Regulators must hold UK asset managers to higher standards

November 11, 2013 6:20 pm

Regulators must hold UK asset managers to higher standards

By Patrick Jenkins

Pay and churn should be the focus of UK regulatory reform

By the end of this month, the UK’s Financial Conduct Authority will come up with its latest proposals to reform the asset management industry. A consultation paper will focus on customer charging structures, raising further questions over the sector’s murky interactions with the research and sales staff of investment banks.Martin Wheatley, the FCA’s chief executive, hinted at the direction of reforms in a recent speech that ushered in the review. There were shortcomings in “transparency and accountability”, Mr Wheatley said, urging an “unbundling” of the payments asset managers pass on to clients – from insurance companies and pension funds to individual investors.

He makes a good point. The typical actively managed fund in the UK charges an “annual management fee” of up to 1.5 per cent, a supposedly catch-all overhead that is then topped up with other charges to cover analyst research and trading, leaving you wondering what the annual fee really covers in the first place.

How groundbreaking the UK’s reforms are remains to be seen. The precedents are hardly encouraging. Britain’s last effort at change was halfhearted. An industry review a decade ago by Lord (then Paul) Myners led to improved disclosures, but reform proposals were only partially implemented. In a fudge, the FCA’s predecessor body, the Financial Services Authority, came up with loose, “principles-based” guidelines that remain today as a hangover from the broader pre-crisis “light-touch” regulatory regime.

The US has had its own issues with investment banking research. Around the time Lord Myners was writing his report, New York’s then attorney-general, Eliot Spitzer, was spearheading reformsaimed at tackling conflict of interest at the heart of “sell-side” analyst research – analysis provided by banks to investors, but at the time often used dishonestly to help ramp the share price of companies the bank was also working with commercially. The issue had come to a head amid the dotcom flotation frenzy of the day.

On the face of it the Spitzer clean-up was successful. Ten Wall Street banks ended up paying aggregate fines of $1.4bn and the industry was forced to segregate research analysts from bankers and their business pitches. Yet there are signs of the market falling back into its bad old ways. In recent months, as IPOs have begun to rebound post-crisis, there are reports of analysts being drawn into IPO meetings. And research these days seems more bullish than ever – studies have suggested the proportion of buy recommendations on stocks is now higher that it was before the Spitzer reforms, at up to 60 per cent or so in the US, compared with only 4 or 5 per cent of sell recommendations.

Among the asset managers, there remains little evidence that the average actively managed fund outperforms a typical tracker. So where are fund managers getting their information? Is it from the sell side, which may be biased, and why are they paying so much it? The FCA reckons research costs account for nearly a third of the £5bn total of annual asset management fees.

One related area that continues to receive too little attention is the warped practice of paying for “corporate access” – a system that allows an asset manager, via a broker’s research function, to buy time with the management of a company it likes the look of. It emerged last week that the FCA would not take enforcement action against past transgressors of a rule that bars funds from billing investors for corporate access. A new trick, investors say, is to dress it up as “research”.

It is a practice the FCA suggests its review will cover. Yet Mr Wheatley’s recent speech said specifically that the regulator had “no particular concerns with the purchase of corporate access”.

But even a thorough overhaul of fees in asset management amounts to tinkering in the broader context of what is wrong with the industry. There are two big areas that should be the focus of regulatory reform.

First, pay – fund managers are among the best paid across financial services, though there is scant disclosure and frequent reward for mediocre performance. It is hardly surprising that most do a poor job of policing excessive remuneration at the companies they invest in.

Second, the misaligned pay is compounded by the short-term investment horizons of many analyst reports. Partly as a result, asset managers often “churn” their portfolios too much, charging investors more fees and undermining healthier long-term investment.

If asset managers are to play the central role in non-bank financing of the economy that some aspire to, it is time regulators held them to higher standards.