An edited conversation between David Lawton, Director of Markets, FCA and Edward Mangles, Regional Director, Asia Pacfic, FIX Trading Community.
The FSA introduced a new regime for what dealing commissions could be used for in addition to execution back in 2006. We have reviewed it a couple of times since then and are presenting a further round of review this year with.
There are three elements to this;
- The first is that in response to industry questioning, we have clarified in our guidance precisely what research can be bought using commissions.
- The second is that we have done a thematic review of how both buy-side and sell-side firms are complying with our rules and we’re presenting that back to the industry.
- Thirdly, given that in Europe we are in the context of introducing some new legislation , the FCA are keen to put forward some thoughts on what the more ideal longer term arrangements for dealing commissions in the market for research might look like.
While this is a scenario that will remain at the forefront of our agenda, we have no concrete plans for doing another thematic review. There are a number of issues that we want to follow up on with the individual firms who are in our sample but no further review should be required because, as I noted earlier, this is something that has been a big part of our wholesale conduct agenda for the last few years. It’s an important part of how the market works and I’m sure it’s something that will remain at the forefront of the FCA’s mind.
Self assessment
We have published the results of our thematic review setting out what we found in terms of good practice and less good practice as a means of communicating to the firms that weren’t in our sample our expectations as to how the rules should be complied with. We are now looking for all firms to benchmark themselves against that material.
One of the challenges in this space is that research is being bundled up with execution. Our regime is designed to incentivise buy-side firms to identify and put a value on the research that they want to pay for with commissions. We accept that there isn’t really a free market in research yet and that brokers currently provide a bundled service, so we are encouraging fund managers to have a dialogue with brokers to get them to price research. If that is not happening, fund managers can also look at benchmarking against other valuations that they can find. We do recognise that it’s a challenge and that’s one of the reasons we think a longer term better arrangement would be unbundling in this market and seeing research provided and priced for separately.
Our paper surmises two things: the first is that we expect firms to be doing more within the context of the current regime to comply with our rules than they are now. In our survey of 17 buy-side firms, we only found two that were delivering something that we think is fully compatible with our rules. The second point is that we recognise that there are some structural issues across the entire marketplace that need to be looked at.
Our goal is to have a marketplace in which the end investors are best served: in which fund managers are acting as good agents for their clients in terms of the use of their funds and seeking and securing research which is in the best interest of the end investors. The key concern we have about the current arrangements is that the incentives and the market structures don’t drive us to that conclusion.
CSAs
During the thematic review, the firms that were following better practices tended to be the firms that were using CSAs. However, they are not a universal panacea because they still they’re associated with payments to research linked to the volume of trading. CSAs need to be used with care; they’re not mandated by our regime but they are a helpful tool.
Smaller firms
In regard to longer term structural arrangements for smaller firms, our key conclusion is that we think that the market would be improved if there were some unbundling of research from commissions.
We think that a market for research that was separate from commissions could in fact be to the benefit of all brokers both large and small and it would enable smaller brokers to focus on commissioning the research that was particularly tailored to their fund management strategy.
We want fund managers to do more in terms of transparency and accountability: I think it is right that conceptually we can see the benefits of separating research from commissions. That links us back to the European debate where under the revised method, the legislation places greater restrictions on what fund managers can receive in return for commission and the European Securities and Markets Authority’s consultation on what limited benefits might be acceptable associated with the payment of commissions.
So monetary and non-monetary benefits are allowed but anything more than that is not, so the gap between that and full unbundling in our view is relatively small.
And our analysis suggests that this produces a marketplace that is more competitive. It reinvigorates the market for research which benefits the industry as a whole. One of the questions that we’re often asked in this debate is whether the UK is planning to change the rules unilaterally. The answer is that we are not proposing any rule changes at this stage. We are very keen to engage in the European debate about what the final method rules should look like and recognise the importance that there is a level playing field across Europe.
A better functioning market for research and commission arrangements would in fact provide competitive advantage to the fund management industry. We think it will be beneficial to be more transparent and open to end investors about how the funds are being used.
Global conversation
There is already a very lively debate in Europe around finalising the rules and we’re fully engaged in that. Globally I think this topic remains of interest to markets and securities regulators as an important structural feature of how the marketplace works. Aspects of it are already under discussion in IOSCO. We’d be very supportive of global discussions and it’s something that comes up regularly in our bilateral discussions with other key markets regulators.
