05/08/2024 | News release | Distributed by Public on 05/08/2024 07:32
The prohibition on bundling
One of the most controversial features of the 2014 Markets in Financial Instruments Directive (MiFID II) was its prohibition (the "prohibition") on investment managers receiving services from broker-dealers that were paid for by charging the underlying client a higher rate of brokerage commission.
From the beginning of 2018, when MIFID II came into force, research costs had to be 'unbundled' and paid for separately from execution costs. Asset managers could do this either by paying for the research from their own resources (hard dollar payments) or through an elaborate structure known as a Research Payment Account (RPA), which collected payments from broker-dealers and used them to buy research.
While many large assets managers elected to pay their own research costs, smaller managers often made use of the RPA option, or billed the costs directly to their fund clients.
The prohibition did not work well, and the first changes were introduced in March 2022. The FCA now accepted that bond-market research was not being paid for by a hidden mark-up in the trading spreads, and exempted fixed income from the prohibition by reclassifying it as a minor non-monetary benefit. It also acknowledged that the prohibition had reduced the amount of research available, especially for smaller stocks, and exempted research on companies with a market capitalisation of under £200 million and on independent research. In practice, neither of these changes proved particularly helpful.
CP 24/7 'Payment Optionality for Investment Research'
In July 2023 an independent report - the Investment Research Review (IRR) - came out strongly in favour of lifting the prohibition and allowing research to be paid for on a bundled basis.
In April 2024, the FCA published CP 24/7 'Payment Optionality for Investment Research' in April 2024, which accepts the IRR recommendation for a return to bundled brokerage.
In doing so the FCA acknowledge that:
Accordingly, the FCA intends to introduce a new bundled payment option, alongside the existing options of payment from the firm's own resources or via an RPA.
As yet, the proposals relate only to MIFID business. The FCA is aware that they should also apply to UCITS managers and alternative investment fund managers and plans to set out the necessary rule changes to achieve this in a future consultation.
Conditions for payments for bundled research
Under the proposed rules, in-scope firms making a joint payment for third-party research and execution services will need to have the following in place (described by the FCA as 'guardrails'):
In-scope firms will also have to disclose to relevant clients their use of bundled payments for research, the key features of the firm's policy on joint payments, the expected annual costs to the client (to be included as part of the existing requirements on ex ante costs and charges disclosures), an indication of the most significant research providers and the total costs incurred by the client.
The FCA actively decided not to carry over the RPA requirement to obtain client consent to the research payment policy. In so doing, it specifically noted that the asymmetry caused by some clients agreeing to the policy and others rejecting it was unfair to those clients who agreed.
The effect is, broadly, that of a return to the pre-prohibition regime in which asset managers could use bundled payments to pay for research but had strict duties to monitor the cost and use of such payments and ensure the money was properly spent.
More peripherally, the FCA intends to add short-term trading commentary and advice linked to trade execution to its list of acceptable minor non-monetary benefits. In the U.S., certain types of short-term trading commentary may be provided by a broker-dealer (which may not be able to receive cash payments under an RPA) rather than by an investment advisor (which will be able to receive them). This could result in UK asset managers who continue to use an RPA being unable to obtain such services - hence the relaxation.
Next steps
The FCA is working to an accelerated timetable, with an eight-week period for comments ending on 5 June 2024. It has said that it then intends to finalise rules in the first half of 2024. This means the rules should be finalised between 5 and 30 June and are therefore likely to come into effect in the second half of 2024.