Regulatory pressures rising for discretionary fund managers

However, following increased regulation around the fund management industry, and an increased drive to make consumers more aware of what they are paying managers to do, the wealth management industry has also been made to explain its practices.

Discretionary managers have faced increased regulatory scrutiny in recent years as the advent of the RDR and the resultant increase in financial advisers outsourcing investment management has seen them increasingly targeted by the FSA and now the FCA.

Although the industry has been affected in a number of ways by the RDR, it has had two main regulatory impacts on discretionary managers; through the removal of commissions and rebates and through an increased focus on the suitability of investments for clients.

Prior to the RDR, some discretionary fund managers (DFMs) had been buying open-ended funds for their clients at a fee of 1.5 per cent, even though only half of that was taken by the fund manager and the rest was commission for intermediaries and other companies such as platforms.

The removal of the commission meant that the DFMs which had relied on that commission income were faced with two problems: replacing the income with higher fees and the laborious process of converting their back book of clients to clean fee shares.

Mark Rockliffe, head of intermediary sales at Heartwood Investment Management, says: “There are some discretionary managers who have seen a significant element of income from rebates. Those firms now have to replace that lost revenue and now have to re-engineer their back books so that they are all using clean share classes.”

In the past year, larger discretionary managers such as Brewin Dolphin and Charles Stanley have had to raise their fees, and they have cited regulatory pressures for doing so.

Gary Teper, a board director at Charles Stanley, explains: “The cost of providing our high service has gone up so we needed to respond accordingly. Part of this change is driven by the RDR as trail moves out of the system and the cost of complying with regulations mounts.”

But while the loss of fee income is difficult, the conversion process to switch from trail-paying shares into commission-paying shares still only entails a one-off cost. The far more costly, and time-consuming, additional regulation has surrounded ‘suitability’.

The regulator has clamped down across the industry on whether investments are actual suitable for the clients that are within them. This has come after a number of incidents and fines where investors have been sold completely unsuitable products.

To counter this possibility in the future, the regulator now requires checks be done on client suitability down to the smallest detail. This has imposed a huge new burden on discretionary managers, many of whom had not done this level of analysis before.

Mr Rockliffe claims there is still some debate and confusion around who in the relationship has the responsibility for suitability, the DFM or the adviser, but he adds if responsibility falls on the DFM then there will be far more costs and requirements placed on firms than in the past.

Research and consultancy firm Defaqto recently released a guide which in part attempted to delineate who was responsible for which stages of the relationship between a DFM, adviser and client, but the lack of understanding expressed by all sides suggests the regulator may need to step in to communicate its wishes more clearly.

Among other regulations that recently affected discretionary managers was a ruling from the FSA, and then the FCA, to ban rebates paid by DFMs to advisers that recommend clients to the discretionary manager.

These rebates were seen as totally anathema to the spirit of the RDR and while the removal of them has saved DFMs some money, it has also left them needing to find new ways to attract more business.

Matthew Jeynes is senior reporter at Investment Adviser

INCREASING PRESSURES

- Brewin Dolphin and Charles Stanley have had to raise their fees, and they have cited regulatory pressures for doing so.

- The regulator has clamped down across the industry on whether investments are actual suitable for the clients that are within them.

- There is still some debate and confusion around who in the relationship has the responsibility for suitability, the DFM or the adviser.

- The regulator has clamped down across the industry on whether investments are actual suitable for the clients that are within them.

- There is still some debate and confusion around who in the relationship has the responsibility for suitability, the DFM or the adviser.

DISCRETIONARY MANAGEMENT

DECIDING ON THE SERVICE

According to research and consultancy firm Defaqto, adviser due diligence should be structured to reveal why one service is more ‘expensive’ than another.

POSSIBLE POSITIVE REASONS COULD INCLUDE:

Exceptional personal service

A well-resourced research team with a wide range of skills

Expert use of a wide range of investment vehicles that may include alternatives

High quality investment managers (for bespoke clients)

Superior adviser support network

Providing ability to deal with clients with more complex financial affairs

Access to tax wrappers on favourable terms

SOME OF THE MORE NEGATIVE REASONS MAY INCLUDE:

Excessive trading – portfolio turnover rate should form part of due diligence

Cost of underlying funds may be higher than market average

Outdated systems requiring more manual intervention

Revenue replacement following RDR implementation and changing rules

Lack of scale and resulting inefficiencies

Fund rebates still, at least in part, going back to discretionary manager rather than the client (this is gradually declining now)

Source: Defaqto