UK regulator the Financial Conduct Authority (FCA) has toughened up its stance on using dealing commissions to pay for research, following support for its new rules in MiFID II.
However, national regulators and brokers are expected to fight back against the proposals, which would open the way to full unbundling of research and execution services in Europe.
In its latest review of dealing commissions published last week, the FCA stated it welcomed European Securities and Markets Authority (ESMA) proposals to require any significant research performed by brokers on behalf of institutional investors to be paid for out of asset managers’ own funds, rather than commissions.
"It is slightly surprising ESMA has gone for such a tough stance on use of dealing commissions to pay for research as the issue hasn’t been on the regulatory agenda outside of the UK," commented Richard Balarkas, founder of Quendon Consulting and former CEO of Instinet Europe.
"The significance of the FCA aligning itself with ESMA is that it has now clearly declared a preference for full unbundling, and the initiative now has cross-border momentum. "
An FCA policy statement published in May stopped short of fully unbundling research payments from commissions, instead suggesting institutional investors should ensure they are aware of the costs of research, set budgets and ensure the research they buy with client commissions is of a high standard.
Later the same month, ESMA published its first consultation papers on MiFID II, stating that asset managers should use their own cash to pay for any significant or bespoke research they receive.
Tom Conigliaro, head of trading services at data provider Markit, said, "The FCA might not have gone down this path alone because of the risk of damaging competitiveness and creating regulatory arbitrage, but ESMA's strong stance will give the FCA confidence in taking a harder line.”
Lack of European support
However, the two regulators are likely to face an uphill struggle to get new rules on dealing commissions agreed across Europe due to the lack of support for unbundling on the continent.
“The FCA has outlined some options for full unbundling, but I think it will remain fairly cautious due to the potential for the UK to remain competitively disadvantaged if this isn’t implemented across Europe,” explained Rob Boardman, CEO of agency broker ITG Europe.
He added that lobbying from firms that currently benefit from the bundled execution and research commission model alongside a lack of support among national regulators in Europe could lead to ESMA’s proposals ultimately being watered down.
Kish Desai, head of sales for AQX, a Germany-headquartered agency broker, said, “There will be a big push back on this. We’ve been talking to regulators in Germany, Austria and other European jurisdictions and many simply haven’t even looked at reforming the bundled commission model prior to the MiFID II consultation.”
The FCA has steered clear of proposing any new rules at present, instead saying it would await the outcome of ESMA’s consultations on the regulatory technical standards for MiFID II.
If a fully unbundled model is adopted across Europe, it could have significant ramifications for both the buy- and sell-side. Desai said that while overall the move is positive for agency brokers, it could see commission sharing agreements (CSAs) become redundant or even banned if the buy-side were prohibited from buying non-execution services with commissions, which may also hurt independent research providers.
“Independent research providers have it very tough already but can ensure they get paid for their research via CSAs,” he said, “but if CSAs are effectively banned by ESMA then those firms might struggle to get asset managers to agree to pay for expensive research when that money has to come from their management fees.”
However, Conigliaro, who is responsible for Markit’s Commission Manager CSA aggregation tool, is more positive that the industry can adapt. "If these proposals are adopted, then you could see CSA products evolving into tools that focus on allocation of research payments, valuing that research and enabling firms to manage their research budgets."
ESMA’s current consultation on MiFID II is set to close on 1 August, with results expected to be published towards the end of 2014. A concurrent discussion paper on regulatory technical standards also closes on 1 August.