The FCA recently published their thematic review, Meeting investors' expectations TR16/3 (Thematic Review). The main purpose of this Thematic Review is to ascertain whether UK authorised investment funds are being managed in accordance with the investors' expectations as set by marketing and disclosure material. The FCA also considered how firms monitored the distribution of their funds.
In order to carry out the review the FCA took a sample of 23 funds and four segregated mandates managed by UK fund managers. All of the funds were Undertakings for Collective Investments in Transferable Securities (UCITS) available to retail investors, 20 of which were available on commonly used execution-only platforms.
1. Key findings
Overall, the FCA findings were positive, with the FCA comfortable that the fund managers were generally complying with their regulatory obligations and meeting investors' expectations. However, there were three areas of concern for the FCA: clarity of product description; inadequate governance; and inappropriate distribution of products.
1.1 Clarity of product description
The FCA believes in the importance of clear product descriptions, which in their view are key to ensuring that investors understand what they are buying. In particular, the FCA noted that investment strategies and risk warnings need to be clearly explained so that customers can make informed decisions. Examples of good practice included:
involving the fund manager in the drafting of the description of the investment strategy in the prospectus;
clearly disclosing the complexity of a fund and recommending that potential investors seek advice;
being specific about the potential investments to be used by the fund;
accuracy and consistency across all the fund documentation, to avoid investor confusion;
consumer testing - one firm tested a panel of retail investors' understanding of the product documents and used their findings to inform future documentation.
Examples of poor practice included:
a fund with a broad investment mandate, without sufficient information as to how a fund manager might use the mandate, which could lead to customers investing in funds that have a different asset allocation to what they expect. In the FCA's view this posed a risk that the fund might not be appropriate for the customer's needs;
undisclosed passive investments - two of the funds that the FCA reviewed did not mention in their documentation that as part of these funds' overall investment strategy approximately 20% of each fund's assets were passively invested to track an index. This lack of information could pose a risk that such funds did not meet customer expectation.
1.2 Governance and oversight
The FCA also stressed the vital role of governance and oversight in relation to funds, setting out that firms are obliged to act in the interests of their clients when operating or managing funds and that these obligations last for the life of the fund. This relates to one of the key requirements of the Thematic Review, i.e. to ensure fund managers deliver products in line with investors' expectations.
In practice, to meet the expected governance and oversight requirements, firms need to carry out regular portfolio monitoring, and should review on a regular basis all aspects of the fund that investors would expected to be delivered based on the fund documentation. The FCA further stressed that this ongoing requirement to monitor funds applied whether funds are being actively marketed or not.
An example of good practice included a fund manager who reviewed various aspects of the fund's actual management and operation against the communications distributed to investors, such as reviewing the fund's portfolio turnover rate against the long term investment approach communicated to investors.
An example of poor practice included inconsistent reviews across the product range. For example, there was a firm that reviewed the cost of its annual management charge (AMC) for two funds and reduced it because a charge for advice was no longer required to be built into the AMC. However, as it did not carry out this review across all funds with similar charges this meant that there were funds (that were no longer actively marketed) that retained the inappropriately high AMC.
1.3 Appropriate distribution
Both the fund manager and the distributor (such as the platform) are responsible for the distribution of the fund and both should have adequate systems and controls in place to ensure that funds are distributed appropriately.
In order to allow fund managers to properly manage the distribution process, the FCA expects them to monitor sales patterns and indeed most firms were found to be doing this.
Examples of good practice included:
- using specific indicators to monitor sales - for example, one firm treated instances of high numbers of cancellations as a warning sign which should prompt further investigation by the firm;
- carrying out sufficient due diligence on new advisers, providing extensive training on the products and testing their knowledge of the funds provided by the fund managers.
Examples of poor practice included:
- two funds available from execution-only platforms (and therefore without advice) where the fund managers themselves had designed the funds to be sold with advice;
- the preparation and circulation of fund factsheets that did not make it clear on their face that they were intended for professional clients only.
2. Next steps
The FCA wants all fund managers to consider the findings of the Thematic Review and consider their own systems and controls for the distribution of their funds. Firms should pay particular attention to FCA's examples of good and poor practice. The FCA will provide individual feedback to each firm in the thematic review sample and will follow up on the issues identified through its routine supervision. This is perhaps rather a timely reminder for firms. With MiFID II's focus on product governance arrangements, taking account of this thematic review and reviewing existing practices is likely to be part of a bigger project in that context.
If you require further information on anything covered in this briefing please contact Fiona Lowrie (firstname.lastname@example.org; +44(0)20 3375 7232), Grania Baird (email@example.com; +44(0)20 3375 7443) or your usual contact at the firm on 020 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, May 2016