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Editorial

Money managers, advisers should pay attention to U.K. governance

U.S. money managers and investment advisers should keep an eye on the U.K.'s Financial Conduct Authority. The FCA's latest governance ideas will, within the next 18 months, affect any U.S.-based money management firms with businesses in the U.K., and they might eventually gravitate to the U.S.

The FCA's new rules require money managers in the U.K. to annually assess and justify to clients the fees they are charging, to prove they are providing value for the money they are paid, and to provide increased transparency about their fees. It does not specify exactly how value for money is to be measured. Does the manager need to produce alpha, for example?

The FCA justifies the new rules as part of money managers' fiduciary duty to act in the best interests of investors.

It acknowledges that the final rules, after a redrafting, are closer to the Gartenberg standard, which has been used for more than 30 years in the U.S. to determine whether investment advisers to mutual funds have satisfied their fiduciary duty.

This standard, which was blessed by the U.S. Supreme Court, says to be a breach of fiduciary duty, an adviser's fee must be so disproportionately large "that it bears no reasonable relationship to the services rendered and could not have been the product of arms-length bargaining."

While the Gartenberg standard has been applied to advisers to mutual funds, it could be applied to advisers to pension funds and especially to defined contribution plans.

According to the Financial Conduct Authority, many retail and institutional investors in the U.K. find making informed investment decisions difficult because they are not well placed to find better value.

The FCA also requires money managers to add two independent directors whose responsibilities will include making sure the firm is operating in the best interests of the clients.

Also, a senior manager will be required to take reasonable steps to ensure the firm "complies with its obligation to carry out the assessment of value, the duty to recruit independent directors, and the duty to act in the best interests of fund investors."

Given the enormous amount of information available to U.S. institutional and individual investors, it seems doubtful the FCA's new rules are required in the U.S.

Institutional investors — pension funds, endowments and foundations — in the U.S. have many investment consulting firms helping them compare and contrast institutional investment firms that might seek their business. These consulting firms not only help them select managers, but also they monitor the managers to make sure they are providing, in the FCA's term, value for money.

When the consultants in the U.S. determine a manager is not providing value for money, the consultants recommend the manager be dropped and a new manager selected.

Even small defined contribution plans in the U.S. — which primarily use mutual funds to provide investment options to participants — have numerous consulting firms vying to help them select the most appropriate funds to offer in their menus.

Most employers, knowing they are fiduciaries to their defined contribution plans, take their responsibilities for providing appropriate options to their employees at reasonable cost.

Even investors who are not participants in a defined contribution plan have detailed information about the mutual funds they could choose from Morningstar Inc.

It's true that consultants also are deeply involved in the pension investment decision-making process in the U.K. But the FCA in 2017 said it had reasonable grounds to suspect that investment consultants and fiduciary management might be distorting competition in the pension investment market and referred the issue to the U.K.'s Competition and Markets Authority. The CMA launched a market investigation into investment consultants in September and is scheduled to conclude that investigation by March 2019, the FCA's report states.

It will be interesting to see if the FCA's governance ideas or the results of the ongoing CMA investigation prompt U.S. regulators to consider making changes to the U.S. financial system.