New watchdogs tasked with holding pension providers to account will effectively be working with one hand tied behind their back as delays to EU rules cause fund transaction costs to remain hidden for longer.
The FCA and the Department for Work and Pensions are working on measures to boost disclosure but expected delays to European regulations Mifid II and Priips have led to a “dislocation” and forced them to stall.
Increasing transparency of fund management charges is seen as the “final piece in the jigsaw” in years that have seen controls on default pension fund charges and the introduction of the RDR and explicit adviser charging.
But pension customers and the committees overseeing their savings will have to wait to reap the benefits.
Yet providers predict once the requirements are in place they could act as a catalyst for consolidation within the fund management industry or even the break-up of vertically integrated firms.
The new Independent Governance Committees were forced on providers by the FCA after a damning Office of Fair Trading report into workplace pensions. The committees face an April deadline for publishing their first annual statements and assessing whether customers are getting good value from insurers.
Trustee boards also have to report on whether trust-based schemes represent good value. However, both will have to report without crucial data from fund managers.
The problem stems from a mismatch between the UK and European timetables. Across Europe, Mifid II and the packaged retail and insurance based investment products regulation are set to redraw the information passed from investment firms to end consumers.
But the European Commission has admitted it is delaying Mifid II because of concerns that the timescale was too tight. Priips, which aims to extend Mifid II standards on consumer protection to insurance-based investment products, is also likely to be delayed.
“At the moment we are only obliged to ask fund managers for transaction costs, but if they refuse to give them we can’t do anything about it”
As a result, the DWP and FCA have paused their work on transaction cost disclosure, which began nearly a year ago.
A separate Treasury and FCA market study of asset managers is due to report interim findings in the summer.
Professional trustee firm PTL managing director Richard Butcher sits on the Standard Life and Old Mutual Wealth IGCs as well as a governance advisory arrangement that oversees the products of 14 insurers.
Butcher warns: “We are required to assess charges and transaction costs and whether they, balanced against the benefits, represent good value for members.
“We know we’re paying a 0.75 per cent or lower management charge and transaction costs are on top of that. At the moment we are only obliged to ask fund managers for transaction costs, but if they refuse to give them we can’t do anything about it and clearly we can’t assess whether they are value for money.
“To be frank, there are boards that are quite happy about that because once you’ve been given the information there’s an issue around what you do with it and how you assess it. There is no prescribed methodology and you could just be given a huge amount of raw information.”
Investment Association director of public policy Jonathan Lipkin says: “At the UK level there’s a dislocation. IGCs and trustees have a responsibility to ask and report against transaction costs but there is not yet clarity as to what transaction costs are and how managers should respond to the questions. We are awaiting conclusions of the DWP and FCA’s call for evidence. The industry needs greater clarity on what it should be providing.”
Despite the delay, regulators are moving to bring fund management into line with the regimes for advisers and pension providers.
Scottish Widows head of industry development Peter Glancy says: “Providers’ charges have been going downward for a long time. Product charges are down by about 90 per cent since 1995 and the RDR brought transparency to the adviser market. The last bit of the jigsaw is the fund space.”
Glancy says while the RDR has forced advice costs out, customers have been left unable to distinguish between product and fund charges.
He says: “Within the fund charges there are explicit charges – an annual management charge of say 60 basis points – but there are a lot of costs charged to the fund itself. They could easily total 200bps but the customer doesn’t see them as charges, they just see the fund has delivered 5 per cent growth instead of 7 per cent. That’s the area the DWP and FCA are increasingly concerned about.”
“Tesco doesn’t tell you how much it spends on every bit of the business. I’m not sure what marginal benefit there is for customers to make their decisions on a fifteenth of a basis point on varied underlying costs”
These obscured costs include a range of charges (see table) including stamp duty on equity trades, spreads in bond markets, broker fees and more subjective areas such as the opportunity cost of inefficient trading.
Lipkin says: “Expressing product charges in a consistent language and using consistent methodology is fairly simple. Extracting explicit costs – payments to brokers, stamp duty incurred – is also relatively straightforward. That information is now reported at unit-level for reports and accounts.
“It gets more difficult, in terms of systems and interpretations, in the implicit cost debate, such as where you buy an instrument with a spread. We are keen to see a pragmatic approach on the part of regulators, recognising that while the industry wants to provide greater granularity there are some very significant challenges in producing reliable data.
“The debate is now about how most effectively to capture that information for clients and how to communicate to consumers and reports made for IGCs and trustees.”
Daniel Godfrey was pushed out as chief executive of the Investment Association last year when several members threatened to quit the trade body, reportedly over his focus on transparency.
Now Big Issue Invest Fund Management non-executive director Godfrey reiterates calls for the industry to produce a single figure for the cost of running a fund.
He says: “The only cost that funds would charge for in addition to this single charge would be the cost of execution when buying and selling shares for the portfolio and any transaction taxes that may be payable when the fund buys and sells shares. The gist of investment research would also be included in the single charge.”
However others say it is inefficient and ineffective to compel managers to disclose underlying costs to consumers.
Investment consultancy Gbi2 managing director Graham Bentley says: “From asset managers’ point of view I don’t know what the fuss is about. Charges are explicit in the sense these are the management costs, and the stuff that sits underneath that – foreign exchange costs or how much firms pay for hedging – is unnecessary.
