The changing landscape of fiduciary management: Spotlight on the CMA reforms

The investment environment is constantly changing, and with that so are the needs of pensions schemes. As such, the Competition and Markets Authority (CMA) recently proposed a number of reforms to the investment consultancy and fiduciary management sector. Today, we take a look at how these changes are expected to impact fiduciary management.

Change is upon us

A frequently heard criticism of the pension industry is that change, if it happens at all, takes place at a glacial pace. While this might be fair sometimes, it certainly can’t be said of the changes currently taking place in the fiduciary management and investment landscape in the UK.

The Financial Conduct Authority (FCA) Asset Management Market Study, launched in November 2015, and the subsequent referral of the investment consulting and fiduciary management market to the CMA, thrust the fiduciary management investment approach into the spotlight.

Pension scheme investment requirements

At the same time, we’ve witnessed significant changes to pension scheme investment requirements. The closure of pension schemes to new membership and accruals as well as the ongoing changes of scheme demographics, have dramatically changed the investment requirements. Open schemes with long-term investment requirements have historically been able to set static portfolio asset allocations and accept the volatility in investment returns, with time diversification smoothing the bumps. This is no longer the case for most schemes whose liabilities resemble a closed annuity book.

After a period of sustained challenges for pension schemes from rising deficits, some respite has been witnessed with changes to mortality assumptions and strong investment returns. But while the sustained bull run in most asset classes has provided windfall gains for pension schemes, it leaves them with the unenviable task of trying to replicate these returns in the future.

The changing needs of pension schemes

We’ve been through a long period where managing scheme funding positions has been a continual battle. Falling interest rates have pushed up liability values, improving longevity estimates have further driven up liability values and investment returns have failed to keep pace. Those schemes that took early decisions to hedge liability valuation risks have been well rewarded. For others, the higher balance sheet risk has been evident on the evolution of the funding level. More recently, the tide has turned somewhat. Continued strong investment returns have been supported by changes in liability valuations. A slowdown in the expected longevity improvements has fed through to reducing liability valuations and long-dated yields are up from their lows of mid-2016.

DB pension liabilities

However, scheme closures to new members and future accrual have changed the demographic profile of DB pension liabilities dramatically. The majority of schemes are now cashflow negative, with benefit payments exceeding contributions. Managing cashflows has become a key objective for many trustees, with the regulator taking an increasing interest. Alongside the structural change created by demographic changes, many schemes are experiencing significant transfers as members take advantage of the ‘freedom and choice’ rule introduced in 2015. The natural evolution to a cashflow negative position is being compounded by near term liquidity needs.
The long-term set and forget investment approach that was a feature of pension schemes historically is no longer valid. Schemes have much shorter investment time horizons, real-time risk measurement and management and immediate liquidity needs. By necessity, schemes are having to more frequently review and adjust their investment portfolios.

The impact of the FCA and CMA Reviews

The consecutive reviews of the industry by the FCA and then the CMA have provided a ready source of material for journalists. Beyond that, they have shone a light on the complex industry structure through which pension scheme investments are managed. MiFID II, regulatory change and a number of voluntary initiatives have worked in parallel with these reviews to increase transparency and enable pension schemes to make informed choices.
It feels like the publication of the CMA’s provisional report in July 2018 will soon bring the period of introspection to an end and will result in changes that produce better outcomes for trustees and the members that they represent.

What reforms are the CMA suggesting?

The proposed remedies for the fiduciary management sector seek to redress the ‘incumbency advantage’ that exists for the big three investment consultants. This advantage has been successfully exploited over recent years and the sheer volume of mandates that have been awarded without competitive tender is a sad indictment of this and has been highlighted by the CMA. What’s done is done but greater transparency and competition will serve consumers well going forward. A leveling of the playing field will benefit trustees, particularly where they are supported by The Pensions Regula­tor in running tenders.

The big three consultants

Unsurprisingly, the big three consultants are already resisting the idea of mandatory tendering, citing the additional cost and burden on smaller schemes. However, there is no reason why a procurement exercise should be unduly time consuming or expensive.

The CMA review has highlighted the complexity of an industry where there are few common definitions of the various services provided. Fiduciary Management, Implemented Consulting, Delegated Consulting and Outsourced CIO are all terms used to represent a similar set of services. As a result, we’ve been in a weird world where some providers of fiduciary management services have been in the full scope of the FCA and European regulatory environment.  Whereas other providers of similar services, by dint of their business model or organisational history, have fallen outside the FCA jurisdiction. The CMA’s recommendation to extend the FCA’s regulatory perimeter to include the main activities of investment consultancy and fiduciary management providers will ensure a consistent application of the regulatory protections that benefit trustees and members.

Fiduciary management: Balanced and transparent

The final output of the market review by the CMA – due by March 2019 – appears likely to result in a more balanced and transparent fiduciary management market in the UK. Enforced competition should be to the benefit of prospective (and existing) investors, as should greater focus on transparency, not least in the areas of past performance and fees. We welcome the new direction and look forward to contributing to an improved FM market and – most importantly – better outcomes for clients.

Learn more about Russell Investments’ approach to fiduciary management.

Next time, we look at the broken consulting model and how a fiduciary management approach can help you.