The regulator has published its feedback statement to the discussion paper it released last summer, scrutinising the use of dealing commission – an area of the market the regulator estimates is worth around £3bn a year.
The FCA said EU reform proposals to separate portfolio managers’ payments for research from execution payments “will better align their incentives to control costs and procure research in the best interests of their customers, and will improve competition in the market for research.”
ESMA’s final advice was submitted to the European Commission in December 2014. The EC will draft the actual legislative proposals during 2015, taking into account ESMA, the European Parliament and European Council, which will have three months – with the option ot extend a further three months – to formally scrutinise or object to the legislation before it is finalised.
Under ESMA’s proposals, a manager can purchase research provided it is paid for out of its own resources or through a separate account dedicated to that purpose. Brokers offering multiple services must charge separately for research and trade execution to ensure no influence from one service onto the other.
The FCA Feedback Statement FS15/1 said: “We believe ESMA’s proposal will lead to direct accountability over the expenditure on third-party research by portfolio managers and how these costs are passed to their customers, leading to better outcomes for investors across the EU.”
Further, applying ESMA’s approach to fixed income markets will introduce greater transparency to a sector currently more opaque than the equity markets, with bid/offer spreads expected to narrow.
“In fixed income, costs of research, as well as some other discrete costs, are usually embedded within the negotiable bid/offer spreads quoted by brokers.
“We believe this would mean that, in the new regime, a manager would have the option either to pay directly for research, or use the research charge and payment account to do so, which can be applied to clients with fixed income portfolios in the same way as for equities. If research is currently a material part of a broker’s costs, we would expect a narrowing of spreads as a result of the decoupling of research from trading spread.”
Daniel Godfrey, CEO of The Investment Association, said: “There is still plenty of work to be done, not least in ensuring that implementation is workable for the gaining of client consent and the allocation of costs among clients. Additionally, we would like to see all Europe’s regulators reach a common view of what constitutes research and explain how these rules will apply in practice in fixed income markets.”
The FCA added it expected transaction costs to come down as the embedded research costs were stripped out of their currently ‘bundled’ costs.
While the watchdog acknowledged some potential negative unintended consequences, it largely rejected them.
These included the chance asset managers would cut spending on third-party research altogether, causing a drop-off in performance. It was also viewed as a barrier to smaller players and start-ups, discouraging competition. Further concerns were raised that EU investment managers would be less competitive versus overseas and that further reform might prevent EU managers from sourcing US broker research, for example.
But the FCA has rejected these assumptions, as well as the suggestion that brokers focused on the smaller end of the market face a disadvantage, following “some initial transitional costs”.
