UK: Fiduciary Management: Improvement Through Competition?

Have you ever considered using fiduciary management services?

  • Does your scheme have a fiduciary manager?
  • Are you considering appointing or replacing a fiduciary manager?

If so, you should already be considering the implications of the Competition and Markets Authority's final report into the investment consultants market. The new requirements arise from concerns around the operation of the £1.6 trillion market for managed investments.

New rules are expected to come into force in late 2019. These will require trustees who appoint fiduciary management services for their scheme's assets to run a competitive tender process in respect of the appointment.

If you are considering appointing or replacing your provider, act now to ensure you are not storing up trouble for the future.

Key action points for trustees considering fiduciary management

  1. Are you already in the process of appointing a fiduciary manager? Consider running a competitive tender.

    The introduction of mandatory competitive tendering is not expected to come into force until late 2019. However, in light of the report, trustees should already be considering whether it would be appropriate to make an appointment without running a tender process first. To a large extent, we think it is possible to anticipate the Pensions Regulator's likely stance on how that should be done.
  2. Are you considering appointing or replacing a manager in the near future? Awaiting guidance could help your process.

    The report confirms that the Pensions Regulator is expected to produce guidance for trustees when running tenders for investment consultancy and fiduciary management services. If you have the option, it may be beneficial to wait for the guidance to ensure your process is fit for purpose and meets the requirements.
  3. If you're considering an appointment, how does that fit within your wider business plan, budget and investment strategy?

    The competitive tendering process is likely to be more time intensive and costly than trustees may be used to experiencing on past appointments. You should ensure your business plans and budgets contain sufficient capacity for making an appointment/re-appointment. Likewise, the process is likely to take longer, so ensure that is not going to impact negatively on your investment strategy.

The investment landscape

In November 2018, we published an article considering whether the outpouring of recent pension investment publications, legislation and guidance meant a sea change for trustees' investment duties, or whether it was just more of the same.

We now consider the impact of a further publication on trustees' investment duties, the Final Report from the Competition and Markets Authority ("CMA") on its Investment Consultants Market Investigation.

The CMA describes itself as the UK's primary competition and consumer authority, with responsibility for carrying out investigations into, among other things, regulated industries, and enforcing competition and consumer law.

In September 2017, the CMA launched an investigation into:

  • investment consultancy services, which provide advice to institutional investors (mainly pension funds) and employers on their pension schemes; and
  • fiduciary management services, where the provider makes and implements decisions for the investor.

Of particular interest to trustees, the investigation considered whether there are competition problems arising from the sale of fiduciary management services by integrated investment consultancy and fiduciary management firms (referred to in the report as "IC-FM firms").

On 12 December 2018, the CMA published its Final Report into its Investment Consultants Market Investigation. While the report contained a number of remedies, this article considers what it means for trustees appointing fiduciary managers for their scheme.

A new focus on competitive tendering

The CMA's Final Report found there is an adverse effect on competition in the investment consultancy market and the fiduciary management market from which substantial customer detriment may be expected to result. Given the volume of investments under the control of these providers (with some £1.6 trillion of investments being managed on behalf of scheme members), the CMA concluded that it is vital that competition within these markets works well.

Competition concerns

A host of competition concerns were raised in the 440 page report.

The report noted that decisions about using fiduciary management services and which provider to choose are important for trustee boards. In this context, the report noted that concerns had been expressed about IC-FM firms steering clients towards their own firm's fiduciary management services. Half of pension schemes where trustees have appointed fiduciary managers have used those supplied by their investment consultant's firm.

The "steering" behaviours adopted by some IC-FM firms, combined with low engagement by some trustees when first making these appointments, has contributed to an advantage for incumbent providers to such an extent that schemes are less likely to get the best value deals. The nature of fiduciary management means that, once the appointment is made, it becomes harder for trustees to stay close to what is happening (and extremely difficult or impossible to make clear comparisons between what the new manager is delivering and what another might have delivered).

The remedies

The CMA's report sets out a series of remedies it is seeking to use to improve the market. In respect to the concerns above, these include:

  • mandatory competitive tendering for pension schemes first buying fiduciary management services or if they have not tendered previously;
  • the separation of advice and marketing by IC-FM firms on fiduciary management services; and
  • a recommendation to the Pensions Regulator to provide enhanced trustee guidance on competitive tender processes.

Mandatory competitive tendering

Of all the CMA's recommendations, the introduction of mandatory competitive tendering is likely to create the greatest burden on trustees (whether or not it also creates any long term benefits).

