Fund managers’ assessments of value

September 2023

The FCA has completed its second supervisory review of authorised fund managers' (AFMs') compliance with its assessment of value (AOV) requirements. This follows on from the rules entering into force in 2019, and the FCA's initial supervisory review in 2021.

Overall, the latest review identified significant improvements, but in some cases action is required. It's clear that the FCA expects AOVs to be backed more robustly by evidence, to go beyond an overly narrow focus on comparable market rates for fees, and to ensure that good governance is facilitated by decision-useful MI, independence from external influence, and objective challenge. 

Fund managers should review and enhance their governance arrangements and processes as needed, paying close attention to the synergy with the Consumer Duty. 

The FCA's findings

In its 2021 findings, the FCA appeared frustrated that some firms simply did not understand the requirements. While noting significant improvements, it has set out further observations regarding the AOV minimum considerations and highlighted new areas of focus:

• Overall governance: The FCA considers that the independence of AFM boards is still being impacted by other group companies or delegate managers — noting that wider parties should respect the AFM board's responsibilities. This is a familiar and ongoing supervisory focus across wider topics, but fundamentally relates to the profile and prominence of the AFM's board. Conflicts between firm profitability and investors' best interest are a continuing concern, as is the robustness of challenge provided by independent non-execs. Although MI has improved, some board decisions ignored or unreasonably explained away the MI.
• Quality of service: The findings here expand on the 2021 observations — with some assessments of delegate managers and affiliated companies continuing to be being insufficient (e.g. simply relying on an attestation). Firms should reflect on their approach to ESG in the context of the good practice identified — i.e. by not crediting the investment process for ESG where it is simply an extension of the existing process. Good practice also draws on metrics to measure service provision and to provide meaningful MI.
• Performance: Performance was a significant concern in the last review, and there remains room for improvement. The FCA notes that no firms included in the review have reduced fees for poor performance. Good practice includes setting appropriate fund objectives and performance thresholds, and appropriately rating underperforming active funds that significantly underperform their benchmark. 
• AFM costs: The focus on profitability also continues. The FCA is clear that good practice involves detailed activity-based cost allocation at both fund and share class levels. 
• Economies of scale: This concept should be embedded into the product development process, and where firms claim to reinvest economies of scale for the benefit of investors, this should be better evidenced — specifically with reference to the fund involved (rather than the broader firm). Best practice involves negotiating better prices with third party asset managers and service providers as funds grow, passing on the full benefit of savings to investors via reduced fees.
• Comparable market rates: The FCA still observes this consideration overriding the others, resulting in price clustering, and raised concerns that firms are not complying with the rules. This will be further challenged in a post-Consumer Duty landscape. 
• Comparable services: Firms should note the good practice, including appropriate analysis of segregated mandate clients' fees based on their size, and making meaningful comparisons by adequately considering funds' potential buying power.
• Classes of unit: Unlike the previous report, this was not a significant focus in the latest review. The FCA noted some firms had moved investors to lower cost classes since the previous review.

Implications for fund managers

There is plenty in the FCA's review for firms to act on. They should:

• Complete a thorough, formal review of the FCA's observations. This should systematically work through and address each of the findings and should be documented, reviewed and approved by the board as a matter of good governance. The FCA specifically noted that some firms have overlooked or not addressed some of its 2021 findings.
• Focus on embedding the AOV process into the firm's wider policies, processes and culture (e.g. the product governance approval and review processes).
• Substantiate claims or assumptions with evidence, including via appropriate analysis, documentation, and MI provided to the board. For example, in its 2021 findings, the FCA noted that firms often assume that existing fund charges already reflect shared economies of scale without providing justification.
• Ensure governance arrangements deliver good outcomes — this can be achieved by mitigating conflicts with other entities and ensuring independent challenge. AFM boards should receive decision-useful MI and be able to appropriately challenge methods and conclusions.
• Consider simplifying the annual AOV report where possible — this was a specific FCA suggestion in response to feedback from firms.

Links to the Consumer Duty

Although the Consumer Duty price and value requirements entered into force on 31 July, AFMs should continue to prepare AOVs for authorised funds in line with the COLL rules (as the FCA considers that they are equivalent to the Duty's "Price & Value" rules).

However, lessons learned from the fund AOV process and wider Consumer Duty fair value assessment performed for other products should feed into one another to promote good practice. For example, any actions already taken as a result of the FCA's May 2023 findings.

AFMs should specifically consider the robustness of evidence surrounding their value assessments through the lens of the Consumer Duty — where the FCA has higher expectations.

Asset managers can expect the FCA to undertake a proactive review of the price and value outcome in 2024 — as noted in its latest portfolio letter.

Developments in the EU

UK firms with EU operations will also have one eye on developments there. Lessons learned in the UK should be played into work that EU fund managers have undertaken in the context of completing the new version of the European MiFID Template — EMT 4.1 (i.e. information to be provided to UK distributors).

Looking to the future, ESMA's opinion regarding "undue costs", the output of the AIFMD review, and the European Commission's proposed retail investment strategy all indicate that value for money is likely to feature heavily on the forward-looking agenda. As the agenda progresses, firms should consider where the UK approach can be leveraged in order to meet new requirements.