Efforts by the Financial Conduct Authority (FCA) to reform how institutional investors pay for research and execution services have been praised following last week’s policy statement by the UK regulator.
Last Thursday, the FCA provided additional clarity on asset managers’ obligations to clients when paying for bundled research and execution services from brokers.
Industry reaction supports the aim of the proposed reforms to provide more robust and useful research while also cutting costs for end-investors.
Adam Toms, CEO of Instinet Europe, said, “This is all about transparency and accountability and that’s a good thing for the industry. The FCA has come up with a clear policy that the buy-side needs to have controls in place to ensure they get value for their investors’ money.”
The policy statement released last week, which takes into account industry feedback to the consultation paper the FCA launched in November 2013, firmly places responsibility for managing the cost of research with the asset manager. However, sell-side reliance on the bundled payment model to sustain their research operations means the fallout of reforms may be most felt among brokers rather than the buy-side.
Institutional investors will need to ensure that they have reasonable grounds to be satisfied that research they have paid for is substantive and helps them add value to their customers. The FCA stresses that research paid for from dealing commissions does not necessarily need to lead to a decision to invest or trade a security.
Toms said the policy statement has provided firmer guidelines on issues raised in the ‘Dear CEO’ letter sent by the FCA’s predecessor, the Financial Services Authority, to asset managers in November 2012.
“The FCA delivered some much needed clarity in some areas. Wording around what constituted substantive research in the consultation paper was unclear but the policy statement has clarified many of those concerns,” he said.
Corporate access ban
Michael Hufton, CEO and founder of corporate access platform Ingage IR, said the buy-side has been uncertain of what many of their obligations are when paying for bundled services.
“I think it’s beneficial for everyone that the FCA has published this statement as there has been a lot of confusion in the market.
“Now we know what the rules are and firms know they can expect enforcement action if they don’t comply,” he added.
Perhaps the biggest initial change for the buy-side will be the banning of paying for corporate access through dealing commissions. The ban was proposed in the original consultation and will now come into force on 2 June.
The FCA said it does not believe corporate access can be considered a form of research and many buy-siders have complained that brokers only offered corporate access to their high-volume clients or charged too much for it.
Hufton said this was a major frustration when he worked at as a portfolio manager at Polar Capital, leading him to set up Ingage IR last year.
“Asset managers are really positive about this and there has been a broad acceptance that the way things used to operate was not really in the best interests of the buy-side,” he said.
Hufton said the ban on corporate access payments through research will also be beneficial to banks, by allowing them to focus on providing a better quality research and execution business to their clients.
The policy statement also fleshed out proposals on cross-border application of the unbundling rules. The FCA said last year that it wanted to change the way the research market worked without damaging UK competitiveness and would seek to introduce the rules as part of MiFID II.
With MiFID II now entering its implementation stage, the FCA said existing rules banning inducements in MiFID II should enable it to lobby / persuade ??? European politicians and regulators that the opaque bundled research and execution model effectively counts as an inducement. However, with the first consultation paper from the European Securities and Markets Authority on Level 2 rules for MiFID II not due until late May, the Investment Management Association (IMA) said it had hoped for more concrete proposals on cross-border application.
“Whilst the FCA has provided more comment about international aspects than before, the impacts on those managers with international operations still remain a challenge – especially with the new rules taking effect in only 16 working days,” said Guy Sears, director of risk, compliance and legal at the IMA.
However, Instinet’s Toms said clients in both the UK and elsewhere have already begun changing their behaviour to achieve better value for their investors and will not be heavily impacted by the relatively short deadline to comply.
“Clients have already been making changes to the way they do business and we’ve seen a significant increase in the use of our commission sharing agreement programme since the consultation paper was launched last year,” he said. “We’re also seeing a lot of interest from clients in continental Europe and in the US on this as well.”