Financial Reporting by Investment Managers

Financial reporting by investment managers

The need for clarity

December 2015

kpmg.co.uk © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. 02 Executive summary Contents 04 Benchmarking

12 Survey

18 Narrative reporting

24 Corporate Governance

26 Remuneration

29 Accounting update

34 Conclusion

Welcome to the 2015 A complex task more information in reports – without fully considering how that information edition of Financial Factors such as increased regulation is selected, presented and structured Reporting by Investment and market volatility are impacting – preparers will deliver documents that upon performance. In this respect, are opaque rather than enlightening. Managers. there is a real challenge inherent in As new risks emerge, arguably one of The investment industry is working in preparing reports that take account of these factors, while also providing the greatest challenges is to quantify an ever-more complex environment. the threats in a way that is meaningful. Businesses in the sector are not only a true and accurate picture of the performance of individual businesses This year’s reports suggest that cyber faced with tighter regulation, at a time risk, in particular, has been under when investor pressure to deliver that can be compared to reports published by other firms in the sector. reported, perhaps because firms have improved performance is increasing, struggled to quantify the danger to but they are also faced with a This raises questions of consistency. their business. significant degree of market volatility In addition to the financial report, the and the arrival of new technologies. alternative performance measures The pressure to produce better reports cited by investment managers highlights the importance of the They are also facing new risks. Across finance, risk, compliance and internal the financial services sector as a whole, continue to play an important role in providing investors and analysts with audit functions within companies. challenger companies are entering the This year, for the first time, we have market, typically harnessing the potential the information they need to assess the performance of individual firms. It conducted a survey of how these of new technologies. The investment functions are resourced and run. management industry is unlikely to is therefore vital that commonly used remain immune from these disruptive measures – such as Assets Under forces. Meanwhile, cyber and IT risks are Management – should be compiled becoming ever more acute. Technological according to parameters that are changes are helping investment consistent across the industry. Equally managers to deliver a better service important, within each individual but this in turn exposes companies to company the parameters should be the threat of malicious attack or indeed consistent year to year. damaging systems failures. Reporting is also affected by Against this backdrop, the demands regulatory requirements that on firms to produce annual reports ultimately result in reports becoming that provide a clear and transparent larger: the new rules on enhanced risk account of performance goals, the reporting are a case in point. Providing progress being made towards those shareholders with a greater degree of goals, and emerging risks has probably insight is clearly a good thing but there never been greater. is a danger that by simply including

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 02 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. The need for clarity Narrative reporting Accounting Annual reports in the investment Longer annual reports are in part The consolidation suite of standards management sector are, on average, due to preparers responding to the (IFRS 10, 11 and 12) were effective for 24% longer now than they were requirement for enhanced narrative EU preparers for accounting periods in 2011 and that increase in size is reporting. The challenge is to provide that began on or after 1 January 2014. understandable given the factors greater clarity and ensure consistency As a result of the changes, a number outlined above. However, it is vital that when non-GAAP alternative of groups are including consolidation a bigger word count is accompanied performance measures are used. as a key policy judgement. by more, rather than less, clarity. The Preparations for transition to UK GAAP sections in this year’s report cover Corporate governance and the implementation of IFRS 9, 15 investment management firms, wealth and 16 continue. The coming year’s annual reports managers and alternative managers. will mark a first attempt by firms to comply with the new risk-reporting The benchmarking report requirements. It will be necessary for This year’s report suggests the businesses to provide an assessment performance of investment managers of risk management, a review of has been relatively resilient in internal control systems and the recent years, with firms in the viability of the business, but also to sector diversifying to drive improved provide a full account of the underlying performance. Pressure on fees has assumptions. Meanwhile, investment been less acute than expected. Wealth managers are lagging the wider FTSE- manager performance has been 250 community in terms of gender more mixed, with increased Financial diversity. Conduct Authority (FCA) regulation being a factor. Remuneration The trend towards increased use of Annual survey variable remuneration components is In the first of what will be an annual continuing and there are indications survey, we have compared the that recently implemented shareholder resourcing and cost base of the voter rights are having an impact on finance, compliance and internal audit remuneration policy. This is evidenced functions within firms. The growing by one company in our sample, importance of these functions is in acknowledgment of the views evident, but this is not in all cases expressed by a significant group of reflected by a commitment to investors, not pursuing a proposed increased resourcing. policy change, despite shareholder voting not being binding.

The performance of investment The variation in the performance Adjusted PBT arguably provides managers has been resilient in of wealth managers may in part be the focus when investors scrutinise the financial years under review due to the impact of regulation in annual reports but the figures and there are signs that there is the sector. In particular, the industry need to be treated with a certain more diversification in their product has been grappling to keep up amount of circumspection. As we offerings. Performance of wealth with changes in the expectations explore in greater depth in the managers on the other hand has from the regulator over suitability. section on Narrative Reporting, been more mixed. This has eaten up resources and the criteria underpinning the move placed pressure on performance. from statutory to adjusted PBT It may also be the case that wealth are not necessarily consistent Adjusted profits before tax managers are feeling the heat from one business to another, so from new competitors coming direct comparisons are not always The profits before tax (PBT) into the marketplace. A number of straightforward. figures contained in this year’s wealth managers are consequently reports suggest that investment rationalising their client base with the management firms have been aim of exiting/reducing the burden stable overall. In contrast, there is of smaller clients that are no longer significantly more divergence among profitable. This may help to shore up wealth management firms. performance in the longer term, but could also limit access to the next generation of savers.

