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Defined Contribution

DC managers, plans in a pickle as U.K.’s transaction-cost disclosure reports near

Alex Toney said inconsistent reporting standards are making it hard to calculate transaction costs.

Transaction cost data sought by regulators hard to get, execs say

Money managers and defined contribution plan sponsors in the U.K. are being challenged by yet more regulation that is going to shine a spotlight on fees.

U.K. managers are working to provide transaction cost data to defined contribution plan clients following mandates from the Financial Conduct Authority and, indirectly, the Pensions Regulator earlier this year. The regulators want DC plans to disclose to participants how much is being spent on transaction costs as part of overall fees being paid to managers.

"I don't think we've expected it to be this tough, but the data isn't there," said Alex Toney, associate at defined contribution consultant Barnett Waddingham in London.

The FCA's rule, requiring managers to provide clients information on transaction costs, among other fees, became effective Jan. 3. The Pensions Regulator's rule, effective April 6, requires DC plan trustees to publish for their plan participants a breakdown of transaction and other investment charges within seven months of the plan-year end. The first DC plans will need to start publishing the cost data starting in November.

The regulator wants to unpack the investment management fees charged to DC plans and participants — and in doing so, see if plan sponsors are correctly charged for investments strategies they choose in order to deliver value for money to plan participants.

Defined contribution strategies were not specifically included in a host of recent regulations — including the European Markets in Financial Instruments Directive II — designed to improve transparency of investments; these latest transaction cost regulations are an effort to fix that, sources said.

In addition to the time constraint of gathering, providing and publishing this information in less than a year, managers already are encountering another challenge: Firms that provide multiasset strategies or target-date funds are finding it difficult to gather data, and comparable data, from underlying managers because the regulations require a specific calculation methodology — slippage cost — that most managers have not used in the past.

"Managers are struggling to get the data from underlying managers because there was no consistent reporting standard prior to the regulation. Often what managers are getting isn't comparable and it is taking a lot of time to get the information," Barnett Waddingham's Mr. Toney said.

Added pressure

The fact that not all money managers are able or ready to provide the necessary data to clients is adding to the pressure on DC plan sponsors facing the November deadline, warned consultants monitoring the reporting process. Investment consultant Lane Clark & Peacock, London, estimated in an Aug. 21 report that 56% of money managers are not going to deliver the required information until March.

In part, that is due to the newly required calculation methodology.

Most money managers previously used individually derived calculations to provide fee breakouts. Now some are investing in systems needed to translate data into the regulator-friendly format.

"Many of the managers can't quote the slippage cost at the moment, and expect to be ready later this year or the beginning of next year," Mr. Toney said.

"Now that the slippage method has been mandated, we are building systems to make the reports to clients and expect to deliver data for the second quarter of 2018 sometime in the third quarter," said Alistair Byrne, head of Europe Middle East and Africa pensions and retirement strategy at State Street Global Advisors in London.

"There hasn't been a lot of clarity in terms of what data needs to be provided and in what format, and guidance has been provided late in the day," Mr. Byrne said.

However, industry sources are divided over whether the transition to the new methodology is going to be beneficial for DC plans, which predominantly use passive funds for equity exposure. Money managers warned the switch in methodology might have greater implications for asset owners, such as potentially increasing the cost of investing in passive funds.

In the slippage cost calculations, the implicit expense of trading, understood as market impact, typically costs managers a few extra basis points, in addition to the regular trading costs such as broker or custodian charges. But the methodology does not take into account that passive managers tend to execute trades at the end of the day to remain as close to the index they are tracking as possible.

Jonathan Parker, director at consultant Redington in London, explained that "slippage (cost) is calculated based on the price you buy your stock at, less the price at the time your trader places the trade in the market. Because passive managers experience a bigger delay during which the trade is placed, the slippage value is higher."

"In a more volatile environment these costs will be even higher for managers," Mr. Parker said. "And the method (is) certainly more challenging for funds that invest across many asset classes."

For some managers using slippage could mean indirectly passing costs onto clients because the total cost of trading will become higher. Sources said slippage methodology also creates confusion as to how passive managers should provide the data. Slippage calculations combine actual transaction cost with unrelated market movements through the course of the trading day after the market-close order has been placed, Mr. Byrne said. In some market conditions, slippage cost calculations could produce a negative transaction cost, which is impossible for the manager to declare and for a plan sponsor to assess in terms of the value for money.

"As a metric for index funds, (slippage) can produce strange results," Mr. Byrne said.

However, Mr. Parker said, "it is the cost of doing the business."

Absorbing the cost

But some money managers accept they will be forced to absorb any costs resulting from the new calculation method. David Porter, head of investment delivery Europe, Middle East and Africa at AllianceBernstein (AB) in London, said the firm is planning on "absorbing the additional costs and will not be passing them onto clients," even though managers might be additionally charged by vendors of data rather than building system in-house.

And there will be a ripple effect throughout the money management chain: Target-date fund and fund-of-funds managers potentially will be unable to disclose costs in the new format if they can't get the data from their underlying managers.

In the end, "RFP processes now require managers to have the ability to produce transaction costs using the slippage cost methodology. If these managers won't provide it — how can we work with them?" Mr. Porter said.

However, it is not yet clear whether underlying fund providers or wrapper providers will be penalized if data are not delivered on time, with the specifics of penalties not yet clarified by the regulator.

A spokeswoman for The Pensions Regulator said in a telephone interview, "Where a third party has caused a trustee to breach their legal duties, we may issue a as third-party notice."

Warning letters, known in the U.K. as third-party notices, could be issued to suppliers of services to retirement plans that aren't directly regulated by TPR. But if the third party fails to comply, the TPR has fines and criminal prosecution at its disposal.

The Financial Conduct Authority may also take action where a provider does not supply information requested. An FCA spokesman said, "We expect firms to follow our rules but won't comment on if we would penalize them."

Mr. Toney said there is too much focus on the costs and not enough on the outcome of that cost, such as what does this cost deliver in terms of performance. "With the transaction costs review, the regulator is losing sight of the reasons for these costs. In a DC plan, transaction costs are a small percentage of total expense ratio and would amount to 2 basis points compared to 30 to 40 basis points that these plans have to spend on administration," Mr. Toney said.