FCA brings new MiFID II unbundling exemptions into force

MiFID II amendments mirror some of the changes brought into force in the EU yesterday through the Quick Fix Directive, including the removal of best execution reports.

The UK’s Financial Conduct Authority (FCA) has introduced new research unbundling exemptions in a bid to foster competition in the research market.

Brought in under MiFID II, unbundling rules – which required brokers to separate payments for research and execution –  have been criticised by those who claim that it has led to a lack of competition in the research market, favouring larger providers who can afford subsidise their research departments.

“I don’t think regulators foresaw the ability for large banks to reduce the cost of their research, subsequently creating a less competitive market. Essentially freezing a lot of independents out of being able to compete,” Substantive Research chief executive, Mike Carrodus, told The TRADE.

Among the changes to be implemented by the FCA is the exemption of small- to mid-cap listed or unlisted companies with a market capitalisation below £200 million from the unbundling rules, meaning research on firms under this threshold could be offered on a bundled basis by brokers.

The UK watchdog has also offered an exemption to third party research on fixed income currencies and commodities (FICC) instruments  (although macroeconomic research is not included in the exemption), and to research providers who do not provide execution services.

However, a survey of 40 UK asset managers conducted by Substantive Research in January found that of those surveyed, 60% said they planned to change nothing at all in light of the new changes, calling the SME exemption “unworkable”, while around 70% of firms said they would not be changing their FICC research processes.

The lack of desire in asset managers to change their approach to FICC trading stems from the fact that macroeconomic research is excluded, said Carrodus.

According to him, the exemptions present two complications for the buy-side, number one being finding a way of separating macro research from FICC workflows and the second ensuring that no marco research slips through the net, leading the firm to fall under the inducement rules.

“These changes address the right areas but in effects because of the way they were drafted will create marginal change at best. Asset managers got to a place where they were happy with what was put in place. It’s tough to benefit from these exemptions,” he said.

“In practice macro sits in FICC at every broker and bank and so therefore it’s difficult to separate. How to price a stand-alone macro product may become ridiculous at places which were pricing their whole FICC offering as low as possible whilst obeying the rules.”

According to him, the current economic situation unfolding following the Russia and Ukraine conflict has placed a greater need for research.

“The buy-side are leaning most heavily on their research list now to provide scenario analysis extrapolation, key conviction calls on things, added value information,” he said. “This is now when your research list justifies its existence. This is a stress test of this post-MiFID evaluation process.”

The FCA also scrapped RTS 28 and 27 best execution reports as part of its consultation, with the change actioned in December.

“The general principal behind the reports was valid but the delivery and consumption of them was both cumbersome and resource intensive for market participants. I don’t believe they will be sorely missed,” Gareth Exton, head of execution and quantitative services EMEA at Liquidnet, told The TRADE.

“Even though the requirement for the reports to be machine readable was embedded in the rules, the different delivery methods used by firms (csv, xml, excel, pdf, etc.) meant each counterparty report had to be consumed individually. This, in a sense, defeated their purpose as it made getting any aggregate view very difficult and evaluating the contents of the reports costly, both in terms of time and resources.”

The changes mirror similar changes brought in in Europe yesterday under a MiFID II Quick Fix Directive.