Consulting, OCIO review gets qualified thumbs-up

The long-awaited provisional outcome of an investigation into the investment consulting and fiduciary management sectors in the U.K. was largely welcomed by market participants, even if they found the results unsurprising.

The Competition and Markets Authority on July 18 published its provisional decision report, which is now open to comment from the industry, with a final report expected by March.

While the details need to be worked through, "broadly these were remedies we thought were both helpful to the industry in terms of creating a level playing field in the way things are done, and the sorts of things the industry has been working on in some ways anyway," said Ed Francis, head of investment, Europe Middle East and Africa at Willis Towers Watson PLC in London.

The CMA started its work last year after the U.K. financial watchdog, the Financial Conduct Authority, referred the investment consulting and outsourced CIO sectors for investigation because of competition concerns.

Highlighting the importance of these sectors, the CMA report said investment consultants "influence" £1.6 trillion ($2.2 trillion) in U.K. retirement plan assets, while fiduciary managers run £110 billion in assets. The investment consulting market doubled in size in the decade ended 2016, to about £303 million in revenue, the report noted. The OCIO market is "expanding rapidly," with revenues more than tripling in five years to hit about £255 million in 2016.

In its report, the CMA said it had "provisionally found that there is an adverse effect on competition and that material customer detriment may be expected to result from it in both the investment consultancy and the fiduciary management markets." It said it is more worried about OCIO, including greater competition problems.

To remedy these concerns, it made a num-ber of suggestions to the industry, including a call for the practices to fall under the regulatory auspices of the FCA, for mandatory searches under OCIO arrangements and for clarity over fees.

Industry sources said the proposals could have been far more burdensome, with initial fears that the CMA might have called for the separation of advisory and OCIO functions within firms providing both services.

One thing that was particularly welcome, but unexpected, was the "strong message around the unbundling of fees," Mr. Francis said.

In its report, the CMA proposed a requirement for fiduciary managers "to report disaggregated fees to existing customers," and called for "minimum requirements for fee disclosures for prospective clients."

"That strong message was a very healthy one — there are some dysfunctions that come from the bundled fee model," Mr. Francis said.

Caroline Escott, policy lead-investment and defined benefit at the Pensions and Lifetime Savings Association in London, said the report came to "sensible conclusions and focuses on some of the key areas that require attention."

At the same time, there were issues on sources' wish lists that didn't make the cut.

"Ideally, we'd have liked to have seen the report focusing on additional measures to improve scheme governance. While this is discussed in the report, we believe it would have been helpful for both the FCA and The Pensions Regulator if the CMA had elaborated further on its recommendations to improve the governance," Ms. Escott said.

Regarding OCIO appointments, the CMA called for compulsory searches for initial OCIO appointments, and also proposed that pension funds that have not held a competitive process previously be required to do so within five years from the start of their current arrangement.

Regarding this remedy, Sam Gervaise Jones, U.K. head of client consulting at bfinance, London, said, "There is no indication on whether independent advice should be sought as part of the recommended compulsory tenders for fiduciary management, but we would not be surprised to see that specified in the final decision."

He also said there is "little comment on investment consultants providing advice that results in clients utilizing asset management products managed by the same consultant," where the consultant acts as a money manager rather than OCIO.

And besides a move from the feared requirement that firms would have to split out advisory and OCIO services, the CMA also backed off from making the employment of a professional trustee mandatory.

"That makes sense," said Peter Dorward, Edinburgh-based managing director at IC Select Ltd., which provides third-party consultant and OCIO monitoring and other services. "They have a great part to play and add significant value, but not all schemes are of the size to be able to afford a professional trustee."

While the call for increased regulatory scrutiny and the changes such as compulsory searches mean increased costs for the industry and, ultimately, pension funds, sources largely felt the proposals were justified.

"There is clearly a regulatory burden that is being added to our business, but it is proportionate," WTW's Mr. Francis said.

Regarding mandatory procurement, "I think the tender regime clearly introduces a bit more cost in the industry — and I do think that's proportionate — but there is a concern about the imposition of that on every single mandate regardless of size," he added.

There's also a risk to OCIO business.

"Clearly the mandatory tendering from a fiduciary manager, or an adviser offering fiduciary management, point of view may mean they would risk losing more of their clients to a (different) fiduciary manager and not win that mandate if it goes into a tender situation," said Mr. Dorward. "The fact that the CMA is suggesting anything awarded in the last five years should go through a tender process could (mean OCIOs) risk losing clients."

Regarding the cost to pension funds of mandatory searches, the CMA proposed a "supporting remedy" of enhanced trustee guidance and oversight by The Pensions Regulator. Mr. Dorward thinks this will help.

Added bfinance's Mr. Gervaise Jones: "Although tendering for asset management services can be more resource-intensive for pension funds than simply switching the relationship with the same consultant (or) fiduciary management firm, assessing a small shortlist, it is our experience that this cost is more than compensated for by the benefits of broad, robust searches. These benefits include better fees and terms, driven by stronger competition."

He added executives at bfinance do not see "pain points for consultants, although there are some 'known unknowns' such as the framework that will be used to assess asset manager product recommendations, and we strongly hope the CMA will consult with a broad range of providers, including smaller specialist consultants, when designing that framework."

The PLSA's Ms. Escott also highlighted a need for care and attention in some of the proposals. "There was potential that a spanner could be thrown into the works if overzealous mandatory tendering — or even switching — had been recommended by the CMA. This would have been an additional burden on trustees who are already dealing with significant levels of compliance. … We also welcome the recommendation for additional guidance for trustees to follow, but would stress that this will need to be carefully designed given the vast amount of information already out there for schemes."