On 5 November 2024, the Financial Conduct Authority (“FCA”) published a consultation paper (CP24/21) on investment research payment optionality for fund managers. The FCA is proposing to take forward the recommendations of the Investment Research Review (“IRR”) and feedback to its earlier consultation for MiFID investment firms, by extending payment optionality for investment research to fund managers and pooled funds (including UCITS and AIFs).
The proposals would allow fund managers to purchase investment research by making joint payments (i.e. by paying for bundled investment research and execution services), subject to a set of guardrails. This consultation is relevant to:
- the management companies of Undertakings for Collective Investment in Transferable Securities (“UCITS”);
- full scope UK Alternative Investment Fund (“AIF”) managers (“AIFMs”); and
- small authorised UK AIFMs and residual collective investment scheme operators.
The proposals are modifications to the rules introduced for MiFID investment firms on 1 August 2024 in relation to segregated mandates, to reflect differences in the pooled funds context.
What guardrails will fund managers be required to implement?
The existing rules on best execution will continue to apply and the provision of investment research must not be considered as a factor as part of the execution process. The new guardrails include the following requirements:
- Policy: fund managers must have in place a written policy on joint payments for each fund they manage and this must cover governance, decision-making, controls, and ensuring research costs are maintained separately from trade execution costs.
- Approach to research costs: fund managers must stipulate the methodology for calculating research costs and separately identifying them within total charges of joint payments.
- Research provider allocation: fund managers must establish a payment allocation structure for research providers (irrespective of whether they offer trade execution).
- Operational requirements: fund managers will be responsible for the administration of accounts for purchasing research from joint payments, timely reconciliation and regular reporting of the joint payment account.
- Research budgets: fund managers will be required to set research budgets for each fund they manage based on the expected amount of third-party research, independent of the volume or value of trade transactions. The budget must be set at an appropriate level for the fund to avoid cross-subsidisation between funds. If the research cost increases or exceeds the budget, fund managers must inform the governing body of the fund (if independent of the firm), assess whether it is in the investors’ interests, and where applicable, ensure it is assessed in line with the relevant sections of the Collective Investment Schemes Sourcebook (“COLL”) or value assessment under the Consumer Duty. Fund managers must provide appropriate disclosure in the relevant funds’ documents and for authorised funds, this will include the reason for higher research costs for joint payments. Where the research budget is exceeded or increased, authorised fund managers must disclose this in the annual report, and either explain the reason for why the budget is exceeded or update the prospectus to reflect the budget increase.
- Value assessment: fund managers must assess the value and quality of research for each fund they manage periodically and within the wider assessment of value under COLL.
- Cost allocation: fund managers must allocate research costs to funds fairly, taking into consideration the budget set for each fund.
- Disclosure: fund managers must provide appropriate disclosure of joint payments in funds’ documents.
How are fund managers expected to implement these changes?
Where fund managers for authorised retail funds adopt the joint payment option, it will be considered a “significant change” for COLL purposes, and fund managers will need to give unitholders written notice of the new payment option at least 60 days in advance and obtain FCA approval.
Fund managers must continue to meet their costs and charges disclosure requirements in the key investor information (KII) and if the new joint payments option substantially increases the transaction costs of a fund, it will need to be disclosed in the “objectives and investment policy” section.
The FCA does not intend to provide additional guidance to managers of Qualified Investor Schemes if they use the joint payment option. Managers of Long-term Asset Funds who wish to utilise the joint payments option must meet the requirements of the FCA’s existing rules, which will depend on the investor type. The requirements do not apply to fund managers making changes to unauthorised funds. However, the expectation is that fund managers act fairly in the interests of investors.
What else do fund managers need to know?
- Short-term trading commentary. The FCA proposes adding short-term trading commentary, which does not contain substantive analysis and bespoke trade advisory services, to the list of acceptable non-monetary benefits, meaning they do not need to pass the quality enhancement test.
- Research on smaller companies. The FCA is proposing to remove research in relation to companies with a market capitalisation below £200m from the list of acceptable non-monetary benefits. This will mean there is no distinction between the payment for research based on company size. However, corporate access service for smaller companies will be retained as an acceptable non-monetary benefit.
- Changes for clarity. For ease of navigation, the FCA proposes moving rules relating to the prospectus and annual report disclosure for funds using Research Payment Accounts (“RPAs”) into the COLL rules from the Conduct of Business Sourcebook (“COBS”). However, the FCA will not change the RPA requirements as part of the move. The FCA is also proposing to amend rules in COBS to specify that payments for research will be permitted out of scheme property. Other miscellaneous corrections will be made to the COBS rules.
When do the changes take effect and what should fund managers do next?
The FCA invites comments on the consultation paper by 16 December 2024 and if it chooses to proceed with the proposals, aims to publish the new rules and any guidance in the first half of 2025. The implementation timeline will be confirmed at that point in time, at which point fund managers will want to consider whether they adopt joint payments and if this can be timed to coincide with their next prospectus update.
If you have any questions about the proposed changes and how these are likely to impact your firm or funds, please get in touch with the key contacts listed or your usual contacts at CMS, who would be happy to discuss these considerations in more detail.
Co-authored by Jessica Ng
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