FCA Sector Views: The State Of Investment Management

The sector is experiencing substantial growth, but challenges loom

Every spring, the UK’s Financial Conduct Authority publishes its Business Plan, in which it offers a detailed explanation of its priorities and activities for the current year. The Business Plan always includes “Sector Views,” in which the regulator lays out the major issues and developments in each sector of finance, what’s driving change, and how that change might be harming consumers or markets.

This year, the FCA decided to publish its Sector Views ahead of its Business Plan, to give stakeholders a more “up-to-date insight into our view of how the financial system is working.” The FCA says it plans to continue this practice. As this is a blog focused on financial compliance, a business niche concerned with issues such as monitoring employee conflicts of interest and preventing market abuse, we’ll focus on two sectors covered in this year’s Sector Views: Investment Management and Wholesale Markets. Today’s blog will look at Investment Management. Next week’s blog will look at Wholesale Markets.

A growing sector
The investment management sector of UK finance includes asset management, institutional intermediary and advice services, and custody and investment administration services. Per the FCA, the sector overall remains a key contributor to the economy, though this year’s report focuses on happenings in asset management in particular.

One of those happenings is growth. Assets under management, or AUM, grew to £9.1 trillion in 2017, up from £8.1 trillion in 2016. The FCA attributed this to “strong stock market performance.” (Note: while these Sector Views were published last fall, they reflect mid-2017 data positions, well before stock markets tanked at the end of 2018.) The FCA also attributed AUM growth to strong net inflows from both retail and institutional investors. Net retail flows into UK funds grew from £7 billion in 2016 to more than £47 billion in 2017. Net institutional flows grew from £9 billion to £16 billion.

Also notably, the UK has more AUM than any other country in Europe, and manages as much as the next three countries combined. France has the second most AUM, but it’s still half that of the UK. Finally, though there are more than 1,500 UK asset managers, the top ten manage about half the total AUM.

A changing sector
The report identifies four drivers of change in the sector. First is Brexit, and the continuing uncertainty surrounding it. The UK government lost the first “meaningful vote” on its Brexit deal in Parliament, with no other option in sight, yet is still set to leave the EU on March 29. Asset managers are worried about the possible loss of passporting, and wonder whether delegation of portfolio management services will be affected. Whether the UK exits the EU with no deal or a negotiated deal, any exit will impact every sector the FCA regulates.

Political and social pressure for more responsible investing is pushing asset managers more and more into the role of steward, though there’s a lack of consensus on how to define and benchmark social-impact investing. And regulation is on the upswing, with both the Markets in Financial Instruments Directive II (MiFID II) and the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation having come online in January of 2018. Technology is the final change driver, naturally a big one, with increasing use of technology across all front, middle, and back office firm functions. 

A challenged sector
The FCA identifies two primary areas of challenge regarding the sector. High fees for poor quality asset management services is the main concern: from consumers struggling to assess and compare fees and products, to poor governance practices at asset managers. The result is investors overpaying for products or services, receiving poor returns after fees, and holding investments that diverge significantly from their stated objectives. Both MiFID II and PRIIPs should help this situation.

The second area of challenge is threats to the stability and the resilience of the UK’s financial markets. The report identifies four sector-wide issues, centered around the increasing use of automation in financial services and the lack of proper oversight. First is the potential for the effects from the failure of a custody bank to ripple out to the broader market. Second is the potential for the effects from a failure of a firm relied on for outsourced technology services to likewise ripple out into the broader market. Third is the potential for cyber crime to threaten market confidence and participation overall. Fourth is the harm poor technology-led asset management decisions, e.g., machine trading, could have on markets.  

Growth is good
Brexit is a big unknown. As this is being written, about two months out from the March 29 Brexit date, possibilities from all points on the political compass are being floated, including no-deal, a second referendum, and a delay or outright revocation of Article 50. No one knows what’s going to happen. But for the period reported in Sector Views, there’s nothing but good news for the investment management sector. Challenges do loom, but that’s the case for any era. Get more detail from the FCA on this critical sector in the full Sector Views report. And return to this space next week for a look at another key sector of UK finance: the wholesale markets.