Previous FSA Progress Reports have attracted attention for their frank assessments of financial products, such as last year’s critique of structured bond*.  Every year as the publication date approaches, industry insiders speculate about what products the report will mention next.  FSA’s 2023 report contains no mention of specific products.  Instead, it takes a bird’s-eye view of the investment chain and financial opportunity ecosystem and focuses on structural distortions.

Officers at FSA’s Office of Asset Management Business Reform explain that the report is based on interviews with a wide range of stakeholders.  This year's report is noteworthy for incorporating themes that have long been debated in the industry, such as fee structures and system efficiency, thus implying some level of recognition from the supervisory authority.

          * https://www.fsa.go.jp/en/news/2022/20220527/20220527_4.pdf, pp. 59-63

1) Strengthening disclosure requirements

The latest FSA report criticizes asset management firms for insufficient of senior management biographies, fund manager names, and the names of holdings.

FSA encourages asset management firms to rethink how top managers are selected, in light of several problematic findings:

- Top managers with too little experience in fund management
- Few internal promotions
- Many managers from affiliate companies
- Short tenures
- Bias towards men

While more funds overseas tend to disclose the names of fund managers to avoid moral hazard, only 2% of all publicly offered toshin in Japan do so, the lowest rate among major countries.  The report argues "it is desirable to promote voluntary efforts, such as enhancing information disclosure, starting with flagship funds".  As "one measure to gain trust", FSA suggests asset management firms oblige fund managers to invest in funds they manage themselves.

According to the report, it is common overseas for all retail fund holdings to be disclosed monthly or quarterly, while in Japan disclosure occurs often once a year or once every six months.  Also problematic, many monthly reports in Japan limit disclosures to the top 10 outstanding issues/stocks.

The report calls for the entire industry, including self-regulatory organizations, to review and improve its disclosure practices.

2) Reviewing agency fees

The report includes an in-depth description of how agency fees, the distributor's share of trust fees, should be paid.

Agency fees for toshin funds are generally regarded as compensation for managing the fund after purchase and disseminating information, such as management reports.  FSA’s report notes that agency fees tend to be higher for active funds than indexed funds, while fees for both in-person and online retail channels are the same.

The report states “some argue that a higher commission for active management is justified because it requires more effort to follow up with customers due to the greater fluctuations in NAVs”.  However, "not all distributors devote the same quantity of resources to follow-up with customers who have purchased actively managed toshin funds". 

Furthermore, "even for toshin funds sold by web-based securities companies, which in principle do not provide face-to-face or telephone customer service, agency fees for the same toshin fund are the same percentage of the trust asset balance as in the case of face-to-face sales".  Citing examples from the US, the report suggests a fee structure that compensates companies based on a percentage of a client’s balance and calls for "clarification of the nature of agency fees".

3) Making management more efficient

The report suggests three main reforms to improve efficiency in toshin management:

- Promote standardization of the public distribution systems
- Shift prospectuses to HTML
- Eliminate dual-calculation

Under the public distribution system, which connects managers and retailers and exchanges NAVs and other information necessary for fund management, contracts tend to be concentrated with the same vendor to avoid incurring additional fees when incompatible systems must be connected.  An oligopoly has developed, together with accounting systems that are linked to public sales systems.  To encourage new entrants into the market, FSA recommends the Investment Trusts Association, Japan standardize specifications.

The report calls for managers to shift the format for prospectuses from the predominant paper and PDF to HTML, which is considered easier to read and use for both customers and operators.  Under the FSA’s draft amendment to the Financial Instruments and Exchange Act submitted to Parliament in March, the ban on the electronic provision of sales literature would be fully lifted.  The latest Progress Report reiterates the agency’s intent to promote DX to improve customer convenience.  

FSA also recommends improving efficiency by consolidating operations and other measures aimed at eliminating 'dual calculation', whereby the same work is carried out by asset management firms and trustee companies (trust banks) to calculate NAVs.

As the supervisory authority, FSA includes in the report its views on other financial service issues, such as clarifying added value of fund wraps, and mandatory introduction of a 'designated investment method' for corporate defined contributions.  Issues raised in the 2023 Progress Report are likely to be revived and discussed at the next meetings of the Financial System Council and its affiliates, including the Customer Focus Task Force.  The meetings are expected to resume soon.