Response to FCA consultation (on provisional view to reject undertakings in lieu of a market investigation reference of investment consultancy services) July 2017 Making Sense of Pensions
FCA Asset Management Market Study: Market Investigation Reference of investment consultancy services Response to consultation on provisional view to reject undertakings in lieu of a market investigation reference of investment consultancy services This is a response to the FCA s consultation request dated 28 June 2017 regarding their provisional view to reject the undertakings in lieu of a market investigation reference of investment consultancy services. About Xafinity Xafinity is a UK specialist in pensions actuarial, consulting and administration, providing a wide range of advisory and compliance services to over 550 pension scheme clients. The Company combines expertise, insight and technology to address the needs of both pension trustees and sponsoring companies. The Group has more than 400 employees, with offices in Reading, Leeds, Stirling, Belfast, London and Manchester providing it with access to staff, expertise and clients in geographic locations across the UK. Xafinity floated on the Main Market of the London Stock Exchange on the 16th February 2017. Xafinity comments on the investment consultancy aspects of the FCA Asset Management Market Study Xafinity welcomes and supports the conclusions in relation to the work of investment consultants contained in the FCA's Asset Management Market Study published in June. In particular, Xafinity shares the concerns of the FCA regarding the market for fiduciary management. These include that there is a concentrated market, especially among Aon Hewitt, Mercer and Willis Towers Watson. This is characterised by low switching levels and inherent conflicts of interest. A full review of this market will likely lead to better outcomes for schemes and ultimately their members. Xafinity is not a fiduciary manager nor is it an asset manager, instead focusing on the traditional consulting model of advising pension trustees independently, where these particular conflicts do not arise. The FCA has suggested that there should be a more general increase in the regulation of the work carried out by investment consultants. We support this suggestion, provided that it does not disproportionately increase the cost burden faced by pension schemes, particularly smaller schemes. The FCA s aim is to ensure the markets work well and investors receive value for money. The report covered both asset management and investment consultancy. This reflects the importance of pension schemes as institutional investors. We at Xafinity completely agree with the aims of the FCA in this regard. Fundamentally, we believe that the client must be at the heart of all pension scheme advice. We fully support actions that will improve our industry and the outcomes for pension schemes. Making Sense of Pensions Page 2
We welcome that the FCA has remained focused on improving the outcome for investors. This is despite significant lobbying from some parties (including Aon Hewitt, Mercer and Willis Towers Watson through a combined reply) to retain the status quo. Xafinity wholly supports the aims of removing conflicts of interest in the industry, restoring savers trust in asset management and ensuring pension schemes receive high quality advice. Xafinity welcomes these actions and the increased regulation that will follow if this achieves the desired aims. We also believe that increased competition amongst investment consulting firms will only be beneficial to schemes and their members. A growing number of pension funds have entrusted investment consultancies to oversee and manage their assets, a practice known as fiduciary management. In its interim report the FCA found that on a per-client basis, fiduciary management generates more than twice the revenues that traditional advisory services generate. The opaqueness of fiduciary managers performance and fees comes in for criticism, and the level of fees compared to traditional services can create conflicts. A lack of publicly available, comparable performance information on fiduciary managers also makes it hard for investors to assess value for money. In our view, it is possible that fiduciary management can bring some advantages and so work well for some schemes. However, there are also some issues which require addressing. An example is the conflict of interest concerns about performance reporting (and hence assessing the success of the manager), typically being carried out by the manager themselves. Using an independent third party to help choose, appoint and monitor a fiduciary manager or other in-house funds should become the norm and not the exception. We support the FCA s proposals to refer investment consultancy services to the Competition and Market Authority and make asset allocation advice subject to FCA regulation. We support the findings in the report and the direction of travel that the FCA is driving the industry. This report puts investors (in our case pension schemes) back at the heart of the asset management and investment consulting industries. For us, this is where they ve always been. Notwithstanding that we support the FCA s provisional view to reject the undertakings in lieu, as requested we now go on to provide our response to the consultation on the specific undertakings in lieu proposed by Aon Hewitt, Mercer and Willis Towers Watson (referred to throughout this response as the Parties ). Xafinity comments on the specific undertakings in lieu UIL 1: Investment consultancy tendering regime We are supportive of the concept of mandatory retendering of investment consultancy appointments. This does not mean that a scheme has to change advisor, but it does have to undertake a genuinely competitive tender process. We do not believe the proposal from the Parties is bold enough. We would favour mandatory retendering every 5 years. Where schemes have already exceeded this timeframe, there should be a requirement to hold a retender within a short timeframe, say 1-2 years. We would not want the burden on schemes arising from this to be too onerous or costly. However, it should be recognised that the investment consultant can be very influential to the outcome the scheme achieves in terms of funding and risk. As such, the choice of investment consultant and the concept of regular review should be taken seriously, reflecting its importance. Making Sense of Pensions Page 3