IM – Adjusted PBT Growth 2010/2011 to 2014/2015 WM – Adjusted PBT Growth 2010/2011 to 2014/2015

300 200

250 160

200 120

150

80 100

40 50 % growth from 2010/11 adjusted PBT % growth from 2010/11 adjusted PBT

0 0 2010/11 2011/12 2012/13 2013/14 2014/15 2010/11 2011/12 2012/13 2013/14 2014/15

Schroders Henderson Group Rathbone Brothers Charles Stanley Man Group Ashmore Group IFG Group Brewin Dolphin Jupiter Fund Management Aberdeen Asset Management

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 04 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. “In order to assess the performance of investment management businesses, shareholders and analysts need to understand the underlying factors driving higher or lower AUM figures. This in turn raises the question as to whether the data provided is granular enough to offer an accurate picture.”

This year our industry analysis Traditional Investment Wealth Managers Alternative Managers Managers (‘IM’) (‘WM’) (‘ALT’) covers 15 investment managers Aberdeen Asset Management PLC Brewin Dolphin Holdings PLC 3i Group plc in the UK for the year ends Ashmore Group plc Charles Stanley Group PLC Electra Private Equity PLC falling between 30 June 2014 Henderson Group plc IFG Group Plc Intermediate Capital Group plc Jupiter Fund Management plc Rathbone Brothers Plc IP Group plc and 31 March 2015: Man Group plc SVG Capital plc Schroders plc

Assets under management IM – AUM by Asset Class1

Assets Under Management (AUM) 100% is a key indicator of performance in Other the investment management sector 80% Multi-A. but there are certain question marks over the transparency, usefulness and Fixed inc. relevance of the data presented. The 60% financial years under review show an Equities overall rise in AUM. 40%

Give that changes in headline AUM figures can be driven by a number 20% of factors, including: falls or rises in

the value of a particular market (for 0% example, equities or property); inflows 2010/11 2011/12 2012/13 2013/14 2014/15 and outflows of investor funds; foreign currency fluctuations or acquisitions. ¹Man Group Plc did not disclose AUM by asset class and is therefore not included Shareholders and analysts need to understand these underlying factors in order to assess the performance of AUM growth from 2007/2008 to 2014/2015 (IM and WM)2 the business.

400 For instance, the degree to which an improvement in the AUM number is 350 due to organic growth or acquisition is 300 not always presented.

250

Current trends 200

150 As we pointed to in our ‘Investing in the Future’ report in 2014, this year’s 100 results reveal a degree of change in the asset classes held by 50

businesses in the sector mainly 0 through strategic acquisitions. In 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 particular, there is greater emphasis Schroders Henderson Group Rathbone Brothers on multi-asset classes. Man Group Ashmore Group Charles Stanley Jupiter Fund Management Aberdeen Asset Brewin Dolphin Management 2 Other entities covered by this report did not disclose AUM figures.

110 This shift towards multi assets is underpinned by an increasing demand 100 for solutions and outcome orientated

90 propositions in the retail and institutional markets. 80

70 There has been less diversification in terms of geography, perhaps because 60 specific market expertise has been harder to acquire. 50

40 Basis points fees 30 2010/11 2011/12 2012/13 2013/14 2014/15 As the graph illustrates, there has Schroders Ashmore Group Jupiter Fund Management Aberdeen Asset Management been some downward pressure on Henderson Group fees, although this trend has not been

3Man Group Plc did not disclose bps within their Annual Report as great as we might have predicted. Looking ahead, we would expect to see changes in the range of products that companies are offering having an impact on fees, but as yet the degree to which fees will be impacted remains uncertain.

“Operating margins for investment managers have remained relatively resilient in the face of significant fee pressures. These pressures are only likely to increase in light of the FCA’s recently announced asset management market study. We expect that this will lead to an increased focus on transparency and comparability across managers. It will be interesting to see what long term implications this has on the industry and how well positioned investment managers are to adapt accordingly.” Ravi Lamba, Director, KPMG in the UK

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 06 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Margins IM – Operating Margin The good news for investment managers is that margins have Aberdeen Asset Management Plc remained reasonably consistent

across this year and last year. Ashmore Group Plc However, the same is not true of wealth management firms: as we Henderson Group Plc observed earlier in this section, wealth managers are facing much tighter regulation from the FCA and, Jupiter Fund Management Plc in particular, this has meant expending more resources – namely time and Man Group Plc money – on regulation. Schroders Plc

Labour-intensive wealth 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% managers Operating margin PY In addition, wealth managers operate Operating margin CY on much more labour-intensive business models than investment management firms. Clients often expect a bespoke and personal service, which requires an investment in a sufficient number of highly paid WM – Operating Margin advisers.

Looking forward, investment Brewin Dolphin Hldgs management firms and wealth managers may have to adapt to a changing marketplace if they are to Charles Stanley maintain their margins. Certainly there is a case for more investment in information technology (to replace IFG Group Plc legacy systems) if they are to compete

with pressures and new challengers in Rathbone Brothers Plc the marketplace.

