New rules on how commissions can be used by investment managers to pay for research and other services have been proposed by the UK regulator.
The Financial Conduct Authority (FCA) released these proposals on November 25, 2013. The FCA estimated that the UK asset management industry generated over £3 billion in commissions in 2012, of which £1.5 billion was spent on research. The regulator is concerned, however, that the industry would not have spent this much on research if asset managers had to pay for it using their own P&L, rather than using dealing commissions, which are funded by their clients.
The new rules are designed to clarify when commissions can be used to pay for research and other services. They include restricting them to be used for “substantive research” that presents “meaningful conclusions” to the investment manager. The regulations also reiterate the fact that commissions cannot be used to pay for corporate access.
The FCA is giving the industry 3 months to respond to its proposals, with new rules to be finalised in Q2 2014. A link to the FCA’s press release can be found here.
The proposed rules could have a far-reaching impact on the industry, especially if they are designed to lower the amount that the buy side (asset managers) spend on sell side research.
According to an article in the Financial Times, quoting a McKinsey report:
“Simply enforcing existing FCA rules which ban the use of commissions to pay for corporate access might in theory reduce sell side revenues by a third. Appropriate prudential controls on the use of commissions to buy research will squeeze margins further… Sell-side institutions are already facing a crisis, and unbundling may be the butterfly wing that turns into the perfect storm.”
There is also a European dimension to this as the EU’s MiFID II (Markets in Financial Instrument Directive) regulations are being discussed. There are questions around whether these rules could try to ban the use of commissions for research entirely.
If regulators do move to actually bar asset managers from using commissions to pay for research, it could have a drastic impact on that industry, as firms would be forced to take on at least some of these costs themselves (assuming that they don’t cut their sell side research usage to zero).
Another study quoted by the Financial Times examines this issue:
“Most industry figures believe asset managers would cut spending on research if they were forced to use their own balance sheet, rather than client money, to pay for it. If they bought half of what they buy now, this would reduce industry-wide profits by a quarter…”
There is also a question around whether further regulation of the investment management industry in the UK/EU could place it at a competitive disadvantage versus other regions with lower regulatory burdens in this area, including the U.S.
The topic of research payment regulation was discussed during the CFA UK’s “Future of Equity Research” 2013 conference. I was pleased to participate as a panel speaker at that event and I am also working on a book on this topic.
There is a sense that the FCA is moving quite aggressively on this issue of how research is paid for, perhaps at a faster rate than expected.
It will be interesting to see how the industry responds, what the final rules from the FCA will be, how all of this interplays with EU MiFID II regulations, and what the overall impact on the sector will be.
The next few months are likely to be critical to seeing how some of this develops, particularly in the UK.
New Regulations on Commissions Proposed
Posted on the 15th December 2013 by Gillian Elcock
New rules on how commissions can be used by investment managers to pay for research and other services have been proposed by the UK regulator.
The Financial Conduct Authority (FCA) released these proposals on November 25, 2013. The FCA estimated that the UK asset management industry generated over £3 billion in commissions in 2012, of which £1.5 billion was spent on research. The regulator is concerned, however, that the industry would not have spent this much on research if asset managers had to pay for it using their own P&L, rather than using dealing commissions, which are funded by their clients.
The new rules are designed to clarify when commissions can be used to pay for research and other services. They include restricting them to be used for “substantive research” that presents “meaningful conclusions” to the investment manager. The regulations also reiterate the fact that commissions cannot be used to pay for corporate access.
The FCA is giving the industry 3 months to respond to its proposals, with new rules to be finalised in Q2 2014. A link to the FCA’s press release can be found here.
The proposed rules could have a far-reaching impact on the industry, especially if they are designed to lower the amount that the buy side (asset managers) spend on sell side research.
According to an article in the Financial Times, quoting a McKinsey report:
“Simply enforcing existing FCA rules which ban the use of commissions to pay for corporate access might in theory reduce sell side revenues by a third. Appropriate prudential controls on the use of commissions to buy research will squeeze margins further… Sell-side institutions are already facing a crisis, and unbundling may be the butterfly wing that turns into the perfect storm.”
There is also a European dimension to this as the EU’s MiFID II (Markets in Financial Instrument Directive) regulations are being discussed. There are questions around whether these rules could try to ban the use of commissions for research entirely.
If regulators do move to actually bar asset managers from using commissions to pay for research, it could have a drastic impact on that industry, as firms would be forced to take on at least some of these costs themselves (assuming that they don’t cut their sell side research usage to zero).
Another study quoted by the Financial Times examines this issue:
“Most industry figures believe asset managers would cut spending on research if they were forced to use their own balance sheet, rather than client money, to pay for it. If they bought half of what they buy now, this would reduce industry-wide profits by a quarter…”
There is also a question around whether further regulation of the investment management industry in the UK/EU could place it at a competitive disadvantage versus other regions with lower regulatory burdens in this area, including the U.S.
The topic of research payment regulation was discussed during the CFA UK’s “Future of Equity Research” 2013 conference. I was pleased to participate as a panel speaker at that event and I am also working on a book on this topic.
There is a sense that the FCA is moving quite aggressively on this issue of how research is paid for, perhaps at a faster rate than expected.
It will be interesting to see how the industry responds, what the final rules from the FCA will be, how all of this interplays with EU MiFID II regulations, and what the overall impact on the sector will be.
The next few months are likely to be critical to seeing how some of this develops, particularly in the UK.