According Boardman, the FCA’s discussion paper last week represents an ongoing shift in the sector toward greater transparency, particularly in terms of price.
In the discussion paper (covered in more detail here) the FCA points out that the bundling together of the payment of the two services – research and dealing – from dealing commission results in a number of inefficiencies. Not only does it make it difficult for brokers to know whether or not their research is valued highly or, indeed, even used, but it also means that investment houses often end up paying over the odds for information.
Currently, investment managers can pay for research with dealing commission in one of two ways: either, the manager will pay a bundled rate including the execution of trades as well as research, a sum that is paid entirely to the executing broker, or it can separate out the research element by using a commission sharing arrangement.
CSA’s enable firms to split out part of the execution commission to be used for research and at the point of execution, the two sums are funnelled into separate accounts.
While CSAs are not new, they haven’t yet entirely lived up to their billing as providers of greater flexibility in terms of where firms get and how they pay for research.
Part of the reason for this is the manner in which research has traditionally been valued and allocated.
Most firms still rely on the broker voting process in order to decide how to allocate their research budgets, currently.
But, as the FCA explains: “The broker voting process ranks the brokers based on the investment manager’s view of the research service(s) provided, but does not directly assess the monetary value of the research they are receiving”.
This results, the regulator said, in a process lacking in detail in terms of what the fund manager was valuing when voting for a particular research provider.
Not only does it lead to a muddying of the waters in terms of the value attached to research, but also, as funds are often deposited in a lump sum, it is also often hard to distinguish how much is actually being paid for research and how much for execution.
“The nuclear option would be to completely separate the two from one another,” Boardman explained, “But I don’t think they will go that far.”
The main industry argument against a change to the status quo would be that it would disadvantage UK institutions in other markets that are not bound by such rules. Companies not able to pay for research with dealing commission would have to pay for it from fees which would raise the costs associated with management of the various offerings available. This is why Boardman believes the FCA is pushing so hard for a pan- European solution to this problem.
“I think they have a preference to outlaw it but they are at present reluctant to go it alone, so they are seeking a pan-European option,” he said.
“I think what the FCA is looking for is the second generation of CSAs, where firms have agreed to pay for research and, importantly, know what they are paying for. This would be good for both the independent brokers and the independent research houses who currently are sometimes disadvantaged by only providing one of the two services,” he added.
The key is going to be ensuring there are sufficient processes in place for firms to know exactly what they are paying for and what they are getting.
