23 January 2018

Changes to the way we report transaction costs

On 20 September 2017, the Financial Conduct Authority (FCA) announced that asset management firms whom they regulate and which manage client DC investments will be required to disclose administration and transaction costs to their clients from 3 January 2018. 

This development will help to resolve the impasse where Trustees were required to assess value for money and disclose transaction costs as part of the annual Chair Statement, but were unable to as asset managers were not legally required to provide this information.

Overview of transaction costs

Transaction costs are incurred by asset managers as a result of buying, selling, lending or borrowing investments. These costs are taken into account via the daily unit price for each Legal & General fund in which the DC assets of your pension scheme are invested.

Transaction costs are typically categorised as being explicit costs or implicit costs:

  • Explicit costs are directly observable and asset managers should be able to readily provide this information. Examples of explicit costs include broker fees, transaction taxes and custody fees. These are available for our internal pension wrapped funds and are currently available upon request.
  • Implicit costs cannot be observed in the same way but will also result in a reduction in the total amount of capital invested.

The two common approaches to calculating implicit transaction costs:

  1. The ‘spread’ methodology. Most financial instruments are available to be bought at a higher price and sold at a lower price. The difference or ‘spread’ between the bid / offer prices can be used to calculate ‘implicit’ transaction costs.
  2. The ‘slippage cost’ methodology calculates implicit fees by comparing the price at which a transaction was executed, with the price at which the order was authorised.

Regulatory requirements on the reporting on transaction costs

The law requires trustee boards to report at least annually the transaction costs to which members’ funds are subject, and to assess and report the extent to which these costs represent good value for money in the annual Chair’s Statement.

Until the FCA’s recent announcement, asset managers were not subject to any reporting or disclosure requirements in respect of transaction costs which made it difficult for Trustees to fulfil their regulatory duties.

Legal & General has been able to support Trustees by providing an initial view of explicit transaction costs, however respective implicit costs have not been made available; this is consistent with other asset managers due to the complexity and varying methodologies that exist.

Legal & General has turned to both the Department for Work and Pensions and the FCA to provide a consistent and standardised methodology across the industry for identifying and calculating total transaction costs.

FCA regulation on transaction cost disclosure following consultation paper 16/30

Under the new FCA regulations a new cost methodology was prescribed which required regulated asset managers to supply information about implicit transaction costs using the 'slippage cost' methodology. According to the FCA, this methodology is consistent with other European regulations such as PRIIPs (Packaged Retail and Insurance-based Investment Products) and MIFID (Markets in Financial Instruments Directive), albeit under PRIIPs funds with less than a three year history use the spread-based methodology.

The development of an industry standard transaction cost reporting template

The FCA has implemented a Working Group (which has Legal & General representation via the chairman of the Independent Governance Committee) to agree an industry standard approach for calculating and reporting both explicit and implicit transaction costs. It is expected that the conclusions from this Working Group will be shared imminently.

Transaction cost information for 2017 and beyond

Legal & General have committed to the following timelines:

Transaction costs for 2017

Legal & General intends to make full year transaction cost reporting for 2017 available by the end of Q1 2018.

The reporting will use the new industry standardised template (as defined by the FCA Working Group) and will use the ‘spread’ methodology to calculate implicit costs.

The ‘spread’ methodology has been approved by the FCA for calculating prior years’ transaction costs; this will enable Trustees to conduct value for money assessments and fulfil regulatory requirements on reporting transaction costs.

Legal & General are doing further work to collect historic implicit costs using the slippage methodology and aim to report these 2017 numbers in due course.

Transaction costs for 2018

From Q2 2018, transaction cost reports will be issued on a quarterly basis to Trustees using the new standardised template and will capture transaction costs incurred from 1 January 2018.

The ‘slippage’ methodology (as defined by the FCA regulation) will be used to calculate implicit costs.

Third party manager’s data

We are still working with third party managers to agree the collation of their data and reporting timeframes. It is envisaged that these will be made available to trustees on a quarterly in arrears basis.

The first report on this data is therefore likely to become available towards the end of Q2 2018.

More information on transaction costs

Legal & General has created a guide on transaction costs for Trustees and will be creating further supporting material including a guide for members and training/informative materials for governance bodies, such as Trustees which will be available shortly.

For more information view the PDF file: View - Guide to transaction costs PDF size: 277KB .

Should you have any further questions, please feel free to contact your normal Legal & General representative.