When it comes to the FCA’s consultation on investment research funding and payment rules, what are the most important aspects from the trading perspective?
Things are definitely evolving and all the noise creates more discussion. In terms of initial impact we took a first look and the main thing was that there were no major stumbling blocks in the consultation paper, no real sting in the tail. For asset managers there is nothing operationally, or from a regulatory perspective, that will act as a real dealbreaker, however there are some things that asset managers will either need clarifying or will have to make a call on in terms of interpretation.
There are a couple of specific areas that many on the buy-side have found unhelpful, including how granular the reporting and disclosure requirements would have to become. Right now you can already charge clients for your research costs using an operationally burdensome Research Payment Account (RPA) arrangement which puts most firms off, so it’s key that this new structure is seen as a simpler option.
These freedoms soften the burden to an extent. Asset managers will move onto the commercial conversations with their client base about whether they will allow these costs to be returned to them, and change will hinge on whether managers feel confident that there’s not going to be any sort of negative competitive consequences.
What are the expected speed bumps following this news?
It links to pre and post reporting, and how that fits into regulatory alignment – across the US and UK. There are a lot of American firms who use research and pay as they go, as opposed to setting a budget. Many just pay using the commission sharing arrangements (CSA) and then assess – they’re not setting a clear, delineated research budget at the beginning of the year, and others that do set a budget often set it at a firm-wide level which may not be sufficiently detailed.
It also depends on a firm’s structure internally, such as whether they share research around the firm which can create issues within this new structure. For those who already have the systems in place in terms of budgets and metrics, they will feel like this is less of a challenge. However, for others, they’ll have to set up steering groups and take more time. There’s a clear spectrum of varying responses to the consultation paper from our survey group.
Is there a common denominator between the parties that are quite pro-rebundling?
I think it’s easier to understand the eagerness from those who are just trying to have consistency across different regions and jurisdictions, it’s an authentic narrative that shows a preference for global alignment and the ability to mirror the regulatory alignment with your own global process. Outside of those use cases the positivity for these new freedoms is not so clear cut.
The review led by Rachel Kent outlined that returning research costs to end investors could be commensurate with their best interests, and could contribute to better performance and allocation of capital. But whether asset owners buy into this is another question.
In addition, for firms which do not have business in multiple geographies, the importance of global cohesiveness and aligning with that shift loses gravitas, and it’s unsurprising that some firms that are UK-only are less keen. It’s a nuanced conversation, and following this consultation paper, end investors will have two key questions – what do I get for the extra money that I’m being charged? and how do I know it is an appropriate use of tightening budgets?
Read more: FCA tables re-bundling to support more ‘flexible’ approach to research
In the first instance, they’re not going to be guaranteed alpha, but these new freedoms could add a flexibility and structure that allows for optionality in getting different research inputs to contribute to investment decisions. This could be in the interests of the asset owner. In terms of spending budget wisely and focusing on value, that’s the intention of the FCA’s guardrails and constraints. It’s extremely interesting for us at Substantive Research that price benchmarking is one of the suggestions to come from the Kent review.
It’s important to note that price benchmarking is not necessarily about always driving the cost of research down. Even if this payment optionality trend didn’t take off, our data already shows that research budgets and research payments have stabilised somewhat. But what benchmarking of this kind does is illustrate to firms where they are over or underspending versus peers, so for example if they want to reward a provider 20% or 30% more than peers, they can do so from a position of knowledge which they can report confidently to clients.
Now that the US and the UK are more closely aligned, what’s the current state of play across the rest of Europe?
I’m not an expert on EU processes but we now have some of the new language to assess, and it appears that there is more openness to actual rebundling from the EU bloc. However, also included are mentions about separate research agreements, assessing the value of research and understanding how much firms are paying, which indicates an element of CSA.
So on the one hand, you’ve got language that leans positively towards rebundling, but then there are other factors, for example one intriguing part of the EU rhetoric which says that in essence end investor clients should be able to ask firms for details about their managers’ policies on research, if indeed they have them. But if your asset manager decides not to have that information collated, then they might not have to deliver it. It’s a potential loophole in theory.
This aside, the EU will have fewer guardrails but a similar approach to whatever final form the FCA’s new rules take. In the end, I suspect the EU research market will get to a very similar place, which is a CSA-led process, plus more specific terminology for optionality on how to pay for research, but with a greater disclosure burden. Longer term, I think the US will mimic Europe and the UK in those requirements for greater disclosure in exchange for continuing research payment optionality.
For the moment conversations are almost entirely internal, but there are some outlier firms who are more keen to test the waters on this with their clients. There may be an early adopter group this autumn making changes, and all eyes will be on them to see how they get on!