-10% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Operating margin PY

Operating margin CY

Risks 2. Wealth managers Loss of key personnel, treasury and a. Data protection and cyber credit, and legal and regulatory issues security services for High-net are identified as the top three risks worth individuals or Ultra high in both the investment management net worth individuals. and wealth management sectors. b. Risks form theft of private Meanwhile, alternative companies data of clients. name investment performance, liquidity, and loss of key personnel as 3. Alternative managers their top risks. a. Cyber risks in portfolio Given the prominence of cyber companies – specifically if risk issues in the news in general, investments are concentrated and in the financial sector – the on a handful of portfolio Bank of England stated in 2014 that companies. investment management firms were b. Risks from theft from insiders underestimating the danger – this (disgruntled employees, is surprising. It may be that, while bribery etc.). businesses are well aware of IT and cyber risks, companies don’t know how to describe or quantify them to shareholders. Loss of key personnel risk Some of the key cyber risks across Losing key personnel remains the the industry segments are: number one risk, at least in the 1. Investment managers investment management and wealth management sectors. Fund managers a. Theft or loss of sensitive within companies are brands in information or IP leading to themselves and when they leave one reputational, financial risks. company for another, there is a danger that funds will follow. b. Loss of availability of key IT systems/services or website (particularly if there are retail investors). c. Regulatory penalties from a cyber-breach. d. Third party/supply chain cyber risks.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 08 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. IM - Top 5 risks identified by the board ALT - Top 6 Risks identified by the board

5 7

6 4

4 3

2 2 Number of companies Number of companies

1 1

Loss of key personnel Investment performance Investment Liquidity risk compliance Economic risk performance

Brand/reputational risk/negative press Loss of key personnel Foreign currency risk Credit/ treasury/ financial/ counterpartyLegal and regulatoryrisk changes / compliance

Legal and regulatory changes /

WM - Top 5 risks identified by the board

2 Number of companies

Loss personnelof key Market risk

counterparty risk Legal and regulatory changes / compliance Credit/ treasury/ financial/ Informationdata and technology cyber security /

2 Number of respondents

Assets under EBITDA margin management/ administration Compensation ratio Investment performanceManagement fee margin

Inflows/outflows/new business Variable compensation/EBVCIT/

ALT - Top 5 KPIs used by the company WM - Top 6 KPIs used by the company

4 4

3 3

2 2

1 1

0 0 ROE

Net assets Assets under management Underlying PBT /administration Inflows/outflows/new business /administration Investment performance Share price performance Dividend payout/growth Number of SIPPs/clients Assets under management Year end/average headcount

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 10 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Financial reporting by Investment Managers 11 03Survey Behind the Finance, Compliance and Internal Audit Functions

Against a background of increased For many in the finance function, the “Our survey suggests regulation – and the rising information they are being asked to expectations of internal and external feed into the reporting process is that despite stakeholders around reporting and taking them some way out of their transparency – finance, compliance comfort zone. For instance, to some finance functions and internal audit functions within the extent they are being asked to ‘own’ investment management industry information supplied for governance being asked to do have never been under greater and remuneration reporting, which pressure. might be considered the more natural province of HR and compliance teams. more, increased There is widespread awareness among investors and analysts of Indeed, of the eight firms questioned, expectations are the important role these back-office only three intended to grow their functions play in providing and finance functions, while three not necessarily validating information while also expected them to remain around the underpinning regulatory compliance. same size and two were planning to However, there is little transparency shrink the departments. being matched by on how they are structured and resourced. Equally, there is little Systems a commensurate opportunity for investment managers The survey also found a significant to compare the performance of variety in the number of finance increase in their own back offices with those of systems used by respondents. On competitors. average, firms in the sector are investment.” We have taken the opportunity to running six different systems – with carry out a survey of the companies one business reporting a total of included in this year’s FRIM report. 14 systems. Different systems Eight firms responded, providing are often used for reconciliations, us with insight into how these key payroll, regulatory reporting, treasury functions are managed and resourced management, general ledger by key players in the industry. All recording, consolidation, financial the reporting was conducted on an statement production, portfolio anonymous basis. company accounting, AUM analysis, budgeting and working capital The finance function management. The pressures on finance functions There are potential risks here, as the are mounting. Not only are staff being use of multiple systems can result in a asked to provide additional information number of problems, including: for annual reports, but there is also »» Operational inefficiencies internal pressure to provide higher quality and more timely management »» Control weaknesses information and budgets along with »» An increased likelihood – additional regulatory reporting. particularly in the case of older systems – of manual interventions, which exacerbate the two points above.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 12 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Reporting and the need for internal/ Finance external consistency. When we asked respondents to a. Size of finance function provide details of their most significant KPIs, some named as many as 40 measures: some of these were operational, some financial, and others AUM category < £50bn >£50bn Alternative related to compliance. Each individual business will have its Number of respondents 3 2 3 own measures but it is important that companies are consistent between Avg. number of legal their internal reporting and external 25 119 85 communications. The KPIs that are entities seen as most relevant internally should also be communicated in the Avg. number of staff 28 100 20 annual report.

