Speaking at an event in London last month, Frost Consulting principal Neil Scarth said asset managers have to adopt, or at least move closer to, the processes of the most conservative regulatory regime in which they operate, adding that the FSA’s November 2012 CEO letter banning asset managers from using broker commission to pay for corporate access has already led to a change of behaviour at a global level for several asset managers.
The use of commissions to pay for research, which do not appear in either a fund’s AMC or its TER, has been identified as one of the potential hidden charges within the pension system, bringing into question the validity of published pension charges and any charge cap that is introduced.
Last month pensions minister Steve Webb announced that all defined contribution workplace pension providers will have to offer complete transparency to savers and employers about how much they are being charged for their pension, following pressure from Labour pensions shadow Gregg McClymont.
Scarth, who was appointed to the Investment Management Association’s research review advisory panel in June 2013, identified five different possible outcomes from the FCA’s thematic review of the use of dealing commissions, CP13/17, the findings of which are due to be published later this month.
These range across a spectrum of intervention from no change, through mandatory commission allocation, monetary research budgets, full unbundling or a full ban on the use of commission to buy research.
The ‘no change’ option would mark the least intervention in the market, allowing current practices to continue.
Mandatory commission allocation would see some methodology required to be applied to the way fund managers allocate commission.
Monetary research budgets would see fund managers allowed to take dealing commissions for research up to a pre-determined level.
Full unbundling would require all dealing commissions to go through commission sharing arrangements (CSAs).
The most extreme intervention would be to ban the use of commission to buy research altogether.
Scarth predicts that whatever line the FCA adopts, less will be spent on analysts’ research in the future. The monetary research budget option is considered a possible course of action for the FCA, as the FSA referred positively to an asset manager that had used such a structure in its 2012 Conflicts of Interest paper. In that paper the regulator said: “Another firm set a maximum spend on research services and, once these limits were reached, switched commission rates for the brokers concerned to execution-only rates for the remainder of the commission period. These firms could show us they were both acting in their customers’ best interests and putting customers’ interests before their own”.
Scarth said: “Asset managers like to operate a harmonized process around the world. The other big thing is legal risk. If I am the head of legal at a US asset manager it is going to be pretty hard for me to explain why in the case of our UK institutional client we give them certain advantages that we do not allow our US clients have. In a US context that is called ‘looking for trouble’. We are under the impression that a number of managers have reviewed their position to create a global – already for conflicts of interest already changed.
“The nuclear option is to ban the use of dealing commissions altogether. The impact that would have on the margins of asset managers is quite severe and that has drawn quite a lot of comment. The industry will also argue that if UK asset managers are denied the ability to use commissions to buy research, and other managers, particularly in the US are allowed to continue to do so, because that is enshrined in a federal statute that has been on the books since 1934 and would require an Act of Congress and the signature of the President to change, do you really want to create a competitive environment internationally that puts UK asset managers at a disadvantage?
“The FCA would argue that it would help with transparency if we did this though, and rather than pay commissions for research, UK managers would raise their annual management fee to cover that cost. So the asset owner would still end up paying that cost but it would be an up front and more transparent way to pay for it.
“The probability of no change is about zero. The probability of an outright ban is not that high. But to be frank the credible threat of banning commission has had the effect from the regulator’s point of view of galvanizing attention and getting asset managers moving in the direction that they have wanted.
“The impact on asset manager research spending under any of these scenarios is unidirectional.”