Carry on unbundling!

A recent crackdown on corporate access will likely continue as incoming UK regulator the Financial Conduct Authority seeks to push for further unbundling of payments for broker services.

What indications are there that the new Financial Conduct Authority (FCA) will take a hard line on bundling of broker services?

As part of a renewed focus on eliminating conflicts of interest, the UK’s Financial Services Authority (FSA) sent letters to CEOs of asset management firms last November requiring them to attest their commission spending processes were in line with the FSA’s rules by the end of February. As the FSA morphs into the FCA this month, the focus on preventing commission dollars going towards corporate access under the guise of research, will remain a top priority.

Ed Hardy, head of asset management supervision at the FSA, who will hold the same role in the FCA, has clearly indicated the buy-side must comply or risk being penalised. A ‘thematic review’ by the FSA accompanying the CEO letter showed only two of 15 asset managers were in line with current rules – a signal of the need for change.

“When we challenged firms, they couldn’t justify the way they used client commissions against the existing criteria,” Harley told in March. “Our rules on dealing commissions are quite clear – you can’t use client commissions to pay for dealing services other than the direct costs of execution and some very specific areas of research,” Harley said.

Is the buy-side ready to demand full transparency on all the services they buy from brokers: execution, research and corporate access?

Greater transparency is a key tenet for all aspects of the financial markets in the post-crisis environment, for asset managers as much as brokers. The current regulatory push for greater unbundling of payments for broker services in the UK will likely cause a rethink on what and how buy-side firms consume from their sell-side counterparts.

In this period of cost-cutting, driven by lower equity trading volumes and returns to end-investors, as well as the need to revise systems and processes in line with impending regulation, the buy-side will stop paying for services it doesn’t use, and the sell-side will eventually stop providing them. Institutional investors will have to provide a clearer account of what they have bought, which will drive value for end-investors.

Commission sharing agreements (CSAs), use of which has been growing for the past decade, offer asset managers a mechanism to concentrate costs, particularly in terms of research. By channeling payments to specific research firms, they will reduce their spend on broker research that isn’t core to their trading strategy, while execution will remain with bulge bracket firms.

So will the FCA oversee the end of corporate access?

Long slotted under the research umbrella, the usage and packaging of corporate access services are bound to change. Some corporate access services legitimately is considered research and can be paid for with dealing commissions if brokers are present in meetings and actual research is developed (which must include the manipulation of data according to FSA rules), but the regulators’ new attitude will also open the door to new corporate access schemes.

Themed events offering insights into particular geographies, trends or industry verticals, such as seminars where brokers present original research and link investors with management teams from relevant issuers, may sprout.

Specific businesses offering corporate access have proven difficult to establish in the past, but a clearer separation of payments for broker services may lead to a clearer price asset managers can attribute to corporate access, as some have indicated it is central to the proper functioning of their investment strategies.