Finance staff and b. Number of finance systems resourcing According to our survey, on average only 17% of finance function personnel have no finance- 1 specific qualifications, while 30% have graduate or post-graduate Lowest number of qualifications and 53% have finance systems used professional qualifications. 14 In other words, finance functions are populated by well-qualified individuals and this is reflected in salaries. However, there are some variations in pay and costs across the sub sections of the industry. Senior finance staff in wealth management firms tend to be 6 least costly – an average of £78,028 Highest number of (pay and related costs) – while the finance systems used most costly are seen in alternative firms, with costs for senior people Average number of averaging £128,814. Investment finance systems used management costs sit in between, with an average of £100,465.

Alternative finance functions lead 17% the way in terms of processing and providing management information. The average turnaround time in alternative managers is 11 days, while the figures for wealth management 30% and investment management were 12 53% and 13 days respectively.

Compliance departments No quals Grad/post grad quals Professional quals In both traditional investment management and wealth management d. Direction of function firms, we found that the number of people employed in compliance rises sharply between companies with an AUM of less than £50 billion and firms managing sums above that figure showing that, in today’s environment, compliance needs to be able to scale up to support growth and expansion. In contrast, the compliance function in alternative firms is relatively small. Compliance personnel tend to be Grow Shrink No change more costly than those in the finance e. Costs function, with average costs coming in at £79,778, £112,821 and £158,333 (pay and related costs) across wealth Category WM IM ALT management, investment management and alternative managers respectively. However, compliance people tend to Avg. finance staff 36 72 20 be less directly well qualified, with on average only 39% holding professional Avg. finance people costs qualifications and 44% educated to 2.77 7.20 2.53 graduate or post-graduate level. It is (£m) likely, however, that the slightly higher salaries reflect the growing demand Avg. cost per FTE (£) 78,028 100,465 128,814 for compliance staff, who have to be attracted from other functions. Demand is expected to grow further, continuing the upward pressure f. Efficiency and speed of reporting on salaries. As with finance, three out of the eight WM IM ALT firms surveyed expected to grow their departments and three expected to retain the current size. However, 12 13 (£M) only one respondent was considering Days Days Days a reduction.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 14 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Compliance:

a. Composition

AUM category < £50bn >£50bn Alternative 17%

Number of respondents 3 2 3 39%

Avg. number of regulated 10 30 4 entities 44%

Avg. compliance staff 21 50 4 No quals Grad/post grad quals Professional quals

b. Direction

Grow Shrink No change Don't know c. Costs

Category WM IM ALT

Number of respondents 2 3 3

Avg. compliance staff 23 39 4

Avg. finance people 1.79 4.40 0.63 costs (£m)

Avg. cost per FTE (£) 79,778 112,821 158,333

a. Structure and people Internal audit The responses to our questions on Avg. People Costs per internal audit present a more complex % employees costs (£) person (£) picture. Firms have a choice here: they can do everything in house; they can outsource; or they can opt for a fully co-sourcing model, under which In-house 50% 4 0.55 137,500 third-party auditors are coordinated by an internally appointed director or otherwise responsible individual. Our Co-sourced 37% 5 0.73 146,000 survey shows that of the 8 firms who responded 37% co-source while only 12.5% outsource, with the remainder Outsourced 13% N/A N/A N/A using an in house model. Overall, investment managers carry out the greatest number of Scope internal audit reviews each year – 30 reviews, compared with 26 and 10 in wealth management and alternative, Avg. Total costs Cost per respectively. The cost per review is number of (£m) review (£) highest in investment management reviews and lowest in wealth management.

Conclusion Traditional 30 1. 5 50,000 Demand for the services provided by finance, compliance and audit Wealth 26 0.63 24,231 continues to rise, and the high qualifications expected in these functions are reflected in rising salaries and rising costs. Against this Alternative 10 0.3 30,000 backdrop some firms are seeking to either limit the size of functions or even reduce them. However, that intention must be balanced against the rising pressure on personnel to address new regulatory and reporting demands and the need for better, streamlined technology to support the functions.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 16 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Financial reporting by Investment Managers 17 04Narrative Reporting

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 18 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Word for word and pound for pound, annual reports WM - Report length over time have progressively increased in size in recent years.

As our graph illustrates, an annual report in 2011 was, 180 on average, 112 pages in length. Today, that figure is 170 129 pages, representing an increase of 24%. 160 There are a number of good reasons why reports 150 have grown weightier: narrative reporting has become important and demanding. Equally, there 140 is a requirement for narrative reporting to spell out 130

the objectives, strategy and progress made by the 120 company. Across all sectors, listed companies have responded to the demands of regulators and the Number of pages 110 expectations of investors by including more financial 100

and non-financial information. 90

70 2011 2012 2013 2014 2015

Annual Industry Average Rathbone Brothers IFG Group Charles Stanley Brewin Dolphin

IM - Report length over time ALT - Report length over time

180 180

170 170

160 160

150 150

140 140

130 130

120 120 Number of pages Number of pages

110 110

100 100

90 90

80 80 201 2012 2013 2014 2015 201 2012 2013 2014 2015

Annual Industry Average Schroders Annual Industry Average Schroders Man Group Jupiter Fund Management Man Group Jupiter Fund Management Henderson Group Ashmore Group Henderson Group Ashmore Group Aberdeen Asset Management Aberdeen Asset Management

