As part of the Edinburgh reforms, which were intended to drive growth and international competitiveness in financial services, the UK government called for an independent review of the country’s investment research market.
This 2023 review issued a series of recommendations to help boost the UK investment research market.
Investment research has a crucial role in providing information to potential and existing investors. It helps investors understand the company and risks of investing in such a business and hence allows informed investment decision-making.
The quality of investment research is significant in attracting and retaining issuers and investors to UK capital markets.
The Financial Conduct Authority’s Consultation Paper CP24/7, Payment Optionality for Investment Research (CP24/7), focuses on just one of the recommendations made from the 2023 review and may potentially give UK buyside companies — asset managers and others — greater flexibility on how they can purchase investment research.
The current rules allow companies to either fund research out of their own resources such that research payments are a cost in a company’s overall profits, or agree a separate research charge with each of their clients with the payment for research made from a so-called “research payment account”.
New third option
The FCA is consulting on a “new” third option of “bundling” payments for third-party research and execution. It says the greater choice should suit companies of varying business models and sizes, helping to promote competition.
The regulator’s rules are said to favour larger asset managers, to have reduced the number of research providers and hence competition in the market, and to have restricted UK companies’ ability to buy investment research produced outside the country.
There has also been a suggestion that while providers continued to provide good research on larger issuers, the amount of and quality of research in relation to smaller issuers has fallen and is being produced by more junior staff.
The current rules stem from Mifid II, which introduced requirements to separate charges for trade execution from charges for research, thereby “unbundling” these two services and left companies with the two options mentioned earlier.
The concern was that this bundled practice led to a less-disciplined spending on duplicative or low-quality research, inappropriate influence of research procurement considerations on trade allocation decisions, and opaque charging structures.
The Mifid II policy objective at that time sought to remove any conflicts of interest and create costs and pricing transparency to clients.
For this third option, companies would need to establish appropriate “guardrails” to protect investors including:
- a formal policy on use of the approach. This approach would need to fall within the company’s governance framework and hence its decision-making, periodic monitoring and controls;
- a budget for the research to be purchased will need to be set and reviewed on an annual basis;
- ongoing assessments of research value and price. This will need to be benchmarked annually;
- an approach to the allocation of costs across their clients;
- a structure for the allocation of payments across research providers;
- operational procedures for the administration of accounts to purchase research;
- disclosures to clients on the company’s approach to bundled payments, their most significant research providers, and costs incurred. Full transparency would need to be given on the firm’s approach to bundled payments.
CP24/7 also highlights that companies to which the consumer duty applies would need to consider whether their policies and arrangements for bundled research meet the requirements of the duty. Companies will need to consider price and value aspects, as well as customer communications about research.
The FCA will seek to implement this new option by adding to the list of minor non-monetary benefits commentary and advice linked to trade execution.
