the opportunity to identify and switch to better value products, for example.
- There would be no share classes within the product that purported to give one class of shareholder better rights or commercial terms over others – or alternatively it would make clear what detriment an investor faced by having particular types of investors investing alongside them in the product.
- It would provide clear disclosure on any delegated investment management and cross investments in other related products managed by the manager.
- It would not hide behind professional client status within the relationship structures, so that transparency is available on a look-through basis.
- The manager would need to deploy a flexible system to manage these requirements and deliver client service through better client experience, understandable reporting, clearer and comparable fees, fairer products and through digitalisation – and, consequently, in the longer run, saving time and resources for the asset manager.
For product development this is undoubtedly a tall order but, if the FCA proposals are anything to go by, this is the general direction of travel regardless of Brexit – and whatever form Brexit finally takes, such a product is likely to meet the requirements of MiFID II and PRIIP KIID disclosures without too much effort. I mentioned digitalisation earlier and one way of meeting these requirements would of course be a heavy investment in technology. The manager would be directly responsible for controlling the impact of slippage and other factors on their own bottom line rather than being able to lose their impact by charges against the client’s assets – and information technology would be at the heart of driving through that change.
With the development of concepts such as the robo-adviser, asset managers are already beginning to invest heavily in technology to reduce costs and risks. Modern technology tools can range from cloud-based, web-based or platform-based solutions. Asset managers cannot afford to ignore the operational efficiencies that these can deliver, enabling a much better relationship with their clients – better access, comparable costing and improved reporting all facilitating the assessment of investment objectives and comparing of results, that enable investors to make better decisions.
In such a scenario, even if passporting is no longer an option for distribution, digitalisation could deliver a solution that increases the demand for such a product and makes opening local investment management offices in Europe and elsewhere a cost-effective proposition. After all, that is what the Irish fund market did, not so long ago, to accommodate the needs of European investors, such as the Germans who needed to invest in European-approved wrappers.
So the opportunities that Brexit brings are vast and could potentially disrupt the existing worldwide model very profitably for asset managers in the UK. And, in those circumstances, who cares whether ‘Brexit really does mean Brexit’?
Note to readers: Rajiv Jaitly is the Managing Partner of Jaitly LLP a consultancy that specialises in fund governance, fund due diligence and risk. Rajiv was appointed an expert by the Office of Fair Trading for its review of the DC pensions market and prepared a report for the Financial Services Consumer Panel on fund costs and their implications for retail investors, which was published in 2014.
The views expressed are without accepting any liability to any third party whatsoever or howsoever arising and are intended solely to encourage discussion. This article should not be taken to provide legal, regulatory, technological or compliance advice in relation to which specific professional advice should be obtained.