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Financial reporting by Investment Managers 19 traditionally been the heart of the how these measures are calculated, Greater length, less clarity? annual report, as it contains audited, compiled and presented. GAAP-compliant information. However, In theory, stakeholders should be over time an increased emphasis on better informed than ever before. additional narrative reporting has, in In practice, greater length and the turn, resulted in much greater use of APM inconsistencies provision of more comprehensive alternative performance measures There continues to be some variation information does not necessarily (APMs). Three classes of APM have in the APMs that companies choose equate to increased clarity. Indeed, become commonplace in annual to deploy or emphasise from one year by including a greater amount of reports: to the next. This potentially makes it information without paying the difficult for investors to assess the necessary attention to its relevance 1. Disaggregation or subtotalling company’s year-on-year performance. and presentation, businesses run (e.g. earnings before interest, tax, the risk of publishing reports that are depreciation/amortisation). Equally, investors should be aware incomprehensible to many investors. that outside the constraints of GAAP 2. Quasi-financial measures (e.g. compliance, variations can exist in the Faced with the prospect of falling BPS or operating margins). time periods over which data for APMs foul of regulators, or failing to meet is compiled. The potential problem investor expectations, preparers have 3. Operational metrics (e.g. assets here is that a similar APM used in two little incentive to edit the information at under management or flow separate annual reports may, in fact, their disposal – the tendency is to play of funds). be based on different timeframes or safe and include as much as possible. The use of APMs is not a bad thing. even bases of compilation. As a result, However, the result can easily be less For instance, in the investment it is not always possible to compare clarity and less relevance. management sector, performance- like with like. There is an awareness of the related metrics – such as assets problem. The International Accounting under management (AUM) and flow Standards Board (IASB) has published of funds – provide relevant, industry- amendments to the IAS 1 guidelines, specific information about individual Selective calculation businesses that is not conveyed by with the intention of encouraging There is also a danger that companies information in the financial statement preparers to move away from a will be selective with the facts section of the report. checklist approach to reporting and to present the most favourable to focus instead on relevance and Our research into this year’s reports position possible. For instance, when materiality. This should, in turn, give and analyst presentations confirms companies quote earnings with preparers the platform that they need that companies in the investment factors such as one-off costs stripped to produce more concise reports, management sector tend to focus on away, the intention is clearly to which nonetheless provide investors at least one – and often more than one highlight the underlying strength – or with the ‘big picture’. – alternative performance measure, weakness – in medium and long-term with AUM flows considered to be the trends and performance. The danger most relevant. is that a company will choose to strip out an unexpected charge but include The most commonly used measures Non-GAAP measures a sharp spike in revenues that is (AUM is a case in point) are generally As our research indicates, the financial also attributable to a one-off event or understood by investors. Perhaps statement section of the report unusual circumstance. more importantly, there is an informal currently accounts for around 35% of understanding within the industry as to the average annual report. This has

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 20 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Industry - Composition of annual reports

Aberdeen Asset Management Ashmore Group Henderson Group Jupiter Fund Management Man Group Schroders Brewin Dolphin Charles Stanley IFG Group Rathbone Brothers 3i Group Electra Private Equity Intermediate Capital Group IP Group SVG Capital

Other Financial Statements Auditor's Report Corporate Governance

Corporate Responsibility Strategic Report and Director's reporting Performance Review

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Financial reporting by Investment Managers 21 To take another example, not all The narrative challenge “There is clearly companies adjust amortisation of intangibles, or Financial Services What we are looking at is a complex a debate to be Compensation Scheme (FSCS) levies in narrative containing a broad range of arriving at adjusted PBT. In other words, information, some of which will have had about the it is still the prerogative of the company traditionally been presented in other to decide what to include or exclude. sections of the financial report. use of APMs. In order for APMs to be useful, and The challenge is to pull together this provide the information investor’s information in a format that tells a KPMG believes want, the key is the disclosure around coherent story. The least effective way the APMs need to be clear and is to simply drop existing information the investment transparent so that investors can use into the strategic report, without the information as needed. considering how it will be structured and presented. However, the result management can be a mishmash of data that fails to provide a comprehensive but industry for the Regulation on the horizon easy-to-understand narrative – the information is present but there is no most part is clear There is the prospect of more real connection between the various stringent regulation. The European components of the report. Securities and Markets Authority and transparent (ESMA) recently issued a consultation Our view is that a much more effective document containing proposals strategy is to effectively start with but there may be a to enhance transparency and a blank sheet of paper. Rather than comparability when APMs are used. recycling old material, the preparers case for additional work on the premise that the strategic The proposals acknowledge the report is something new that should independent importance of APMs but would require be designed and structured from the companies to give them much less bottom up. prominence than GAAP information. scrutiny” ESMA is also recommending that That means taking a holistic approach companies using APMs should give to the report, with preparers them ‘meaningful names,’ explain their understanding how content contained context, present them consistently in other sections – for example, in over time, and cross-reference the areas such as remuneration policy measures to the most meaningful or governance practices – relates to GAAP data. Any additional narrative strategy narrative. reporting should be reconciled with GAAP amounts. There is clearly a debate to be had about the use of APMs. KPMG believes the investment management industry for the most part is clear and transparent but there may be a case for additional independent scrutiny or extended assurance from auditors before the figures are published. This would provide investors and analysts with the assurance that APMs are calculated according to consistent principles.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 22 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. “Annual reports have lengthened but while much of the additional information is useful, the key to effective communication is coherence, coupled with a commitment to providing performance data that is consistent and comparable, and underpinned by a verifiable methodology.”

