Understanding Transaction Cost Regulations

January marked the introduction of new regulations around the measurement and disclosure of transaction costs for workplace pension schemes in the UK. Alongside this, two sets of EU regulations for products that come under MiFID II and PRIIPs regulation, also came into force.

It’s unlikely this will be a smooth ride for trustees as they start to digest this flurry of new information. However, there are a number of things that we believe you can be doing now, to prepare for when the data lands.

Know the why and when

Firstly, make sure you’re aware of why and when this is happening.

The FCA’s main aim for bringing in the regulations is to help pension scheme trustees and governance committees make a more complete assessment of value for money (VfM). The new information will also bring greater transparency to the costs paid by pension scheme members and allows governance bodies to better question service providers about their approach to areas such as trading.

The new rules came into force in January 2018 and follow several years of concerted activity to agree a common framework for measurement and disclosure. But it’s likely to be the latter months of the year before a full set of data emerges. This is due to the difficulties in capturing some of the information and applying it to workplace pension fund structures.

Ask questions and get yourself familiar with what is coming

Next, make a formal request for data. It may sound obvious but if you haven’t already, you should really be doing this now, even if the data is not yet available.

At the same time, there are some key questions that you should be asking your asset manager or workplace pension provider about their approach.

1. When will the data be available?

You’ll need it in good time to build into your framework for making wider VfM decisions and disclosing in the chair’s statement. It’s no secret that gathering the information defined by the FCA has been a challenge. While it could be later in the year before the data becomes more meaningful, some parts of it may be available before then.

2. What calculation basis is being used?

The FCA rules state that the ‘slippage methodology’ should be used as the measure of total transaction costs. This calculation needs a crucial piece of information, an ‘arrival price’ for each underlying security within a fund. This price could be captured in several ways, so understanding which method has been used will be important.

3. How much detail will be provided?

The FCA rules state that both aggregate and breakdown costs should be provided. Headline figures are useful, you might be satisfied with the total transaction cost per fund. But you really do need the detail to understand precisely what’s happening. For example, what level of turnover was there within the fund? Does your manager do any stock-lending? If yes, how much of the revenue is given back to investors?

4. What’s the approach to anti-dilution and fair value pricing mechanisms?

Anecdotal evidence suggests that this is one area which service providers have found particularly challenging to incorporate in their calculations. These mechanisms have the capacity to influence the results, perhaps significantly, but this can depend on a number of variables, such as the size of the fund, and inflows and outflows.

5. How have multi-asset fund transaction costs been determined?

Here we’re talking about managed, diversified growth and target-date funds which are used frequently by workplace pension schemes. If the asset allocation changes through the year, what has been used to calculate final costs?

6. How have ‘lifestyle’ fund transaction been calculated?

The majority of workplace pension schemes use lifestyle approaches as their default investment option. Governance bodies should understand how transaction costs have been calculated over the lifetime of the strategy.

7. Do any fund assets have transaction costs that are difficult to determine?

We’re thinking here about less liquid investments, like property and derivatives, which can be more challenging to calculate than, say, equities and bonds.

What now, and what next?

Right now, governance bodies are just at the start of the journey of getting to grips with the complexities of understanding transaction costs and what they mean for pension scheme members. By taking some sensible steps now though, we believe you can be in a good position to make informed decisions when you receive your cost data.

For more information, get in touch with Redington on 020 7250 3331 or email info@redington.co.uk

This piece originally appeared in Professional Pensions magazine. 

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