Today, the FCA published its asset management market study final report.

The report makes a series of recommendations including a strengthened duty on fund managers to act in the best interests of investors, removing barriers to pension scheme consolidation, improving the quality and consistency of asset manager disclosure requirements, and bringing investment consultants into the FCA’s regulatory perimeter.

Commenting on the report, Nathan Fabian, PRI Director of Policy and Research, said,

“The financial system performs many important functions in society, but it doesn’t always work as it should. We welcome the FCA report, which is an important intervention that addresses the fund management services provided to millions of UK and international savers. We encourage the FCA to go further in considering ESG issues as a growing unmet investment industry need and as a driver of competition within the asset management industry.”

In strengthening the duties on fund managers to act in the best interests of investors and beneficiaries, the FCA should make explicit reference to ESG issues. A clarification of investor duties would reflect the findings of the Law Commission, in its report Fiduciary Duties of Investment Intermediaries, which stated that “there is no impediment to trustees taking account of environmental, social or governance factors where they are, or may be, financially material”.

This year, the PRI introduced a major programme of reform to address the risk and challenges that undermine financial system sustainability. The Sustainable Financial System programme identifies causes of an unsustainable system and propose projects to address them. This includes a project looking at the influence of investment consultant advice on the investment strategies and resulting asset allocation decisions of pension schemes.

The FCA report notes major concerns with the asset consulting industry, including high levels of market concentration and low levels of switching rates. We find these issues also influence how ESG factors are taken into account. We find that investment consultants often base their advice on a very narrow interpretation of investment objectives. While the major consulting firms now have responsible investment specialists or small teams focused on responsible investment, these are usually established as separate advisory centres rather than being integrated into all investment advisory services, which results in ESG being an additional service and cost. We recommend the FCA and Treasury ensure that sustainability regulations are aligned, with sustainability issues properly integrated into the advice being offered by asset consultants and used by asset owners.

The report also recommends the DWP remove barriers to pension scheme consolidation. In addition to facilitating competitive pressure on asset managers, there is evidence that pension scheme size is positively correlated with good governance and ESG practices. In Fiduciary duty in the 21st century UK roadmap, PRI, UNEP FI and The Generation Foundation recommend the government should simplify the procedures for pension scheme consolidation in order to enhance consideration of ESG issues. The DWP has previously consulted on pooling, facilitating pooling of UK Local Government Pension Schemes (LGPS) to offer potential cost saving and efficiency, including in stewardship and active ownership. This should be extended to other groups of pension provision as set out in the DWP’s recent green paper on defined benefit pension schemes.

A few respondents, the report says, suggest that ESG factors should be “routinely reported to aid investors’ understanding of long-term performance”. PRI has long believed ESG integration and stewardship practices should be a source of competitive differentiation among asset managers. PRI provides tools to support investors integrate ESG issues across asset class and in company engagement, as well as a reporting framework publishing “transparency reports” of asset manager approach to responsible investment.

Nathan Fabian added,

“We must ensure that the financial system in which investors operate has the structure, regulations and practices that enable long-term investment to flourish.

“Better aligning the financial system with sustainable, equitable economies will enable investors to anticipate and respond to ESG issues and therefore fulfil their obligations to clients and beneficiaries over the long term.

“As the FCA, Treasury and asset management industry consider their response to the report’s recommendations, we recommend that sustainability considerations are at the forefront of regulatory and market structure reform.”