Yesterday the Financial Markets Authority (FMA) released final guidance which aims to assist managers and supervisors of KiwiSaver schemes, and other managed investment schemes, to demonstrate how they are meeting their:
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existing obligations;
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statutory duties; and
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conduct expectations,
in respect of fees and value for money.
This guidance follows a consultation paper issued by the FMA in November 2020 (see our earlier update here). The FMA has also released a report of the submissions received.
Application of the guidance
There is a statutory obligation in the KiwiSaver Act not to charge unreasonable fees, but this obligation only applies to KiwiSaver schemes. Parts of the guidance are therefore specific to KiwiSaver schemes.
However, given the overarching statutory duties in the Financial Markets Conduct Act for managers to act in the best interests of members and to ensure members are treated equitably, as well as the FMA's expectations for good conduct, the FMA has made clear that most of the guidance is applicable to all managed schemes, including closed schemes.
The guidance states that Boards and senior managers of managed schemes should, with the assistance of their supervisors, take a disciplined approach to considering and being more transparent about the fees they charge and why, and what value their members receive in return.
Review of fees
Reviewing fees and value for money should be a continuous process and the FMA expects that reviews should be regular and with members' best interests as the overarching consideration.
A key takeaway of the final guidance is that managers are expected to carry out at least one formal annual review, involving the supervisor, of a scheme's fees and value for money. The review must either formally find that the fees are not unreasonable and the scheme is providing value for money, or alternatively prompt steps to remedy the position by increasing the value of the scheme to members, reducing fees, or both.
Managers and supervisors must be able to prove to the FMA that these reviews have occurred. In addition, it is strongly encouraged that schemes report the results of the reviews to their members.
Role of Supervisors
As supervisors are frontline regulators of managed schemes, the FMA expects them to monitor fees and to regularly challenge managers to ensure fees are not unreasonable or provide poor value for money.
Principles-based reviews
The guidance sets out the following four key principles that reviews of scheme fees should be based on:
1. Risk and return are critical – the two key indicators of value for money for members are how well the manager's process and capabilities appropriately minimise investment risk that members experience and members' return after fees. The guidance notes:
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The simplest indication of whether a manager's investment risk management capabilities provide value for money is whether they consistently exceed the return of their market index if active, or replicate it as closely as possible if passive.
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Net return should be reviewed alongside return before fees and consideration should be given to whether the amount of the return paid to the manager in fees is commensurate with the value provided to members.
2. The financial value of investment management must be shared – a member has not obtained the financial value of investment management if it is not shared appropriately between the manager doing the work and the member paying the cost and providing the capital, and therefore taking the risk. The guidance notes:
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If the financial value to the member of the manager's investment management capability is materially reduced or even eliminated by its cost, the manager's capability is less relevant to the member, who should go elsewhere.
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What is appropriate will depend on various factors and does not mean most or all profits should be allocated to members.
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The FMA expects KiwiSaver schemes to move toward eliminating membership fees from their fee structures.
3. Advice and service is received, not just offered – a service or feature provided by a manager contributes to a member's value for money only if it demonstrably helps the member make better investment decisions (eg advice) or demonstrably benefits the member's investment account (eg an investment process that reduces market risk, enhances returns or both). The guidance notes:
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Offering advice or services of any kind is not evidence of providing value for money. To claim value for advice or service, managers should evidence that the advice and service is received.
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While the FMA prefers that fees for advice are charged to the member, not the scheme, or are otherwise structured so members can choose not to pay the fee, the FMA acknowledges that the KiwiSaver market is still maturing and an optional fee for advice may dissuade KiwiSaver members from seeking advice.
4. Review yourself as you review others – when evaluating their fees and value for money, managers should use the same rigour they would apply to assessing the fees and value for money of any underlying manager. Although there may be good reasons for the outcomes to be different, there is no justification for the quality of the assessment to be different.
The guidance is designed to help managers and supervisors, by setting out a number of questions to guide the review process.
How the FMA can respond
The FMA states in the guidance that it will not hesitate to use its statutory powers to investigate commercial arrangements and obtain information to understand scheme costs.
If the FMA determines a fee to be unreasonable, a wide range of enforcement options are available, including:
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Stop orders, which can prevent a scheme from advertising or accepting new members;
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Direction orders, which can direct a manager to comply with the requirement to act in members' best interests;
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Censures, action plans and directions to a licensee (eg a manager); or
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Court action.
Please get in touch with one of our experts if you would like further information on the guidance and its application in practice. We recommend all fund managers and supervisors review this guidance and consider the fees and value for money of their schemes.
This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.