On 10 April, the FCA published a consultation paper on ‘Payment Optionality for Investment Research’ (CP 24/7), setting out proposed amendments to its inducement rules relating to research, with an aim to provide UK asset managers with greater flexibility in how they pay for investment research. The consultation paper follows on from the July 2023 Investment Research Review, commissioned as part of the UK government’s Edinburgh Reforms package.
The consultation period closes on 5th June 2024. The FCA aims to publish any resulting policy statement in the first half of 2024.
A. The current picture
UK asset managers are presently prevented from combining payments for execution and research (i.e. bundled research) as a result of the inducements restriction set out in COBS 2.3A. Rather, under the current (EU-derived) rules, UK asset managers can pay for third party investment research in two ways:
- The RPA model: the firm charges investment research costs to clients, with payment made from a research payment account (RPA). The FCA has acknowledged that this option can be “operationally complex and resource-intensive to maintain”, owing to the need for the firm to agree with each client a separate research charge.
- The own resources model: the firm pays for the research from its own resources – a model which many asset managers have adopted in practice.
The FCA also found that these options could impede UK asset managers’ ability to compete effectively on a global basis. Specifically, they can negatively affect UK asset managers’ ability to purchase investment research across multiple jurisdictions, without significant and potentially disproportionate operational and regulatory complexities. This can in turn impact the availability of research to end-investors.
B. An overview of the proposed amendments
The FCA is proposing to amend its rules by enabling a third option of payment for third party research - such that a UK asset manager could jointly pay for third party research and execution services (i.e. effectively reversing the restriction on bundled payments), provided that the firm:
- establishes a formal policy setting out the firm’s approach to joint payments, specifying how the firm’s governance, decision-making and controls relating to third party research purchased in this way operate separately from payments for trade execution;
- enters into written agreements with research and execution service providers, setting out a methodology for how research costs will be calculated and identified separately within total charges for joint payments;
- establishes an approach for the fair allocation of costs for research purchased using joint payments across their clients;
- establishes a budget for the purchase of third party research using joint payments;
- periodically (and at least annually) assesses the value, quality and use of research purchased using joint payments, as well as benchmarking and price discovery of such research;
- establishes a structure for the allocation of payments across research providers;
- establishes operational procedures for the administration of accounts to purchase research; and
- communicates appropriate disclosures to relevant clients of the firm’s use of and approach to joint payments, their most significant research providers, and costs incurred.
This new option would increase alignment of the UK regime with the US ‘soft commissions’ model; and proposed EU legislative amendments (which largely mirror the FCA’s proposals to relax the MiFID II unbundling rules).
C. Our thoughts
In essence, through its proposed new option, the FCA is seeking to strike an appropriate balance between its consumer protection and competition objectives.
With FCA backing, the restriction on bundled payments was introduced in January 2018 across the EU to address concerns that this approach fostered a number of poor practices, including: less disciplined spending on duplicative or low-quality research, inappropriate influence of research procurement considerations on trade allocation decisions, and opaque charging structures.
In its initial review of the impact of the unbundling rules, the FCA reported “positive changes” in asset managers’ accountability over costs and transparency towards investors, as well as the quality of investment research made available and used in the market.
However, after only a few years, both the FCA and European Commission have changed tack. A desire to enhance market competitiveness (and, in turn, attractiveness) appears to be a key driver for both authorities. The FCA is being cautious, however, warning in its consultation that should it see poor practices increase again, then additional guidance and more prescriptive standards could be issued – particularly given its commitment to its Consumer Duty rules applicable to firms serving retail clients.
Interestingly, the FCA undertook an extensive pre-consultation engagement with buy-side and sell-side firms, which informed the consultation paper proposals. We would not therefore anticipate significant changes to result from the current consultation process.
The FCA aims to produce the final rules within the first half of this year, in contrast with the EU proposals, which will take at least two years in order for the finalised Directive to be applied in the local laws of member states – providing the UK asset management and equities research industries a ‘first-mover’ opportunity.
If you have any questions concerning the material discussed in this client alert, please contact the members of our Financial Services Regulatory practice.
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