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'A critical period': Martin Wheatley's speech on fund charge conflicts
on Oct 30, 2013 at 11:25
As an example, last year we discovered a firm that was rewarding brokers predominantly based on the corporate access they provided. This averaged out to each individual investment manager paying over £100,000 just to gain access to the management of companies they wanted to invest in.
We believe this is just one area where firms are allocating commission to ineligible services and paying more for services than they would if they had to pay for them out of their own money.
This practice transfers the firm’s costs onto the client, which clearly works against the client’s interests. This raises a concern because asset managers do not control these costs with the same rigour as costs they incur directly. These costs are indirectly borne by the client and do not affect the manager’s profits. Likewise, on the other side of the transaction, chief executives and investor relations officers have learned, sometimes to their surprise, that their time is being billed to the industry by brokers.
As a result of these findings, industry members and representatives, including the Investment Management Association (IMA), have recognised that certain practices need to change. This recognition will also need to extend to the sell-side providers of these services.
But let me be clear, we accept that investors want to engage with the businesses they invest in and practise good corporate stewardship. We have no particular concerns with the purchase of corporate access. And we need a market for good quality research that benefits both the asset managers and their clients. But asset managers should be using their own funds if they wish to purchase access.
The prevalence of bundled services, combining eligible with non-eligible services, can also disguise overpayments for eligible services. This cross-subsidises services that asset managers should pay for from their own funds. And, in turn, it sustains business models that would quickly fail under increased global competition.
Besides, the link between volume of trading and research expenditure appears to be flawed. It creates ‘pots’ of research commissions the fund manager is then incentivised to spend regardless of the added value of the services. This creates a potential conflict of interest.
And we are not seeing great value in regards to domestic competition either. Investment banks appear to sell or provide additional services such as corporate access to the highest bidder. This favours high degrees of trading. This also distorts the market and causes asset managers to pay increasingly more for ‘research’ even if they receive very little value from it.
In a nut-shell, this type of outdated bundled charging system and use of dealing commissions to purchase research lacks the transparency that has attracted a global consumer-base, distorts competition, and supports unsustainable business models.
As mentioned, the FSA committed to keep the regime under review if it failed to address shortcomings it was designed to tackle. We have now reached a point, evidenced by our supervisory work where we need to think again. The system is not working as intended. Wider reform is now required to address these flaws that cannot simply be addressed by incremental improvements to the existing rules.
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