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U.K. regulators getting blowback over report on investment consulting industry

Firms, groups question results of OCIO probe, cite flawed data and unnecessary cost burdens

Service providers and industry groups in the U.K. have serious concerns over a provisional report investigating the investment consulting and outsourced chief investment officer markets.

The U.K.'s Competition and Markets Authority in July published its provisional decision report into investment consultants and OCIO providers — known in Europe as fiduciary management — after months of investigation and analysis. Along with outlining concerns over the functioning and specifics of the services, including worries over conflicts of interest among providers, the CMA detailed eight remedies.

Last month, the CMA published on its website responses from 39 entities, which included investment consultants, money managers, fiduciary managers and trade groups. The CMA aims to make its final decision in March 2019. The majority of the remedies and conclusions reached in the report were welcomed by respondents, who also noted serious concerns.

Pensions & Investments has analyzed responses and identified 10 potential sticking points, according to the industry.

Data analysis questioned

Several submissions questioned the CMA's data and analysis. Mercer Ltd.'s submission said the CMA appears to have based its characterization and analysis of investment consulting and OCIO services on inaccurate interpretations of survey evidence, historical figures and "insufficient regard to the body of evidence of trustees challenging" their consultants. "Overall, therefore, the CMA's analysis appears to be based on data and evidence that are out of date relative to the current operation of the market, unrepresentative across firms, and incorrectly analyzed,'' Mercer wrote. As a result, we believe the CMA's findings of an adverse effect on competition in these markets are not justified."

In addition to its submission, Mercer U.K. CEO Fiona Dunsire sent a letter Sept. 21 to John Wotton, chair of the CMA's investment consultancy market investigation, reiterating the firm's worries.

"I write further to our response to the CMA's provisional decision report and the related calls and correspondence over the last month between our legal advisers and the case team. Those communications concerned errors we uncovered with the data analysis used by the CMA which we consider material and which cast doubt on the credibility of key aspects" of the report, she wrote.

Mandatory searches needed?

One of the eight remedies by the CMA calls for mandatory search processes when a fund first adopts fiduciary management, and a competitive process within five years for funds that first appointed a provider without a competitive process.

"We do not think that the mandatory tendering of existing (fiduciary management) mandates is warranted," wrote Lane Clark & Peacock LLP in its submission. "The process is likely to be costly and take up a considerable amount of trustee time."

The firm recommended instead to require a "review" of the provider in existing allocations, rather than a full search.

Mercer also highlighted additional costs in mandatory searches in both new and existing appointments, estimating mandatory searches would add at least 200,000 ($261,469) in costs to funds and providers per search in aggregate — costs likely to be passed to clients.

Further, a call to conduct searches "for historical appointments would create considerable disruption in the industry, again without any demonstrable benefit. We estimate that the CMA's current proposals could lead to more than six schemes a month, on average, having to put their (fiduciary management) appointment out to tender over the next two years — an unworkable volume for many, particularly smaller, providers," Mercer said.

Fears of regulatory gaps

Increased use of third-party evaluators to help trustees choose and assess consultants and OCIOs raised a concern for Cardano Risk Management Ltd., which offers consulting and fiduciary management services.

"Whilst we support this development, we note that these firms are currently outside the remedies and will not be regulated under any extended (Financial Conduct Authority) perimeter. We encourage the CMA to consider what safeguards need to be put in place to ensure that third-party evaluators are fit for purpose, given their growing importance," Cardano's submission said.

Client-steering fears overblown

Related to the call for mandatory searches, the CMA raised concerns that investment consulting clients might be "steered" toward buying their incumbent consultant's fiduciary management service.

"Clients are not 'steered' into purchasing FM services; (investment consulting) firms do not have an incumbency advantage," Aon Hewitt Ltd. said, adding that cross-selling is a feature of any professional service firm and should not be a problem if adequate safeguards against conflicts of interest are in place.

Willis Towers Watson PLC also disagreed that consultants steer clients toward their own OCIO service. "The evidence provided by the CMA simply indicates that IC-FM providers attempt to cross-sell by raising the existence of other services they offer which would be beneficial to trustees."

Fears of wrong signals

While the report covers both investment consulting and fiduciary management, respondents called out the CMA on aiming most of the remedies at the OCIO market.

"It is also important that the CMA does not send the wrong signals to trustees considering the purchase of FM solutions," Aon wrote. "With the proposed remedies principally focused on the purchase of FM, including the proposal to mark FM related documentation with 'warnings,' the CMA proposals could easily give rise to connotations that FM is an inherently risky decision, or signal that the move to FM is too difficult or burdensome a decision to make."

Ensure provider competition remains

But the CMA also needs to be careful when it comes to the managers themselves, Aon said. "If not carefully constructed, certain of the proposed remedies run a real risk of distorting the IC and FM markets, which would have a detrimental effect on competition. In particular, rules-based regimes, such as the proposed mandatory tendering, risk creating an uneven playing field or a culture of rule avoidance, particularly if applicable rules are overly complex or uncertain."

Barriers incorrectly identified

Aon also thinks the authority made an error in identifying barriers to competition in terms of changing managers. "We disagree with the CMA's findings that because an incumbent IC knows a scheme well, that this creates an 'inherent barrier' to switching, the insinuation being that this evidences a lack of engagement. … However, to suggest that a trustee would only demonstrate 'engagement' by switching presents a misleading oversimplification of the trustee-adviser relationship," Aon said.

Performance reporting worries

The CMA wants to establish basic standards for how consultants and OCIOs report performance of recommended money management strategies. While respondents supported transparency, they also mentioned concerns of unintended consequences.

"We are particularly concerned that a track record of recommended asset management products may be used inappropriately as an overall proxy measure of the performance of an investment consultant," said Lane Clark & Peacock.

And while the Investment Association — the money management trade group — agreed that standards will enhance client information and overall confidence, it argued that a new group to implement and maintain fiduciary management performance standards, as suggested by the CMA, is not necessary.

"Instead, we reiterate our strong support for the work of (provider of oversight and selection services) IC Select in this area." IC Select in April launched a performance disclosure standard for OCIO providers designed to help pension fund executives compare skill.

Broader conflicts missing

Consultant bfinance U.K. Ltd. is worried the CMA "appears not to have addressed broader conflicts of interest that arise when investment consulting firms provide asset management services that do not constitute fiduciary management, although this is an increasingly widespread practice."

Definitions needed

The CMA's use of wording was noted in several responses. Bfinance raised concerns over the report referring to the use of a single adviser and does not account for multiple advisers. "This causes concern regarding unintended consequences for specialist consultants," the consultant wrote.

And Lane Clark & Peacock wants a clear definition of fiduciary management. "The definition of what services are in-scope of the remedies is very important to their successful implementation as there are a number of asset management services that are very similar to FM."