Amendments to the UK Corporate Governance Code (which became effective on 1 October 2015) will introduce new complexity Viability statements - to the preparation of statements on risk, including the statement on leverage from ICAAP long term viability. Meanwhile, the investment management sector Business need not – and has made some progress towards increasing the number of women should not – be starting on boards, but representation at the highest level fails to reflect a from scratch. The investment management industry is more even gender mix elsewhere in organisations particularly well positioned to deal with the new requirements, particular time period has been Risk disclosure as much of the analysis chosen, and why that timeframe is required under the new code Following amendments to the UK particularly applicable in terms of the amendments will already Corporate Governance Code, new risk- circumstances of the business, its have been prepared for ICAAP focused disclosure requirements have business model and objectives. documentation. come into force for reporting periods Equally, the process undertaken to beginning on or after 01/10/2014. The The challenge facing boards make the confirmation will have to purpose of the new requirements will be to take the existing consider exactly what is meant by a is to provide shareholders with an information (along with ‘robust assessment’ of the principle enhanced understanding of the anything new and relevant) and risks. This account is likely to include principal risks facing the companies in use it to demonstrate that the details of the data used in making question, and how they affect long- process of risk assessment the assessment, an account of the term viability. has indeed been robust. stress and sensitivity testing that has Investors and regulators will taken place, and the assumptions also want to be assured that on which the assessment is based. the board has done enough to The shock of the new Any statement on risk and long-term manage and mitigate risks. – questions for the viability will have to factor in how the company is positioned in the wider audit committee marketplace and provide an account of what competitors are doing. The amendments to the Code Some progress has been made in this represent something more than just Ultimately, the board must clearly regard, however, there is still some a small change to previous disclosure map out the relationship between the way to go if firms in the sector are to requirements. To comply with the principal risks facing the business and meet the aspirational targets set both code, audit committees in particular the potential impact of those risks on in the UK and at EU level. will have to answer a new and perhaps the long-term viability of the company. unfamiliar set of questions. Based on an analysis of those firms that provide the relevant information, For instance, under the current we estimate that women account arrangements directors are required Diversity for around 43% of investment to report assessed risk and provide management firm payroll. However, In last year’s report we noted that the assurance on going concerns over things look very different when you Investment Management industry a 12-month period. The new code narrow the focus to representation at lagged behind the wider community requires that directors extend that executive director level. Currently only of FTSE-350 companies in terms of assessment and provide a much around 7% of executive directors are women appointed to board positions. more thorough account of why a women, although the figure is slightly

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 24 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. “It’s important to recognise that we are all operating in intensely competitive times, with unprecendented levels of transformation and the speed of decision making increasing. At times like this, it’s all too easy for us as individuals, and indeed, as companies, to fall into surrounding ourselves with likeminded people to make decision making easier. So it’s important to recommit ourselves to putting diversity at the front of our mind and taking small steps in very practical ways to making a difference.”

Claire Harvey, Head of Diversity and Inclusion, KPMG in the UK

improved upon if non-executives are factored in. This mismatch between the percentage of women working at all levels of organisations and the few who make it through to the highest levels, suggests that the industry should be doing much more to ensure that talented people are promoted, regardless of gender. The balance between male and female employers and directors is part of a larger debate on gender, which 43% also includes remuneration. In July Women in the 7% this year, David Cameron outlined plans to force companies to publish wider workforce Women in the details of the pay gap between men boardroom and women – details which some of the companies in our sample are (Executive Directors) already including in their report. If such measures come into force, the male/female pay issue will be forced higher up the agenda when annual reports are published, and companies will be questioned on policy. This is a development that KPMG supports.

“Remuneration remains More than seven years after the term outcomes rather than short-term collapse of Lehman Brothers, the performance measures. Or, to put it an area of considerable lessons learned from the financial another way, investors are keen to crisis are continuing to influence see remuneration strategies that only focus, not only for remuneration policy and practice. trigger performance-based payouts investors but also for This year’s bonus payouts and long- when a return on investment has term incentive gains are higher than been achieved. Equally important, analysts and regulators. in previous years and are based on shareholders want to see a balance achievement of incentive metrics. between strategies that deliver Companies should focus on returns, and the checks and balances As users and auditors of annual in place to manage risk. Again, clarifying the link between reports, we continue to find limited the expectation is that this will be transparency regarding the role remuneration policy, reflected in remuneration outcomes. that reward policy plays in helping practice and company investment management firms to deliver on long-term strategic goals. strategy in order to satisfy Shareholder voting the investors’ expectations spurs action of transparency and A coherent trend One of the key developments in the In last year’s report we identified an last two years for the main market alignment of interests.” increase in the proportion of variable companies has been the arrival of versus fixed pay paid to executives. legislation giving shareholders the Data from this year’s crop of companies right to a binding vote on remuneration suggests this theme is continuing. policy at least every three years, and this is already having an impact. Of Our analysis of this year’s the companies included in our sample remuneration levels reveals that 2014/15 All Executive Directors: population, to date there have been no median variable pay accounts for 69% Fixed Pay vs Variable Pay majority votes against remuneration of total remuneration, with fixed pay policy, but some significant votes (Median) accounting for the remaining 31% of against remuneration policy (over the total (see graph). This compares 20%) were taken into consideration by with a median variable pay of 62% in company boards. 2013/14 and 50% a year earlier. There is evidence that the new rights While remuneration committees 31% bestowed on shareholders have across all sectors continually address resulted in boards adopting a more the often-thorny problem of aligning responsive and proactive approach pay with performance, the debate to remuneration policy. For instance, over remuneration strategy has been 53% although the policy vote for one particularly acute in the financial company included in our sample fell 69% services sector. short of the figure required to force In the wake of the financial crisis, a change in policy, the board took Fixed pay Variable pay investors have been seeking note of the views expressed by a assurance that pay is linked to long- significant group of investors and

