The review by the Financial Conduct Authority (FCA) focused on what are called host-authorised fund managers (AFMs), companies with a vital but often overlooked role in the industry as low-profile fund overseers. Host AFMs are legally responsible for running funds, but delegate the investment management to third-party fund managers.
The crucial importance of these fund-runner companies in protecting customers was thrown into sharp relief by the collapse of Woodford’s flagship fund in 2019, which trapped 300,000 investors and £3.7bn.
Burnt investors plan to bring several lawsuits against Link Group, the UK’s largest independent provider of AFM services, arguing that the company failed in its responsibility to supervise Woodford and protect investors’ cash.
The FCA’s review report makes no mention of the Woodford debacle, but is seen in the industry as part of the regulator’s response to the scandal. It began in late 2019 months after the Woodford fund’s collapse drew attention to fund overseer companies.
The results suggest problems in the broader AFM industry could go beyond the Woodford case. The regulator said it would now consider whether it needs to change the rules for the sector, or require firms to hold more capital against their risks.
“Our review indicates that some firms are not sufficiently meeting FCA standards and we want to see significant improvement in this area,” said Sheldon Mills, executive director, consumers and competition at the FCA.
The regulators visited a number of AFM groups to check on their governance and whether they effectively oversee the funds they are responsible for. The review revealed some basic confusion about who AFMs were working for.
“We sometimes observed AFMs referring to a third-party investment manager to whom they have delegated functions as their ‘client’. This is an incorrect description of the relationship anticipated by the regulatory framework,” the FCA said.
While AFMs are supposed to look out for investors’ interests in their funds, industry experts have long questioned whether they are unduly influenced by the fund managers who often control their contracts and the related fees.
The FCA flagged instances of “poor” due diligence on fund managers, lack of qualified staff to provide oversight of funds, and weak governance and conflict of interest controls.
“It is exactly these kind of challenges that have been discussed at length regarding the Woodford situation” said Ryan Hughes, head of active portfolios at AJ Bell, an investment platform.
“The FCA had made clear some time ago that they wanted to look closer at the host AFM market in light of events with Link and Woodford to ensure that investors could have confidence in the outsourced AFM model,” Hughes said.
Chris Cummings, chief executive of the Investment Association, which represents the investment management industry, said the review “raises some important issues which the industry will address”.
“Investors must feel confident in the governance, oversight and broader processes that ensure fund managers deliver effectively on their behalf,” he said.
The regulator also questioned whether AFMs have enough resources to do their job properly, raising concerns about their business model. “We observed that several firms operate at relatively low operating margins and appear to lack appropriate investment in systems, controls and people to execute their role as host AFM effectively. Several firms also cited fee pressure from their delegated third-party investment managers,” the regulator said.
Karagh Gilliatt, a partner with law firm CMS, said that if the FCA requires more resources of AFMs then “the model could quickly become commercially unviable”, with fund managers looking offshore for other solutions.