I spend a lot of time criticising regulators. So here, for a change, is a proposal for reform of UK financial services regulation: extend the authorised fund regime to accommodate most retail investment products.
The UK has an authorised funds regime that is essentially unchanged since 1931 mainly because it works. It is based on the principle that investors should not and cannot lose money due to fraud, theft, mismanagement or maladministration by authorised fund managers.
But it offers no warranties regarding returns from investments within those funds, so managers can offer higher-risk and lower-risk propositions. The regime creates a distinction between risk of capital and investment risk.
The cost of insuring against risk of capital is borne by fund investors through modest custodian and trustee charges. There are and should be no upper limits to the compensation available from this form of investor protection. Regulators can and should protect retail investors against the risk of capital vigorously and with iron boots.
Rather than accommodate new types of fund within this regime, though, regulators have allowed different structures that provide much weaker protections for investors.
Extending unlimited protection against losses from fraud, theft or mismanagement to all retail investment products should be the regulators’ aim. This will require changes to the UK fund rules.
For example, it is essential to permit funds with weekly, monthly or longer-interval valuations and dealings, and hence “illiquid”. There is nothing wrong with this so long as people know what the access timescale is. Liquidity, as economist John Kay has rightly said, is great for traders but not that important for investors. Regulators should stop treating it as a fetish.
Many investments that are sensible for advisers to recommend cannot fit within a daily dealing open-ended fund regime. Physical property, for example.
The FSA was wrong to permit commercial property inside such funds, which now offer a proposition to investors they simply cannot fulfil. The next tidal outflow of capital from open-ended property funds is almost certain to result in dealing stops or moratoria at which the FCA will wail and wring its hands.
The bible for collective funds, Managing Collective Investment Funds, produced by Cadogan Management, contains the answers to most of the questions my proposal raises. I would like to think everyone at the FCA involved in fund regulation has read it. And there are enough super smart retired fund management bosses who could help design useful changes if the regulator chose to pull them inside its tent.
An essential part of this process will be to tighten compensation mechanisms. Authorised managers, trustees and custodians must hold enough capital to pick up their share of all compensation bills or carry adequate insurance in order to avoid more Arch cru-style disasters.
A limited-scope, simple authorised fund regime is a huge benefit for retail investors. More beneficial than anything the FSA or FCA have ever accomplished. Regulators should build on the strong foundations they have inherited.
Chris Gilchrist is director of Fiveways Financial Planning