We also note that schemes typically renegotiate fees as part of a retender process, which introduces pricing tension and confirmation as to the scope of the required work overall likely to be beneficial to schemes. UIL 2: Disclosure of performance in active manager recommendations We are concerned that what is proposed could adversely affect investment consultant behaviour. The performance analysis proposed could lead to a greater churn in ratings. This in turn could lead to investment consultants recommending clients change active managers frequently, incurring significant additional advisory fees and trading costs when doing so, perhaps just to boost the quarterly disclosed figures. We have thought about whether a more open and transparent approach might be better, for example, each firm could publicly disclose their list of recommended managers. However, if, like at Xafinity, manager recommendations are tailored to each scheme s requirements, then we question whether this grouped information would add any value. This is an example of where the proposed UIL has questionable merit in improving outcomes for investors. UIL 3: Disclosure of performance of fiduciary manager solutions (whole funds) We think that what is being proposed by the Parties is reasonable. However, we would caution that whilst comparable performance data is welcome, it might not be as useful to schemes as might at first be thought. The reasons for schemes considering and using fiduciary management can be varied, and so performance might not be a key selection criterion. As such, directly comparable data between managers will not greatly aid the selection process. That said, it will still be of some help. An enhancement to the proposal is for each fiduciary manager to disclose metrics for each scheme individually. Clearly this would need to be anonymised, but would then provide a very clear level of disclosure. Ideally, the performance and risk achieved against objectives for both return and risk would be shown. We also believe that information should be provided for partial fiduciary management solutions as well. However, in this case the reporting should be against the objectives for the mandate rather than scheme as a whole. UIL 4: Disclosure of fees and costs for fiduciary management solutions for prospects What has been proposed by the Parties looks like a reasonable start point to us. We d like to see the fees paid to underlying managers split out manager by manager. This would enable a transparent assessment of where the fiduciary manager has used their scale to drive down costs. Another enhancement that we would like to see is a breakdown of the fiduciary manager fee between ongoing costs and initial take on costs. These might include things like asset liability modelling, liability hedge design, de-risking trigger design etc. We believe this is relevant, because these costs are somewhat one-off in nature, and yet are included in the fiduciary manager AMC and hence charged ongoing year after year. We d like to understand if this represents good value for money for schemes using fiduciary management. Making Sense of Pensions Page 4
UIL 5: Disclosure of fees and costs for fiduciary management solutions for incumbents We see no reason why incumbent clients shouldn t receive the same full disclosures as prospects. As such, our comments are the same as for UIL 4. UIL 6: Conflicts of interest Gifts and hospitality We agree with the proposal. In order to avoid any potential confusion amongst pension schemes, we wonder if more guidance could be provided to investment consultancies by the FCA with perhaps some elements becoming rules. For example the FCA could ban attendance at sporting events or other such gatherings where the main purpose is not a business meeting. Fiduciary management We do not think what has been proposed is good enough. For any scheme considering taking fiduciary management services independent advice should be sought. This includes full or partial fiduciary management solutions. We also believe that schemes should be required to take independent advice on funds operated or managed by investment consultants. Schemes have to take advice when selecting a fund manager. We see no reason why the appointment of a fiduciary manager is any different indeed their impact on performance is likely to be greater. By extending this requirement to necessitate the advice to be independent removes the risk that schemes could receive conflicted advice. In our view, this has to lead to better outcomes for schemes. Tender management We agree with what is proposed. Master Trusts There is no requirement for schemes to take advice over a suitable Master Trust provider. However, in practice, trustees may want help and guidance through the selection process. We agree that whilst investment consultancies can introduce their own Master Trust, they should not be able to recommend it. This should be kept under review while the Master Trust market develops the Pensions Regulator is also developing its approach in this area. UIL 7: Complaints and redress policies What is proposed seems sensible to us. UIL 8: Code of conduct We support the inclusion of the more impactful aspects of investment consultancy advice (e.g. asset allocation advice) to be brought under the regulatory framework. As such, the vague code of conduct proposed isn t required as the way investment consultants must act must be covered through the regulatory regime. Making Sense of Pensions Page 5
Overall Xafinity view We applaud the FCA for their aspirations highlighted through the Asset Management Market Study. We support the recommendation to refer the investment consultancy industry to a market investigation. We are not afraid of the outcome of this review. We believe a truly independent investigation incorporating the views of all stakeholders has a better chance of getting to the right outcome than the preferred outcome of a few market participants. There is a fantastic opportunity to drive bold changes through our industry for the good of pension schemes and trustees our clients. We hope this opportunity is taken. Ben Gold Head of Pension Investment, North Making Sense of Pensions Page 6