UK regulator the Financial Conduct Authority (FCA) is soon to launch a consultation on the use of commissions to pay for research, which could have financial implications for end-investors.
Why is the FCA concerned about the way asset managers pay for research?
Over the past year, the UK regulator has made clear its dissatisfaction with the way research and execution costs have been bundled into a single commission payment to brokers. Ultimately, it is worried that the cost of research is not being properly reflected in the price asset managers pay for it and that this is resulting in poor outcomes for end-investors.
It believes the lack of transparency is not only hiding many of the true costs of investing from retail investors in funds and pension savers, but is also leading to complacency in the fund management industry that has encouraged costs to balloon.
How are bundled commissions distorting the cost of research?
When the FCA’s CEO Martin Wheatley spoke at the regulator’s asset management conference in London at the end of October, he gave a startling example of just how the current commission payment system could result in asset managers paying far more for research than it was really worth.
One firm that the FCA investigated spent roughly twice as much on research from one year to the next, largely because it had been trading more frequently. While one would expect trading twice as often would result in a doubling of execution costs, it shouldn’t necessarily result in twice as much research being used. The firm in question had received roughly the same amount of research as in the previous year, but now it was paying twice as much for it.
“The link between volume of trading and research expenditure appears to be flawed. It creates ‘pots’ of research commissions the fund manager is then incentivised to spend regardless of the added value of the services,” said Wheatley.
So will this push up costs for investors?
The FCA has made it clear that it wants to reduce the cost to investors, believing many are being disadvantaged by the uncontrolled nature in which asset managers manage costs.
Some industry commentators have said that, if asset managers are forced to pay for research from their own money, then management fees will need to rise to compensate. While this may well happen, at least then the end-investor will be able to see the cost of research in their fee, whereas currently the cost of both execution and research are taken from the fund, resulting in reduce returns on investment.
Either way, the end-investor is paying for this research. What the FCA hopes is that, when asset managers are forced to be more transparent about their research costs, they will also be more thoughtful about how much and which research they buy. This should result in lower costs overall as many buy- and sell-siders currently recognise that there is significant over-capacity in the research market at present.
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