The FCA has shared its consultation paper on payment optionality for investment research, proposing the introduction of a ‘bundling’ regime for payments. But how will the industry react to yet another regulatory change? And how much of a material difference will this really make? Mike Carrodus, CEO and founder of Substantive Research, speaks to BEST EXECUTION about why firms are hesitant to make a change.
Since the publication of Rachel Kent’s Investment Research Review in July 2023, debates around research rebundling, the way it should be approached and how the Treasury-to-FCA handover would work have loomed large over the industry.
In its consultation paper, the FCA explains that reduced research spend has caused downward pricing pressure, reducing the number of providers in the market and concentrating allocation to large providers. Over time, this has prevented new firms from entering the market, stifled innovation and decreased the availability of information.
It’s broadly agreed that the proposed changes will have at worst a neutral impact on equity market functioning in the UK. Ideally, the new rules will increase competitiveness, lower
barriers to entry and allow smaller asset managers to grow without being disproportionately constrained by available resources, according to the FCA.
“We want to give UK buy-side firms – asset managers and others – greater flexibility on how they can purchase investment research,” the FCA stated. ”To do this we are proposing a new regime which would allow the ‘bundling’ of payments for third-party research and execution services, subject to our proposed guardrails.”
These guardrails, which have been expanded from previous discussions, are a welcome addition, Mike Carrodus, CEO and founder of Substantive Research, told BEST EXECUTION. Carrodus welcomes the changes and sees the paper as a positive development. That being said, how the industry will respond to the report and the overall impact the proposed rules will have is a more nuanced discussion.
So… who wants to go first?
“Once we see how a few of the largest firms are going to react to this, I think we’ll then see sections of the markets making moves in groups”, Carrodus said. He sees three broad subsections in his company’s buy-side client base; those who are determined to make the change, but don’t want to be the first mover; the “wait and see” brigade; and those who are “dogmatically against” the change.
Even from the most enthusiastic third, the majority will wait until 2025 to start implementing change, Carrodus shared. “There will probably be some early adopters that decide to move to commission sharing arrangement (CSA)-funded budgets before Christmas,” but this will be a minimal portion of the market.
These first movers are likely to be small, multi-region firms, he predicted.
The unbundling of research costs is already popular in the US, Carrodus reported – clients want to know where their money is going but, at the same time, don’t want to be paying for research separately. As a result, US-headquartered smaller asset managers who have a smaller presence in Europe, might not have many regional clients they need to check in with before they shift to a different model, he explained.
This group will be able to make the case that they’re homogenising across regions, bringing their UK operations in line with the US’s existing CSA option, which allows asset managers to pay broker-dealers for trade execution while allocating a portion of the commission set aside for research to a third-party broker-dealer or IRP. In a Q4 2023 cross-industry survey, by Global Trading in partnership with Substantive Research, the freedom to set up traditional CSA programmes in the name of the broker emerged as the second most popular feature firms were hoping to see in the FCA’s final rules—there’s a clear demand for this to be introduced. The US also allows for what the FCA report calls ‘soft commissions’, in which payments to broker-dealers for execution and research services are combined.
However, “quite a lot of continental European and medium-sized UK firms are not that keen on moving early, or are internally disposed not to change unless they feel it’s a competitive necessity”, Carrodus added.
For those in this middle segment, a major concern is that the change management processes will take time—potentially a considerable amount of time. There are a lot of moving parts when it comes to making this sort of adjustment, a lot of channels that need to be followed and stones that cannot be left unturned. As a result, adopting this new method in the near future is unfeasible.
“The jury is still out on whether this is something that’s going to affect 2025 budgets in any
large volume,” Carrodus mused, considering the speed at which adoption will occur. He expects the majority to make the changes in 2025, when they have more confidence and more information on the rules, and for 2026 budgets to reflect that.
The third category that Carrodus identifies is those who are fed up with regulatory upheaval, are happy with how their operations are running post-MiFID II and have no desire to instigate further fee conversations with their end investors.
While internal conversations will doubtless be taking place at any number of firms, for the moment it’s uncertain when the first real move will be made. “It depends on how much conviction people have that this document is what we’re going to get in the end,” Carrodus comments. “If you don’t have very high conviction, then you’re going to wait until [the final rules] are in place over the summer” before speaking to clients and getting the ball rolling.
Carrodus emphasised that this report introduces a new option for asset managers rather than a mandated change to operations. When MiFID II mandated the unbundling of execution and research charges, firms had a deadline to work to. Now, though, there’s a little less motivation for firms to introduce a new system—particularly given the cost, time and upheaval that will come with that. These new rules “will be more of an evolving picture”, Carrodus predicted, with firms moving at different paces to adapt to the changes.
All lined up
When asked whether the implementation of this new optionality will just be another step on the regulatory hamster wheel, Carrodus responds with a confident ‘no’. With the advent of these new systems, “I think we’re going to have regulatory alignment across Europe, the UK and North America—which we haven’t had in years. I don’t think anyone is going to want to mess with that”, he explained.
Along with the central goals of the proposed FCA rules are directly related to, a secondary objective is improved alignment with international standards and payment structures, the paper explains. This, in turn, could improve UK growth and competitiveness, a key concern for those across the industry.
However, Carrodus is keen to stress that while the FCA’s paper is certainly interesting, the rules, once finalised, will not have a transformational impact.
“Removing the obstacles on the supply side is great, but if the demand isn’t there then all that happens is a slightly less onerous environment for asset managers when they look at their research budgets,” Asset managers are not demonstrating a particular yen to invest in new asset classes or SMEs, he continued. If they do, then these rules will ensure that the research they need is put online fast. But as it stands, demand needs to be driven up before the industry sees a notable change.
All in all, the FCA’s new rules are expected to have a positive impact. Just when that impact will be felt, though, is less of a certainty. Who will be the first canary to head down the mine and find out?
©Markets Media Europe 2024
