FCA chief Andrew Bailey admits he has serious worries over a controversial piece of EU legislation that has vexed the funds industry.
Bailey (pictured) said he was not alone in being concerned about the packaged retail and insurance-based investment products (Priips) regulations, which came into force on 1 January.
Under the rules, fund managers must provide details on how they expect funds to perform in various market conditions through a standardised key information document (KID). This is designed to help investors make better informed decisions by being able to compare key features, risks and rewards of products.
In a speech on asset management delivered at the London Business School, Bailey highlighted some of the issues with the legislation and the negative impact it is having on the European funds industry.
‘I want to be clear that I am concerned about Priips, and I know I am not alone,’ Bailey said.
‘It carries a risk that it is leading to literally accurate disclosure which is not providing useful context, and there is evidence that funds, for instance from the US, are withdrawing from Europe to avoid the burden. I have also heard concerns about performance projections. We all have to take this seriously.’
Baillie Gifford’s James Anderson has been one of the most vocal critics of the rules, describing them as misleading.
‘We are extremely disturbed by the requirements of the key information document. We do not believe that reliance on past performance data is ever a sufficient guide to the many possible future outcomes in stocks and markets,’ Anderson said three weeks after the legislation was implemented.
In January the FCA published a statement clarifying its views on the KID. However, Bailey indicated more needed to be done in his speech.
‘Some firms have told us they have concerns about this directly applicable EU regulation,’ he said.
‘We will continue to engage with firms and their trade associations to consider how their concerns may be resolved so that investors get the full benefit of the regulation. We will also continue to work with the European Supervisory Authorities, and contribute to the European Commission’s post-implementation review of the Priips regulation.’
ETF and open-ended fund concerns
Bailey’s speech also covered the growth of exchange traded funds (ETFs) and the dangers this could pose to the financial system.
He highlighted that ETFs percentage of the £8 trillion worth of assets run by the UK funds industry has shot up from 20% to 25% in the last two years.
Bailey notes that this growth has come at a time of abundant global liquidity on the back on quantitative easing, resulting in investors seeking greater yield by increasing duration. He is concerned that if there is a ‘snapback’ in yields as monetary policy normalises in major economies, this could pose risks for ETF investors.
‘We know relatively little – as we have not experienced a stress since this structure grew so rapidly – about the capacity and willingness of APs (authorised participants) to execute their function in stressed conditions where they may be under pressure to tighten their own risk limits,’ Bailey said.
‘The result could be unexpectedly large discounts for ETF investors selling their holdings relative to the estimated value of the underlying assets, and possibly a need to suspend fund dealings.
‘We have no easy way of sizing this risk, but we cannot ignore its potential given the rapid growth of ETFs.’
Bailey also expressed some concern on whether the open-ended fund structure could cope in stressed market conditions.
The structure was tested during the dislocation caused by the EU referendum two years ago, when a number of property funds suspended redemptions.
While the suspensions generally operated without major disruption, Bailey feels the system could be improved.
He did not go as far saying the open-ended structure was inappropriate, but said lessons can be learned from the recent bout of property suspensions.
‘I would observe that funds with longer redemption periods did not experience the same issues in this most recent stress situation,' Bailey said.
'There is a lesson here about maturity transformation in a market liquidity context.'