Conflicts of Interest in Asset Management

The developing regulatory landscape
 

The obligation to manage conflicts of interest has been set out in the MIFID and UK regulation and more specifically under the Product Governance requirements but is also the driving force behind the UKs regulation on Assessment of Value and Consumer Duty. 

The shift in emphasis by the FCA from accurate disclosure of fees to an assessment of value together with the Consumer Duty regulation presented a fundamental change in how regulators assessed the industry. The FCA’s approach moved away from the long-held concept of “caveat emptor” for consumers or retail investors and shifted the burden of assessing value and the fair investor outcome to the investment firms and Board of Directors of the funds.

The FCA has since been followed by ESMA with an assessment as to the extent that costs and charges are fair in relation to the product and services provided to investors with a focus on prevention of undue costs being charged in UCITS and AIFs and its unitholders.

This raises the question of how asset managers should position themselves across different jurisdictions and regulatory requirements concerning conflicts of interest. We are setting out below several actions that firms can take to prepare and respond to the paradigm shift in regulation.

Industry Good Practice - Integration
 

It can be helpful for firms to respond by consolidating disparate frameworks to manage the conflicts of interest, the Assessment of Value, Product Governance and Consumer Duty into one framework, to aim for maximum alignment and exploration of synergies within the control and reporting framework.

In most firms, the same or similar data is used to inform separate functions managing the firm’s relevant processes and generating different reporting. Instead of creating one relevant information pool, each function extracts and maintains their relevant section of information in a silo, resulting in duplication and overlap of effort, with cases of data misalignment, different interpretation or misinterpretation. Internal compliance reviews and audits of the processes do occur, but due to the disparity and misalignment of processes and functions, in too many cases these reviews lead only to marginal improvements of small parts of the overall framework.

During the implementation of the Consumer Duty requirements, some firms have undertaken a redesign of all relevant processes and information used to manage the regulatory requirements, ensuring that all dimensions are considered holistically, as exemplified in the schematic below: 

One Policy Framework
 

Firms typically rely on one standard and high-level firm group conflicts of interest policy to manage their conflicts, in some cases with addendums for regional or local additional requirements. These policies are often focused on personal conflicts of interest such as ‘gifts & entertainment’ or ‘directors’ interests’ instead of including all conflicts of interest holistically. This results frequently in a lack of awareness amongst the senior executives and business lines of the variety and nature of conflicts of interest, that could arise in respect of their varied business activities. 

Any redesign of functions and processes into a comprehensive framework should therefore be accompanied with an alignment of all relevant policies and procedures. Firms should have an overriding and comprehensive conflicts of interest policy, supported by underlying specific policies or sections in the policy that drive the detailed procedures for the functions and staff, as exemplified in this schematic.

Governance, Escalation and Decision Making
 

Oversight of all conflicts of interest must be appropriate and effective. While not all conflicts need to be reported to the highest level of Senior Management (Board or Executive committee), the policy framework should require the firm to have adequate coverage of all material conflict types in an appropriate committee or forum that receives the relevant standing information and any ad hoc escalation to make decisions as to the management of the conflicts that arise. This committee or forum should be guided by the risk appetite set for each material conflicts type (see also our blog #2 on Risk Management and Risk Appetite).

While some firms have a dedicated conflicts of interest committee that covers all conflict categories comprehensively, others manage it in a set of specialised risk committees (e.g., Personal Conflicts, Best Execution, Product Governance) that report upwards to one general senior risk committee on an exception’s basis. It is, however, important to ensure that key function holders, i.e., persons who have significant day-to-day influence over the direction of the firm and heads of internal control functions, are members of such committees and that each committee or forum has a clear mandate for specific conflict types.