The Thematic Review involved 17 investment managers and 13 brokers. The aim of it was “to explore the extent of the issues and whether more structural reform is needed to improve … efficiency and transparency”.
The key findings were that:
- many firms do not assess the value of research services rigorously enough – indeed, only 2 firms were operating at the level the FCA expected – although some firms had noticeably improved their governance arrangements for purchasing research with dealing commission; and
- the current state of the market for research services has led to a lack of price transparency; the bundling together of execution and research services by brokers has exacerbated this in particular.
Other findings included:
- in 11 of the 17 investment management firms, the amount of research purchased with dealing commission was linked to the volume of trades carried out, with no budgets or caps;
- one firm used dealing commission to pay for market data services in full without even attempting to determine which parts of the service were eligible to be paid for out of dealing commission;
- brokers did not explicitly price the cost of research as a distinct service; and
- brokers had not adequately considered conflicts of interests when arranging corporate access; some brokers were unclear whether they were acting for the corporate or the investment manager.
This led the FCA to conclude that unbundling “research from dealing commissions would be the most effective option,” and “It would be particularly effective if this reform can be achieved on an EU-wide basis.”
New EU proposals
Large in the background is the EU’s recent adoption of the recast Markets in Financial Instruments Directive (‘MiFID II’), which is due to be implemented by the beginning of 2017.
Article 24(8) MiFID II says:
“When providing portfolio management the investment firm shall not accept and retain … commissions … paid or provided by any third party or a person acting on behalf of a third party in relation to the provision of the service to clients. Minor non-monetary benefits that are capable of enhancing the quality of service provided to a client and are of a scale and nature such that they could not be judged to impair compliance with the investment firm’s duty to act in the best interest of the client shall be clearly disclosed and are excluded from this paragraph.”
The FCA takes this prohibition to include dealing commission arrangements (1.12); it notes that the European Securities and Markets Authority expanded on this point in its consultation on MiFID II secondary legislation:
“any research that involves a third party allocating valuable resources to a specific portfolio manager would not constitute a minor non-monetary benefit and could be judged to impair compliance with the portfolio manager’s duty to act in their client’s best interest”
The FCA concludes: “in our view, this would effectively mean the ‘unbundling’ of research from dealing commission arrangements on an EU-wide basis, except for the most generic, widely available commentary.”
The FCA also supports such a ban on bundling (as above), and intends to put this forward in its proposals for implementing MiFID II in the UK.
The present Discussion Paper is not a consultation on detailed policy proposals: as noted above, the proposed ban on ‘bundling’ would be introduced in the context of the implementation of MiFID II. The DP seeks to gather further comments on this at an early stage. Responses are required by 10 October 2014.
The FCA also encourages interested parties to reply the ESMA consultation on MiFID II secondary legislation. The deadline for responses is 3 January 2015.
The FCA expects that MiFID II “will apply by early 2017”.