The market turbulence caused by Covid-19 in recent weeks has stress-tested the rules governing investment products
A degree of confidence that they will stand up to the tests gives investors one less thing to worry about.
That they have is not surprising, based on the findings of the latest edition of our Global Investor Experience study, which explores the policy and taxation characteristics that encourage people to invest, and the regulatory environment that governs the products that enable them to do so.
Overall, the global market has strong measures in place with robust regulation that generally protects mutual fund investors, provides reasonable disclosure and establishes safeguards.
Strength of UK regulation
The UK is particularly strong when compared with the main investment regions globally, given the success of pensions auto-enrolment; the range of incentives for ordinary people to invest through tax-wrapped accounts; high standards of disclosure; and strong management of conflicts of interest all contributing factors in creating a positive experience for investors.
In recent years the UK investment market has upped its regulatory game even further.
Key Points:
- The UK has particularly strong measures compared with the main investment regions globally
- Costs are a focal area of most regulators
- Strong regulation does not mean investors will not lose money
Some of the provisions of Mifid II have played a part in raising the UK’s standards over the past few years, as they have in every European country.
However, the UK stands out in a number of areas where the regulator and industry have gone further, such as with the outcomes of the Financial Conduct Authority’s Asset Management Market Study.
In particular, the requirement that fund company boards comprise at least 25 per cent independent directors (and a minimum of two) counterbalances executive management.
And the specific board responsibilities around assessing the value that each of their funds provide to investors is a market-leading development.
Money matters
Costs are a focal area for most regulators. In the past few weeks alone, the European supervisory authorities have published their annual reviews of costs and performance, and the European Securities and Markets Authority submitted its technical advice to the European Commission about both Mifid cost disclosures and inducements.
The UK assessments of value impose practical actions that strike at the heart of both subjects, empowering them to tell their investors annually how they measured up against the objectives they set themselves and whether the service they provided represented good value for the fees they charged – in essence, compelling fund directors to wear the hat of their investors when conducting their assessment.
Assessments of value are the next step in the progress the Retail Distribution Review made.
The RDR put the UK on a strong footing regarding inducements, and the value assessments are in some ways finishing the job that RDR started.
A sizeable number of long-term fund investors have remained in expensive legacy share classes, and the new requirements to explain why some investors might not have been moved to a lower cost class with substantially similar terms have helped put a renewed focus on them.
In the first few months of 2020, several companies have taken steps to transfer unit-holders, made easier by another FCA rule change that allowed businesses to dispense with seeking unit-holder approval in those cases where a move would be in their best interests.
Fees also come under scrutiny in the context of the costs of the fund, comparable market rates, comparable services and economies of scale, and together this has directly or indirectly contributed to some fee reductions or restructures on individual funds or fund ranges.
That the assessments published so far are a mixed bag in terms of presentation, engagement and information is no great surprise in light of the FCA’s deliberate approach to not inhibit how and what companies assess and report, with the proviso that seven named factors are included.
Grading performance
Beyond the five mentioned above, quality of service and performance must also be assessed.
Companies have adopted various approaches to grading their performance, and it is the one factor on which boards have criticised some of their funds, calling for closer monitoring.
Otherwise, the vast majority of share classes for which boards have published an assessment thus far have been adjudged overall to offer value in the context of the charges levied.
Initial assessments of value have ticked a box, but there is an opportunity for asset managers to go further.
As we continue through the full reporting cycle over the next nine months, it will be interesting to see the FCA’s views on the first round of assessments and whether they issue further guidance, critiques or highlight particularly good practice.
Equally interesting will be whether any other national regulators in other countries emulate this innovation, or whether, having established the process for their UK funds, some companies elect to roll it out for some of their overseas funds, potentially giving them a unique selling point in other markets.
While the assessments of value are only required for UK-domiciled funds, the FCA, as part of its continuing Brexit preparations, is consulting on an overseas fund regime as a means to preserve the wide choice of foreign funds that UK investors have enjoyed as part of EU membership.
More broadly, HM Treasury is overseeing a review of the UK’s Future Regulatory Framework, specifically considering the issue of coordination between the various regulatory bodies.
A welcome near-term outcome is the Regulatory Initiatives Grid, published this month and updated twice a year thereafter.
It is a simple but potentially effective idea to provide an indicative two-year horizon of upcoming regulatory initiatives, designed to help companies plan ahead and regulators to stagger their work.
While measures such as these contributed to a strong report card for the UK, standards in most major markets have been raised to the overall benefit of investors.
And as the Global Investor Experience study concluded, regulation is but one driver of market outcomes, with factors like competition and specific market-focusing events also being key contributors.
To return to where we started, strong regulation does not mean investors will not lose money during downturns, but Covid-19 has not shaken our faith in the overall regulatory strength in the markets.
Andy Pettit is director of policy research at Morningstar
