FMA’s Managed Fund Fees Guidance – extending the boundaries of unreasonableness

On 14 April 2021 the Financial Markets Authority released its latest guidance note ‘Managed fund fees and value for money’. The Guidance has a very different look and feel to the proposed guidance that was released for consultation back in November 2020. In particular, the explicit extension of its scope beyond KiwiSaver fees will come as a surprise to many.

In this Financial Law Insight, we take a look at what has changed since the original proposals, and what the final form of the Guidance may mean in practice for managers of managed funds.

In brief:

• Reasonableness of fees and value for money is not just something for KiwiSaver schemes – all managed schemes are within scope of the new Guidance
• Fees should be formally reviewed for reasonableness and value for money at least annually
• Four key principles have been provided to guide fee reviews
• FMA’s Guidance does not prohibit or prescribe any particular fee structure, size, or type

Background

The proposed guidance released for consultation by the FMA last November was titled ‘Proposed guidance on KiwiSaver fees and value for money’. At the heart of the approach proposed in that consultation was the statutory prohibition on charging unreasonable fees to KiwiSaver schemes. However, the consultation paper went beyond the prescribed constraint on the fees that can be charged, to outline the FMA’s expectations of scheme managers providing value for money from the fees they charge.

26 submissions in response to that consultation were tabled in the FMA’s submissions report released with the final form of the Guidance. Curiously, we were the only law firm on that list. We achieved a few wins from the concerns we raised, but couldn’t convince the FMA to change its position on all our points.

Our overall impression of the final product? It is pleasing to see better balance in the Guidance than initially proposed, and helpful to have the principles underpinning a reasonableness assessment spelled out, providing an objective reference point for fee reviews. The FMA’s expectations of all fund managers in relation to fees are now very clear.

Scope of the Guidance

Perhaps the biggest talking point of the final form of the Guidance is the shift in focus from KiwiSaver fee reasonableness to value for money for all managed fund fees.

The universal relevance of the issues under consideration was noted in the November consultation. However, the title of the consultation paper will have led most to assume the FMA was only thinking about issuing guidance for KiwiSaver providers. By our count, that means over 60% of licensed managers may have assumed the consultation was not relevant for them, especially given the fact that the statutory prohibition on unreasonable fees only applies to KiwiSaver schemes.

We think the breadth of the Guidance is appropriate. While it is unfortunate the signalling in the November consultation was not clearer, when you read the detail of the Guidance it’s hard to challenge the logic behind extending its coverage to apply to all managed investment schemes.

All managers of registered schemes owe duties to their investors and are subject to FMA’s good conduct expectations. According to the FMA, all should be delivering investors value for money. On that basis, it would be wrong to exclude them from the scope of any fee guidance issued.

Review Principles

The FMA expects scheme fees to be formally reviewed at least annually, and whenever there are changes in the scheme that materially affect the costs involved. The scheme supervisor is expected to be involved in those reviews.

Helpfully, the Guidance sets out the FMA’s expectations as to how reviews should be undertaken.

Four key principles on which reviews should be based are articulated, with a detailed set of questions provided for each to help managers and supervisors work their way through a review:

Risk and return are critical indicators of value for money for members

Forget about previously held views on ‘value-adds’. According to the Guidance, the key determinants of value for money are how well the manager minimises investment risk in the context of the particular fund, and members’ returns after fees.

One-dimensional, perhaps, but in essence results matter. The place of customer service and efforts to enhance investor financial literacy in this equation is unclear. We still think those aspects of what a manager delivers are also part of the value for money equation, but if a scheme isn’t performing on its financial metrics it seems managers will now struggle to point to the costs of providing those value-adds as justifying its fees.

The financial value of investment management must be shared

While a fund manager might provide value through its skills and work undertaken in generating returns, it’s the scheme members taking the risk through investment of their capital. There should therefore be an ‘appropriate’ split of the financial benefits derived from investing member funds. What is ‘appropriate’ will depend on a number of factors.

We like the fact that the Guidance challenges managers to consider the reasonableness of their costs structures, without prescribing anything specific. While some of the assessments based on the FMA’s newly articulated expectations might be uncomfortable, the Guidance raises questions that needed to be asked. We think the balance struck for this principle is about right.

Advice and service contributes to a member’s value for money only if they are received, not just offered

The saying ‘build it and they will come’ springs to mind: if they don’t end up coming, can you still factor in the costs of building whatever you have offered into your fee reasonableness equation?

The Guidance’s answer to that is a fairly emphatic ‘no’. If members don’t receive a service or directly benefit from a scheme feature, they don’t receive value for money from having it available. As with the first principle, the focus is largely on adding value to a member’s account – if a feature doesn’t do that, or doesn’t help investors make better informed investment choices, then according to the Guidance it is not providing value.

In our view this is too one-dimensional. However, that’s the FMA’s expected approach.

The one thing we are pleased to see in the detail for this principle is the concession that it is acceptable for the cost of making advice available for members to be borne by all members, and not just those accessing the advice. The Guidance pulls back from the original proposal that fees for advice should be separately disclosed and charged to the member benefiting from the advice and not incurred by all scheme members.

This was one of our key submission points. Having it reflected in the final form of the Guidance is a massive win for enhancing the availability of advice. While the FMA’s preference remains that the costs of advice should be covered on a user-pays basis (and the FMA’s expectation is that providers will move to this model over time), that preference has not translated to a directive.

Fund managers should review themselves in the same way they review others

A useful set of questions is supplied to guide managers through the process of self-assessment, noting the logic behind applying a similar approach to that they may take in assessing those who provide investment management services for their scheme.

In the KiwiSaver context there is still an expectation of comparing fees charged with those charged by the relevant scheme’s default funds or by other schemes’ default funds where they have similar features. This was another proposal we had argued against, but on this occasion we were unsuccessful.

Practicalities

The immediate takeaway action for scheme managers is to work out the most effective way of operationalising the fee review aspect of the Guidance, in a way that makes sense in the context of their particular scheme. Agreeing the methodology that will be applied with the scheme supervisor in advance of a review taking place then seems a logical next step.

Exactly what will be appropriate and what will be most effective in each case will depend on the dynamics of the particular scheme. While the Guidance provides a framework that could support a cookie-cutter approach to this important task, in our view that would be a mistake. The Guidance challenges managers and supervisors to take a disciplined look at how scheme fee structures are delivering value for money. To our mind, that does not translate to a one-size-fits-all approach. Expect to see some innovations in this space as managers grapple with the appropriate processes to adopt to operationalise the Guidance.

Concluding thoughts

Regardless of whether you agree with the detail of the principles that have been articulated in determining fee reasonableness, the Guidance provides a clear framework for managers and supervisors to go about assessing the reasonableness of scheme fees. Significantly, we now have a regulatory ‘value for money’ concept that scheme managers are expected to demonstrate. Previous assumptions as to what should be taken into account in assessing value will not necessarily hold true.

The next step in the journey is for managers to get on with implementing the Guidance as best they can for each scheme they are managing.

Start a conversation

If you would like assistance with operationalising the final form of the FMA’s managed funds fee guidance, or would like to discuss any other aspect of licensee obligations for managed investment scheme managers, please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840 or email the team at bankingandfinancialmarkets.nz@dentons.com.