Advisers may be becoming increasingly aware of a rising voice in the corridors of power, one to reform the regulation of U.K. investment companies post-Brexit. In this exclusive article, JB Beckett (pictured) does a deep dive into the detail. Not only does he share his analysis and perspective with us on what’s going on with regard to the regulation of investment companies but also what might a future regulatory regime need to look like and what education might be needed too.
It is interesting to hear talk of reforming the regulation of UK investment companies. After all, the grandees of these investment companies are among the oldest investment funds in the U.K., nay the world. To some they are the Jedi of the City. For others they are a dead religion in the face of a disturbance in the force that is indexation, evidence-based investing and Exchange Traded Funds.
That voice has come in the form of a Lords second reading of a private member bill by Baroness Ros Altmann, which I recently watched. The three clauses of Altmann’s bill seek to set aside 3 key pieces of EU-origin investment company regulation. It is fair to say Altmann’s efforts have drawn both plaudits and opponents in almost equal measure from different quarters of the industry.
The arguments produced for and against closed-ended funds are not themselves straightforward. Advisers, wealth managers and discretionary fund managers may feel rightly overwhelmed as to a path through the Consumer Duty.
Matters of cost disclosure
The obvious vex for investment companies centres around cost disclosure. And these quarrels have validity.
The errant reporting stems from the EU’s problematic Packaged Retail Investment and Insurance Products rules (‘PRIIPs’) which exaggerated the reported fees on investment trusts to a significant multiple. I can agree that the market was left uneven with closed-ended funds suffering commercially to the benefit of open-ended funds; whilst U.K. firms generally lost out to the US passive wave.
Set aside of MIFIR and AIFMR
Putting cost disclosure aside; Altmann’s bill also proposes to set aside the Markets in Financial Instruments Regulations (‘MIFIR’) and more reaching Alternative Investment Fund Manager Regulations (‘AIFMR’). To my mind, this step is too hasty.
MIFIR and AIFMR provide a number of investor suitability and systemic protections from the likes of liquidity, reporting, to capital constraints and remuneration codes.
In Altmann’s proposal, only the financial adviser or wealth manager would remain potentially liable for mis-selling if an investment company failed, value went to zero, delisted or otherwise became bankrupt.
Yet, in reality, many household name investment companies are run in a fairly prudent manner and often in tune with open-ended stablemates. Differences do exist nonetheless and over the years more closed-end funds began to invest into real assets, smaller esoteric companies emerged, REITs invested into property and generally many became more “alternative”. The introduction of AIFMR unquestionably stymied their marketability.
An audacious proposal
Altmann’s bill proposes returning investment companies to the U.K. listing rules regime. The narrative behind this audacious proposal is that investment companies should be treated in the same way as any other listed company. That argument is alluring, on face value reasonable, but it is deeply flawed for a number of reasons.
I’d identify a few of those reasons as being;
- Investment companies are mutable and do not make an easily identifiable widget, goods nor provide a consistent service.
- Unlike most stocks, investors may hold more of their portfolio in a single investment company, hinged on an assumption that they are more diversified.
- Investment companies that hold real assets cannot be analysed in the same way as normal stocks. Analysing only the price (as many do) inaccurately captures both risk and opportunity. This is moot given the strident calls to move retail investors and pensions into real assets and private markets.
- An investment company’s capital moves inside the structure and the shareholder has no rights over those assets.
As of now, an investment company is both an exchange security and collective investment scheme, simultaneously. This does not give any credence to removing the protections of one whilst retaining the advantages of the other. It is therefore pressing to flag that U.K. listing rules are under consultation to become even lighter touch, the net effect would be to deregulate investment companies whilst becoming more marketable and accessible to retail investors.
Consultant at Galactico, David Owen, notes the uneven playing field saying; “I feel that the education that we get, especially CPD, is biased towards those with the huge marketing budgets who are usually big American asset managers, and we are made to feel that open funds are the only way to go.”
In contrast Robin Powell, freelance journalist and Editor of The Evidence-Based Investor is concerned. He commented: “I feel very uneasy about the clamour for preferential treatment for investment trusts, not least because there’s a powerful political and industry lobby behind it. What’s good for the investing industry is very rarely good for consumers, and there’s no reason to believe that preferential treatment for investment trusts will be any different.”
Amid the oppositions, the active fund industry is ultimately cannibalising itself between closed and open ended; whilst, all the while, US and European index and Exchange Traded Funds (ETFs) keep subsuming assets away from U.K. companies.
Robin Powell notes a key driver behind this commenting; “There is also overwhelming evidence that, rather than paying high fees for active management, most investors are better off investing in publicly listed companies via low-cost index funds. On top of that, exposure to unlisted stocks and other illiquid assets adds complexity, opacity and, most of all, risk.”
Is it the answer?
Setting aside poorly applied PRIIPs cost disclosures is imperative. However, broader deregulation is not, in my opinion, the answer. If MIFIR and AIFMR were set aside, then the FCA would need to take significant steps to create a new regime that was both competitive but also offered sufficient protections to retail investors.
The FCA would do well to set up a working group to selectively appraise sections of applicable MIFIR and AIFMR, versus listing rules, to retain or identify a new way forward.
The question of riskiness and scalability of investment companies remains. Only through a well-regulated regime can investment companies truly rise, engender trust and become a competitive force.
Written by JB Beckett, Chartered MCSI
Emeritus, Association of Professional Fund Investors
Transparency Task Force Ambassador
Author of ‘New Fund Order’