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 26 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. subsequently changed its approach the wider FTSE-350 annual reports, and did not implement the proposed only one-fifth make the link clear – policy amendment. for instance, by cross-referencing between remuneration reports and the strategic narrative. Of the investment management reports we examined, The regulatory background only one company provides a direct Future trends in the mix of fixed link to the strategic report. and variable pay may be coloured by changes in the regulatory framework. The Credit Requirement Directive The need for transparency IV (CRD IV) has applied caps to the Remuneration remains an area proportion of variable pay that can be of considerable focus, not only awarded by banks and other credit for investors but also for analysts institutions. Final European Banking and regulators. Companies should Authority (EBA) guidelines due to be focus on clarifying the link between published at the end of 2015 may remuneration policy, practice and impact on investment management company strategy in order to satisfy the firms. Those that are part of a CRD investors’ expectations of transparency IV group, or that have a CRD IV and alignment of interests. subsidiary, may fall under the directive

and require a variable pay cap.

The high proportion of variable pay relative to fixed pay, as shown by the data, indicates that the effect of any legislative change of this sort could be significant.

The importance of aligning pay with strategy There is no ‘one size fits all’ approach to linking pay with performance. However, KPMG believes that it is important for firms to align executive reward with the overall strategic goals of the organisation. That link between reward, performance and the fulfilment of strategic goals is not always fully spelled out in annual reports. Indeed, according to our analysis of

Implementation of IFRS 10, wealth management industry, whilst many alternative 11 and 12 managers were able to take The consolidation suite of standards advantage of the Investment (IFRS 10, 11 and 12) were effective for Entity exemption contained EU preparers for accounting periods within IFRS 10 to avoid the that began on or after 1 January need to consolidate their 2014. These standards introduced a investment portfolio. different framework for assessing 2. New and more detailed ‘control’, whilst also introducing new disclosures are required, but and enhanced disclosures detailing questions remain over the interests held in other entities. There usefulness and relevance of this were two main areas of impact for the information investment management industry: –– We observed significant 1. Changes to concept of control divergence in practice resulted in more funds being concerning the disclosures consolidated made about interests in –– Added volatility to financial unconsolidated structured statements as the conclusion entities. As this is a new on control could change year requirement and there is only on year limited guidance within the standard, we anticipate that –– Communicating this change industry best practice and to stakeholders and their understanding will continue expectations over the makeup to develop over the coming and composition of the years balance sheet. Compliance with certain covenants or key –– Challenges in implementing internal ratios may have also the requirements and capture been impacted of all disclosures mandated within the standard –– Differences in practice over whether Defined Benefit A number of groups are now Pension Plan holdings should including consolidation as be included in the holdings a key accounting policy or considered as part of the judgement, along with audit control assessment committees and auditors in the long form audit All traditional investment opinions. Under the old IFRS managers included in the framework, consolidation was FRIM for whom the standards relatively straightforward for was effective were required most investment managers to consolidate additional so it is clear that these new entities as part of their group standards have added a accounts in the current or degree of complexity and prior year. The impact was not judgement to the financial significant for those in the reporting process.

Accounting Key EU-IFRS Key FRS 101 Key FRS 102 area consideration consideration consideration

