The Assessment of Value You Did Not Know You Needed
With the Asset Management Market Study dated 2017 and the ensuing package of measures introduced in 2018, the UK pioneered the paradigm shift towards greater accountability for fund managers. The findings of the study had showed weak price competition in the industry, due in part to non-existing negotiating power of retail investors vis-à-vis fund managers. At the same time, fund governance bodies lacked any focus on the assessment of value that customers received for the money spent to purchase asset management services.
The package of measures introduced further to the Asset Management Market Study was originally conceived free from extraterritorial effects as an obligation incumbent on UK authorised fund managers only, including the ones managing UCITS. The recent introduction of the UK Overseas Fund regime questions this original approach. Recent guidance issued by the UK FCA confirms our expectation that EEA UCITS applying for marketing recognition under the new UK Overseas Fund Regime will have to comply with local rules on assessment of value and undue costs.
A Matter of [Good] Governance
The assessment of value and its disclosure in the UK is essentially chalked up to a matter of [good] governance. Rules existed already, well before the Asset Management Market Study, that required fund managers to act in the best interest of their shareholders. Including rules to prevent that undue costs are charged to them.
However, the fact that fund governance entities were not sufficiently focussed on issues of value for money was also a function of their lack of authority to challenge overall commercial strategies of fund promoters or initiators. The extremely weak competition on price in asset management was confirmation though that the libertarian approach adopted thus far had failed. Additional rules were required to ensure that consumers received value for their money when purchasing asset management services.
The governance model adopted in the UK envisages that authorised collective investment schemes are required to appoint an authorised fund manager. This body becomes responsible for the fund, both for statutory and regulatory purposes, irrespective of its legal structure. The authorised fund manager usually acts as the sole corporate director of UK authorised funds. Authorised fund managers typically either manage their own funds or act as host for third party managers or promoters. Either way, their fund board attracts different sets of conflicts of interest, which inherently undermine their ability to ensure that shareholders receive value for the money spent to purchase the specific asset management services. In case authorised fund managers only deal with proprietary funds, their board members are most typically either in a direct employment relationship with the portfolio manager or are members of the ultimate parent company of the group. Thus, biased in their role for this very reason. In the case of authorised fund managers acting as hosts of third party funds, in a fashion very similar to independent management companies in Europe, the conflict of interest is driven by the commercial relationship with the third party fund manager or promoter.
Without completely altering existing governance arrangements to morph them on the ones introduced in Europe, the solution adopted in the UK revolves around not only more robust governance but accountability of the board of authorised fund managers. On the one hand, introducing a new rule to require that authorised fund managers assess whether value for money has been provided to fund investors. On the other, making the board accountable to respect this rule and introducing a share of independent directors within fund boards.
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The Seven Pillars of the Assessment of Value
When it comes at the UK style assessment of value, authorised fund managers shall carry out their assessment based on the following seven pillars.
- Quality of service
- Performance
- AFM costs
- Economies of scale
- Comparable market rates
- Comparable services
- Classes of units
From a methodological perspective, despite interconnectedness amongst them, authorised fund managers shall carry out their analysis on each of the pillars independently. Individual funds shall be reviewed and scored against these pillars. The analysis shall include a separate discussion and conclusion for each of the pillar and a conclusion as to whether fund fees are justified in the context of the overall value delivered to investors. Especially in case of poor performance, fund managers will have to explain remedies deployed to address specific situations.
For what concerns the pillar themselves, these look at different aspects of the overall asset management service offered. The pillar related to performance will have necessarily a closer connection with aspects related to fund investment objectives, policies and strategies, which will not necessarily be as relevant for other pillars. Some of the pillars like economies of scale, comparable market rates and services will be instead more naturally linked to cost and price considerations.
Lastly, quality of service is the only pillar divorced from performance and cost considerations, hence capable of encompassing other aspects of the asset management service, some of which neglected thus far. These include communications with investors and general customer services offered by the funds.
Transparency of the Assessment of Value
The assessment of value is not a one-and-done on a yearly basis, despite the requirement in the new rules only for a yearly publication of the related report. The expectation on authorised fund managers is to have the value process alive on an ongoing basis throughout the life cycle of their funds. The assessment of value shall be seen more as an additional layer of awareness about the way authorised fund managers carry out their business rather than a mere reporting obligation. In the words of the FCA, transparency of this assessment serves different purposes, including additional scrutiny and broader comparison across the industry.
From a more practical perspective, whilst it is possible to deliver the report on the assessment of value as part of the long form yearly financial reports of a fund, authorised fund managers are at liberty to provide it also on a standalone basis. This seems to be the widespread approach adopted across the industry. General rules on communications to investors having to be fair, clear and not misleading will apply to assessment of value reports.
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Conclusions
As UCITS managers are considering a marketing recognition under the UK Overseas Fund regime, it is no longer speculative to ensure that there is a demonstrable process in place relative to the assessment of value of their funds.
The time required to establish an internal process shall be factored in the timeline to prepare to apply for a marketing recognition under the UK Overseas Fund regime. The FCA has signalled on this point that a withdrawal of an application for recognition under the UK Overseas Fund Regime might be suggested in cases where dealing with their feedback might require a longer time. Establishing a process for the assessment of value does not happen overnight or certainly in one day.