“Most companies do not declare what it costs them to administer their business. Tesco doesn’t tell you how much it spends on every bit of the business. I’m not sure what marginal benefit there is for customers to make their decisions on a fifteenth of a basis point on varied underlying costs.”
Apfa director general Chris Hannant says a single figure could be a “recipe for confusion”. He says: “I struggle to see the benefit of breaking out the component costs from the net performance figure; the net figure is a useful starting point for the consumer to understand how their money is doing. Obviously they need to be informed of further charges, but breaking down the elements of the net performance removes clarity.”
Firms with vertically integrated business models, such as Standard Life and Old Mutual Wealth, could be forced to refocus on a particular part of the value chain as a result of grea-ter clarity around costs.
Glancy thinks transparency will put pressure on fund managers to lower charges and that consequently companies active in multiple segments might drop out of parts of the market.
He says: “Vertically integra-ted providers may need to specialise, the professional fees they charge within members’ funds will be transparent and there will also be downward pressure on profit margins on funds. We’re seeing one or two already beginning to specialise, Legal & General, for instance, leaving the Association of British Insurers and becoming more of an asset manager than product provider.
“In more mature markets you see people begin to look at their core competencies and focusing on those and partnering in other areas where they don’t make as much money. There will be segmentation of the value chain.”
Research consultancy Finalytiq founder and director Abraham Okusanya says tightening disclosure requirements will “exacerbate the tension” in other parts of the chain, such as platforms.
He says: “Vertical integration models are one big great experiment – the idea is asset management is the cash cow of this model and the platform and advice businesses are distribution channels and don’t need to make money. However, each part of the model needs to be successful in its own right.
“As pressure bears down on the asset manager businesses of providers, the bean counters at the parent companies will begin to look harder to trim the fat in other parts of the businesses and loss-making platforms may well be axed. We’ve already seen some signs of this.”
Standard Life re-entered the advice market in 2015 by acquiring wealth manager Pearson Jones, becoming fully vertically integrated. But head of pensions strategy Jamie Jenkins says the market benefits from competition between providers with contrasting business models.
He says: “This will drive down charges and improve the service to members. Combining administration with an investment platform brings a more seamless proposition, while continuing to allow members the freedom to invest in fund solutions from a universe of different investment managers.
“The focus on transparency will help ensure that any proposition remains competitive, regardless of the model adopted. The real issue is not the model adopted but the need for scale. We envisage consolidation among master trusts with the market moving towards fewer, larger providers in future.”
Trevor Whiting, partner, Core Financial
The call for transparency on management charges is likely to be a long haul. We have lately experienced fund managers exhibiting collective tracker funds with perhaps a charge as low as 7bps. However, when you add in the transaction costs the actual charge is too often radically different. An investor is thereby enticed by a lower annual management charge but rarely understands the whole picture, sort of lost in that mystical cloud of ‘tracking error’.
As advisers, I would like to think the community as a whole is absolutely clear with clients about every penny they pay and when. It therefore makes it intensely difficult to be clear about our own charges but look through a haze at the charges our clients pay for the underlying investment. We therefore fully support the motives of the Investment Association to drive through ‘fair, clear and meaningful information on charges’. They have a huge undertaking on their hands.
We have been trying to make our products more transparent: we split out advice charges, product charges and fund charges. But that puts us at a commercial disadvantage if other players in the market are still offering opaque charging structures, because they can appear to be cheaper than us.
One of the things we have to do is press for a level playing field, which is why we are becoming increasingly active in this space. We are not aiming to look at the cost of all the individual components and how much profit individual providers are making. A market with lots of competition means you do not need to go to that granularity.
What we want is to get to a place where consumers can see clearly the difference between propositions and their features, then they can determine what value for money there is. In the pensions market, that is tricky because they are complicated and consumers need help.
The RDR split out advice charges from other charges, so customers were able to see how much advice cost and how much the product cost. But product and fund charges were still bundled together, so it is difficult for customers to see how the charge was split between providers and fund managers.
Within the fund charges there are explicit charges – an AMC of, say, 60bps – but there are a lot of costs that are charged to the fund itself. These could total, say, 200bps, but the customer does not see them as charges, they just see the fund has delivered 5 per cent growth instead of 7 per cent. That is the area the DWP and FCA are increasingly concerned about.
When the charges are finally disclosed it will quickly become apparent that some of the charges being taken out of funds are much much bigger than product providers’ share. Product charges had a lot of attention in the press with rip-off pensions that paved the way for the 0.75 per cent cap on defaults funds – we could see another round of that with fund charges.
But managers will have differing capabilities to comply. For boutique managers it is not worth getting the infrastructure in place to deliver the level of information required. A number are likely to decide they do not want to play in the pensions space. What happens to the money in those funds?
In addition, vertically integrated providers may need to specialise once the professional fees they charge within members’ funds are made transparent. There will also be downward pressure on profit margins on fund managers.
We are seeing one or two already beginning to specialise, L&G for instance leaving the ABI becoming more of an asset manager than product provider, could be a sign of things to come.
Peter Glancy is head of industry development at Scottish Widows