Goodwill Under EU-IFRS, goodwill is not Under FRS 101, goodwill is not Under FRS 102, goodwill is amortised. amortised. amortised over its useful life. Under EU-IFRS, negative Under FRS 101, negative Under FRS 102, negative goodwill is recognised goodwill is recorded on the goodwill is recorded on the immediately in profit and loss. balance sheet. balance sheet. Inter-company Under EU-IFRS and FRS 102, intercompany balances are required to be measured initially at fair value. A difference bettween the loan priciple amount and fair value will arise if the loan is not on commercial terms e.g. term loan with nil interest. Any difference between loan principle amount and fair value is recognised as a capital contribution as appropriate. This a key difference from old UK GAAP. Financial Under EU-IFRS and FRS 101, it is likely that more financial Under FRS 102, preparers will instruments instruments will be required to be carried at fair value. Any be required to categorise their derivatives that are held off balance sheet under old UK GAAP financial instruments as ‘Basic’ will need to be recognised. Embedded derivatives are recognised or ‘Other’. Basic instruments separately from their host instrument (although this is changing will be carried at amortised cost under IFRS 9). and Other instruments will be carried at fair value. FRS 102 contains an option to apply EU-IFRS equivalent financial instrument accounting requirements. Embedded derivatives are not accounted for separately from their host instrument. Deferred tax More defered tax is expected to be recognised under EU-IFRS and More deferred tax is expected FR 101 than old UK GAAP. to be recognised under FRS 102 than under old UK GAAP. EU-FRS 101 uses a temporary difference approach to calculate deferred tax balances. FRS 102 uses a ‘timing difference-plus’ approach, which includes a number of additional specific rules, when calculating deferred tax.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Financial reporting by Investment Managers 31 IFRS 15 IFRS 15 revenue recognition Other Comprehensive Income requirements at each upon initial recognition. For these »» The IASB has delayed the reporting date. assets the fair value movements effective date of IFRS 15 by 12 that are recognised in Other –– Capitalisation of costs: IFRS months to 1 January 2018. Early Comprehensive Income will not 15 requires all incremental adoption is permitted, however, recycle to the profit and loss as costs in relation to obtaining the standard is not yet endorsed they currently do for Available for new contracts with by the EU. Sale assets. customers to be capitalised. »» For investment managers, the Investment managers will »» Unlike IAS 39, an instrument standard is likely to introduce need to first determine who will be classified based upon new areas of judgement, their customer is and then all of its contractual terms. primarily around: ensure that all incremental Preparers will no longer be –– Determining who the costs are correctly accounted required or permitted to separate customer is: whether the for. This could result in certain an embedded derivative from a fund or the individual investor bonuses or other payments financial asset host. is the customer will have to sales or distribution staff downstream implications members needing to be upon revenue recognition and capitalised and amortised. Leases the treatment of costs. In October 2015 and after a long –– Identifying the performance period of deliberation, discussion and obligations: under IFRS 15 IFRS 9 consultation following the release of revenue is recognised as »» IFRS 9 is effective 1 January the leasing exposure draft in 2013, the the relevant performance 2018. The level of impact on IASB announced that the new leasing obligation is completed. investment managers will largely standard (IFRS 16) will be effective Investment managers will depend upon the nature of the for accounting periods beginning on need to determine what financial instruments held and or after 1 January 2019 (subject to they have contracted to how they are managed. EU endorsement) with early adoption do for their customers and available. whether certain obligations »» IFRS 9 introduces a change should be considered as a in the model used to assess Broadly, the impact of implementing single obligation. This could impairment, moving away from the new standard will mean that impact the timing of revenue an ‘incurred’ loss methodology to more leases will come on balance recognition on, for example, one that assesses the expected sheet, subject to a small number of up front or distribution fees. loss. Along with changes to exemptions. Lessees will be required hedge accounting, IFRS 9 also to recognise a ‘Right-of-use’ asset on –– Timing of recognition makes certain changes to the balance sheet, which represents the of performance fees: classification and measurement right to use the underlying asset, and performance fees will be a of financial instruments. a lease liability which represents the form of variable consideration obligation to make lease payments. »» The standard includes three under IFRS 15. Variable The lease liability will be amortised categories of financial assets consideration must be using the effective interest method (Amortised Cost, Fair Value recognised when it is highly and as such will have the effect of Through Other Comprehensive probable that there will not presenting the leased asset as one Income and Fair Value Through be a significant reversal in acquired on a financed basis. the amount recognised. Profit and Loss) and does away Investment managers who with the existing Available for Preparers in the investment recognise performance fees Sale category. Investment management industry will need to at crystalisation will need managers may be able to think about the impact of the new to consider whether any designate certain equity standard upon regulatory capital, portion of the un-crystalised instruments that are not held covenant compliance, stakeholder performance fee meets for trading as Fair Value Through management and financial KPIs.

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 32 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Financial reporting by Investment Managers 33 06Conclusion

In terms of purely physical evidence, governance code will require, in in the front end reporting. When using it is hard to escape the fact that coming years, a more comprehensive alternative performance measures, it is the annual reports published by account of risk. This will, in turn, vital that they are compiled according to investment managers have become require boards and audit committees consistent criteria that not only relate to more bulky in response to the to think hard about the underlying figures used in previous reports but also demands of investors, regulators and assumptions that underpin their provide a high degree of comparability policymakers. assessment. The challenge is then to with other firms in the sector. convey their findings meaningfully. The increasing size of the reports Our study of this year’s reports is perhaps inevitable and reflects More generally, it is important that in suggests that, while much good genuine efforts to ensure that the narrative reporting sections of their work is being done, there is still investors, analysts and other reports, firms convey a clear picture of much that can be improved upon. stakeholders have the best possible their objectives, current performance As firms respond to the increased information when they assess the and the strategies in place to achieve regulatory pressures, we believe it is performance of individual firms. their goals. In order to do so and to help important that each business should ensure consistent and clear messaging, have someone who has responsibility However, there is a danger that more we suggest companies consider for ensuring that reports provide the does not necessarily mean better. For incorporating the information included clarity and transparency required. instance, changes to the corporate in investor and analyst briefing materials

© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent 34 Financial reporting by Investment Managers member firms affiliated with KPMG International (“KPMG International”), a Swiss entity. All rights reserved. Acknowledgements

We would like to thank all the firms that participated in this survey and the analysts that helped to develop our research.

A special thanks goes to Ravi Lamba, Paul McKechnie and Scott Flavin.

Richard Clarke UK Head of Investment Management E: [email protected]

Jon Mills Partner, UK Head of Insurance & Investment Management Audit E: [email protected]

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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