For the last 15 months, I have chaired the Competition and Market Authority’s investigation into investment consultants and fiduciary managers. We began this investigation after the Financial Conduct Authority made a reference at the conclusion of its asset management market study.
Investment consultants and, increasingly, fiduciary managers, play a vital role in institutional investment in the UK, in particular with pension schemes. We estimate that investment consultants have influence over £1.6 trillion ($2 trillion) of UK pension scheme assets; fiduciary managers, despite having come into the sector much more recently, already manage more than £110 billion ($141 billion) of pension scheme assets. And they play an increasingly important role in advising defined-contribution (DC) schemes, which are growing as part of the overall pensions market.
Despite this, little has been known about these markets until now. Our investigation has helped shine a light on them and how well they are working.
Having explored the markets in depth, our conclusion is that many elements of them work well for pension scheme members, particularly as there is a good range of competing firms for pension trustees to choose from. We did not find that the markets were highly concentrated or that barriers to entry or expansion were prohibitively high.
Unfortunately, that does not mean competition is working well overall. In fact, our investigation concluded that there are competition problems in both markets that could result in substantial harm to pension schemes and their members; for example, they could lead to providers charging higher prices or performing worse.
We are, therefore, requiring that pension trustees and firms offering these services make some changes to how they work together.
Our greatest concern is in the fast-growing fiduciary management market. Some pension schemes may benefit by outsourcing the handling of their investments to a fiduciary manager but this service has high costs and represents a delegation of decision-making by pension trustees, most likely for a long time.
Moving to fiduciary management is a major step in how a pension scheme is run. It requires trustees to provide sufficient care and attention. However, in many cases, we found that this was not happening: two-thirds of pension trustees do not run a competitive tender when they first buy fiduciary management and half of them simply appoint the firm that was already their investment consultant.
This lack of customer engagement is not likely to produce the best market outcomes for pension schemes. It results in firms that offer both investment consultancy and fiduciary management having an incumbency advantage with their advisory clients. These firms can also have strategies and financial incentives in place to steer clients to their own fiduciary management service, instead of these clients shopping around for a provider that might suit them better.
It is too early in the development of the fiduciary management market to judge how frequently pension schemes will review or switch their provider. We have noted that both the monetary and time costs of switching would probably be significant, so we would not expect to see high levels of customer churn. This makes it even more important to have sufficient competition when a pension scheme first purchases fiduciary management.
We appreciate that pension trustees are subject to many regulatory and other responsibilities, which may go some way to explain why the cost and quality of investment advice and management have not received the focus we think they merit.
However, our analysis shows that pension trustees who do engage with these matters pay lower prices for fiduciary management than those who do not.
We have set out a package of reforms to tackle our competition concerns. Pension schemes must run a competitive tender with at least three firms before selecting their first fiduciary manager. If they already have a fiduciary manager but did not run a tender for the appointment, then they must do so within five years.
While pension schemes must bear the main responsibility for running these tenders, we will require firms to remind their current and prospective clients of their obligations.
We will also require that investment consultants separate marketing of their fiduciary management service from their paid-for investment advice to clients and they should label marketing as such. This will enable pension trustees to distinguish advice from marketing and ensure that they engage fully in choosing a fiduciary management provider.
Another finding of our investigation is that information for pension trustees on fees and quality of service of fiduciary management, and on the quality of investment consultants, is either limited or does not allow them to compare providers adequately.
We are, therefore, ordering fiduciary management firms to provide clear and comparable fees for current and prospective clients and to agree upon a performance standard based on their historic data amongst fiduciary management clients.
Pension trustees must also set strategic objectives for their investment consultants, most likely linked to the scheme’s investment performance. And we want clearer reporting of the performance of investment consultants and fiduciary managers’ asset manager recommendations.
These proposals complement and build upon new Markets in Financial Instruments Directives legislation and the recent work of the FCA’s institutional disclosure working group. We are keen to see greater engagement by the trustees of DC schemes in particular, as the members of those bear the risk of any under-performance in investments and we found some evidence that trustees of these schemes were less engaged in investment matters than trustees of defined-benefit schemes.
We think the FCA and The Pensions Regulator can play important roles in ensuring that these changes work well and that these markets work for the benefit of UK pension scheme members. So we have asked government to enable each regulator to take on the relevant duties and oversee our changes to the sector.
We expect these changes to be legally binding on firms and pension scheme trustees by the end of 2019.
John Wotton has chaired the Competition and Market Authority’s inquiry into investment consultants. He practised as a solicitor with Allen & Overy throughout his legal career, retiring in December 2012.