UK Regulator to Probe Transition Management, Custody, Fund Fees

(March 25, 2013) — The regulator that will replace the Financial Services Authority (FSA) in the United Kingdom has targeted transition management, ancillary custodian bank services, and fund management fees as a top priority for investigation.

The Financial Conduct Authority (FCA) has set out its business plan for when it takes over from the FSA at the start of April – on Monday next week. One of the first items on the agenda is the transparency offered to investors via various practitioners in the financial services industry, the FCA said today.

Regarding custody banks, the FCA said: “Firms are facing considerable pressure on their business models and strategies and consequential changes in business models may lead to harm to consumers as firms are pushed to exploit areas of profitability. The custody bank business model is evolving and the basic premise of providing safekeeping and custody of client assets − which is high volume and low margin − is facing strain in the on-going low interest-rate environment and because of changing regulatory requirements.”

The FCA said custody banks were increasingly leaning on additional services, including securities lending, foreign exchange, collateral and cash management, derivatives clearing, data analytics, research services, and transition management to make up revenue shortfalls. The agency warned: “There is a risk that the pressure on firms to improve profitability could lead to harm to consumers. We want to investigate the transparency of secondary services to establish whether investors are being disadvantaged or charged excessively.”

Over the financial year 2013/2014, the FCA is to measure the impact of current practices on custody banks’ business models, on direct clients and, where possible, on the indirect end-consumer. “We intend to identify the scale of any issues and develop a strategy for reducing risk where we find issues,” the FCA said.

Separately, the new agency is to probe transition management practices in its first year.

“The use of affiliates by transition managers, unclear fee structures and complex legal and pre/post-transition documentation can result in poor customer outcomes,” the FCA said in its business plan this morning. “This may have an immediate impact on pension fund holders and cause a deterioration in market confidence, with clients choosing not to use transition management to manage portfolio allocation risk.”

Over the past 18 months, aiCIO has led an investigation into various services offered by custodian banks and their affiliates. Areas of transition management and foreign exchange transactions have come under close scrutiny.

“There is evidence that the level of transparency and market conduct among transition management participants is not to the standard we require,” the FCA said, adding that it would be conducting an investigation amongst the largest providers of transition management in the UK market.

It is widely believed that the out-going authority, the FSA, has already begun an investigation on transition management, centring on specific players in the industry. The authority has refused to confirm or deny the existence of this report.

The FCA is also to turn its attention to fund management fees during its first year overseeing the UK’s financial landscape.

“In the asset management sector fund fees have increased in the last decade, additional ‘hidden’ fees have increased and overall charging structures have become more complex as performance fees have become more common,” the FCA said. “There is evidence that fee structures exploit consumers’ behavioural bias, a key cause of risk.”

The FCA said fund managers were often guilty of charging retail customers more than institutional clients for accessing the same fund, but in the UK fees were generally higher than elsewhere for no substantiated reason.

The FCA takes over on April 1. For the full business plan, click here.

Related content: aiCIO‘s own investigation into practices in custody and asset servicing from February 2012 – Reluctant Voices