FCA plans to prohibit asset managers capitalising on risk-free box profits could create a “material hole” in some firms’ balance sheets.
Box profits result from the bid-offer spread between units, intended to cover transaction costs in dual-priced funds, when buy and sell orders can be matched with each other and the revenues then taken by the company.
Asset managers can invest their own money in the fund to profit from these spreads.
The FCA’s Asset Management Market Study released this morning argues that this contravenes the principle of treating customers fairly as investors are unable to scrutinise box profits and many do not know the practice occurs.
The regulator says its proposed ban would result in at least £20m in risk-free box profits being transferred to investors in the future. The changes are also likely to incur a one-off cost of £5,000 per firm.
The ban was already proposed in the FCA’s interim market study last November, prompting Jupiter to announce it would be giving up box profits.
Grant Thornton partner and head of investment management David Morrey says the changes will be detrimental to a number of asset managers.
Morrey says: “As external investors enter or leave the fund, the manager essentially trades its investment with that external investor. It is possible for a manger to make sizeable profits by doing so.
“A small number of managers have enjoyed large box profits for some time and they have resisted giving them up as they are explicitly permitted under current rules.”
The FCA found that most firms don’t retain box profits, but that revenues were significant for those that do. It says bid-offer spreads should solely be for the benefit of the fund, not the fund management company.
In a consultation paper on implementing the Asset Management Study, the FCA says: “We found that [box profits] accounted for 10 per cent of one firm’s revenue stream. In our view, [the proposed rules] will not result in firms going out of business or having to modify their business models significantly. This should be true for smaller asset managers as well.”
PwC partner Amanda Rowland says risk-free box profits have been a “thorn in the regulator’s side for some time” and that the FCA’s own rules are not entirely clear.
She says: “We welcome the clarity of policy intent from the regulator and believe in this case that a rule change rather than statements of expectation will give the required certainty for the industry.”
Asset managers will have up to 12 months to update their prospectus to include their policy on box management.