It has previously been common for IC-FM firms to direct trustees to their own fiduciary management services. In future, trustees will be required to use a competitive tendering process:

  • before first appointing fiduciary management services for 20% or more of their scheme's assets;
  • before increasing delegation to fiduciary management that increases the assets under management to 20% or more; or
  • trustees have previously appointed fiduciary management services without using a competitive tender process:
    • within five years of that appointment;
    • if a scheme's appointment is already more than five years old, within two years from the date the order is made.

What is competitive tendering?

The CMA report states that trustees need to test the market before buying services to ensure an informed choice and to drive competition. In particular:

  • the process should enable trustees to demonstrate that they have made a reasonable effort to obtain at least three submissions from unrelated parties;
  • trustees may find it helpful to use a third party evaluator ("TPA") as part of the tender process. However, this will be voluntary given the cost and the risk of trustees' over-reliance on TPAs meaning they fail to engage with the market themselves.

What this involves in practice for trustees is likely to be made clearer once the Pensions Regulator has published its guidance on conducting a competitive tender process, which has been requested as part of the report. Given the complexity and opacity of some fiduciary management models, care would need to be taken in engaging TPAs and in interpreting and placing value on what they are able to conclude.

Can trustees avoid it?

In most circumstances, no.

Fiduciary management firms will be prohibited from accepting a new mandate that is the first purchase of fiduciary management services by pension scheme trustees unless a competitive tender process has previously taken place. Not all relevant firms are FCA regulated. However, the CMA has announced its intention to liaise with all relevant designated professional bodies to ensure an even playing field and consistent regulation between providers.

Where there is an existing provider in place, they will not be required to stop offering services if a tender does not take place. The duty to comply with the requirement to conduct a competitive tender will lie with the trustee.

There is no minimum threshold of scheme size for the requirement to apply. However, the report notes that some types of schemes may be excluded from the requirement, which will be considered during the implementation phase of the investigation. It is not clear what sort of scheme is envisaged here, the CMA having already ruled out a scheme size threshold.

The one clear exception to the new duty is for staff pension schemes of IC-FM firms, which are excluded on the recognition that they are highly unlikely to appoint a competitor to their own scheme, in part due to confidentiality concerns.

Timetable for implementation

The CMA is intending to implement the remedies by order, where possible. The order must be made within six months of the publication of the Final Report, although this can be extended by a further four months. During that period, a public consultation will be conducted.

Once published, it is expected that the requirement for mandatory competitive tendering will come into force six months after the order is made.

Immediate steps for trustees

Trustees still have some time before the requirement to run a competitive tender comes into effect, which will likely be late 2019. However, trustees thinking about appointing a fiduciary manager should already be considering the impact of the new rules.

  1. If you are appointing or replacing your fiduciary manager prior to the introduction of the new rules, you should at least consider whether it is appropriate to first run a competitive tender process. If you decide to proceed without one, consider documenting your thought-process and your reasoning for proceeding without a formal tender. In light of the current climate, particular care should be taken if you are relying on an investment consultant from the same firm or group to give the advice which trustees are obliged to take before they appoint a fiduciary manger.
  2. Does your business plan for 2019/20 include appointing or replacing the scheme's fiduciary management services? The competitive tender process is liable to be more time-consuming and intensive than trustees may have been used to in the past when appointing advisers. It is important to ensure that sufficient time is given to the process and that the decision does not need to be rushed or have an adverse impact on other scheme business.
  3. Ensure you have budgeted sufficiently for the process. Along with the greater time involvement of a competitive process, the increased advice trustees are likely to require as part of the process could put budgets under strain if this has not been allowed for as part of the budgeting process. For example, will you want assistance from a third party evaluator? On the other hand, the savings and performance enhancements which ought to flow from making the right appointment at a competitive price ought, in most cases, to be capable of dwarfing the costs of the appointment process.
  4. How do your fiduciary management plans fit with your overall investment strategy? If your scheme's investment strategy contains de-risking triggers or other targets, ensure you allow sufficient time to appoint a fiduciary manager so that it can be completed without putting your wider investment plans at risk. It will be important not to miss good investment opportunities because you are between managers. Likewise, you do not want to have to rush the appointment process to enable your desired investments to proceed.
  5. Consider the timing of running your tender. If you intend to appoint or replace a fiduciary manager during 2019/20, it may be worth delaying your process slightly to enable the Pensions Regulator to publish its guidance. This may save time and cost in the long run, and avoids the risk of running a process which may prove non-compliant once the full requirements are known.
  6. Consider when you discuss this matter with the fiduciary manger, because the temptation to manage for the short term and to produce results which enhance their chances in the tender process (rather than focussing solely on implementing the long term strategy) may exist to some extent in some cases.

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