Background – What, When, Why?
The FCA ruled on 20 September that from 3 January 2018 asset managers have a legal duty to respond to requests from workplace DC governance bodies for information on transaction costs using the ‘slippage cost’ calculation methodology.
This has implications for DC Trustees and IGCs, who will need to step up and report whether these costs represent ‘good value’ for members in their Chair’s Annual Statement. To date they have largely side stepped the duty to assess this information, by explaining that the asset managers have been unable to provide the information, that the industry has been in a state of flux, and that they have been awaiting clarity on the calculation methodology. The FCA ruling on 20 September has now changed all that.
Transaction costs & ‘slippage’ method
Transaction costs are generally incurred when securities are bought and sold. They are made up of explicit costs – such as brokers’ commissions or fees, stamp duty, foreign exchange, custodian charges – and implicit (or hidden) costs, which will use the ‘slippage cost’ methodology to calculate the market impact of trading. This method calculates the trading cost by comparing the price at which the transaction was actually executed with the price when the order to transact entered the market.
Issues & challenges around ‘slippage’ costs
There have been reservations around the ‘slippage cost’ methodology because it can throw up odd results. For example, if you are selling securities into a rising market or buying into a falling market the calculation produces a credit that may outweigh the other ‘explicit’ transaction costs, resulting in negative overall transaction costs. This makes the ‘good value’ assessment even harder for trustees.
This increases the importance of assessing the context, not just the number, when assessing value. A high cost is not necessarily bad, so a qualitative assessment of the context will be crucial.
An assessment that addresses product cost differences, e.g. active versus passive, by giving context is essential. This is likely to result in a lot of additional time-consuming and costly work for asset managers addressing these queries.
Asset managers will also want to maintain confidentiality around commercially sensitive information, such as contractual terms with their brokers and their providers, and avoid any security breaches from data being shared with multiple parties.
For trustees and IGCs, this is a complex area, which could be equally time consuming and costly. They will be looking for solutions that allow them to carry out this assessment in an efficient and cost-effective manner.
Shining a spotlight on transaction costs will highlight variable practices across products and asset managers, such as portfolio turnover, efficient trading processes, who pays for brokers’ research and policies around stock lending and box profits. This information will better inform and educate trustees about the products in which they are investing.
It also brings disclosure requirements into line with European-wide regulation such as MIFID II and PRIIPS, which will over time improve transparency and trust in asset management generally and ensure they are delivering ‘good value’ to members of pension funds.