Dan Brocklebank says the FCA's proposed solution to address conflicts of interests at asset managers does not go far enough
The Financial Conduct Authority's (FCA) review of the asset management sector earlier this year and its ongoing efforts since then should be seen as welcome news for fund investors in the UK. In particular, the FCA is right to focus on governance as part of its broader package of reforms. In order to be effective, however, any proposed solution must ensure that asset managers act in the best interests of their clients and that conflicts are managed appropriately.
One proposal that the FCA has put forward in its consultation paper (CP 17/18) is the appointment of independent directors to serve on the boards of fund management companies. While this sounds like a reasonable idea in principle, it actually doesn't address many of the inherent conflicts of interest that were identified in the FCA's interim report.
In our view, the key problem is that even independent directors would face a significant conflict between their duties to the asset management group and to the individual funds and their investors. For example, these independent directors would depend on fund management firms for their selection, remuneration, and ongoing appointment to the board. This is clearly not an ideal arrangement if directors are expected to represent client interests in a truly independent manner, and to seriously challenge the firm's commercial decisions regarding fees and other charges.
As an alternative solution, Orbis has instead recommended that the FCA consider mandating the appointment of independent directors on individual fund boards. We believe this approach would have a number of advantages over the recommendations put forward in CP 17/18. In particular, independent fund directors would be free from inherent conflicts of interest and have no legal duties to the fund management group. They would therefore, be able to focus entirely on the interests of the fund and its investors. Of course, the independent directors would still be chosen by the management company in the first instance, but they would be paid by the fund rather than by the asset management firm, and could not be removed unless authorised by the fund's shareholders.
While no governance structure will ever be perfect, we believe that independent directors at the fund level would be in a stronger position to help enhance the value for money that investors receive. Indeed, legislation in the US has long relied on independent fund directors to do just that by policing conflicts of interest and negotiating fees paid to asset managers. Here in the UK, independent fund directors could play a similarly important role in approving the annual value for money assessment report that is being contemplated by the FCA as part of its reform package.
Last but not least, independent fund directors would help to level the playing field by applying the governance remedies proposed by the FCA to all UK-domiciled funds, including those managed by European management companies that are accessing the UK market through the UCITS passport and which are currently exempt from the FCA's proposed fund governance reforms.
In its final report, the FCA expressed support for fee structures that create a better alignment of incentives between investors and asset managers. Measures such as well-designed performance-based fee structures and significant co-investment alongside clients will help to ensure that managers feel their share of the pain when they fail to deliver value for money.
But none of these are one-off solutions. The real benefits will come when well-designed incentives are combined with strong governance driven by high-quality boards that are empowered to hold managers accountable for their ongoing performance and value for money. To that end, we believe independent fund directors would be yet another important step toward better outcomes for investors.
Dan Brocklebank is head of UK at Orbis Investments
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