The FCA says it has identified widespread failings in the use of dealing commissions, worth around £3bn a year, to fund research costs. In a review published today it said just two of the of 17 investment managers and 13 brokers investigated were complying with its rules on dealing commissions.
Around £1.5bn a year from dealing commissions, which does not appear in the AMC or the TER of a fund, is believed to be used to pay for fund managers’ research costs. Fund managers do not currently separate the amount of their dealing commissions that are used to pay for research and the amount that is used to pay for pure execution transaction costs.
The regulator said too few firms properly assess the value-added and cost of research paid for using client dealing commission.
The review also found that the practice of brokers bundling execution and research services makes it harder for investment managers to assess the value of research.
The FCA says the issues identified have driven it to support proposed European reforms to further separate research from dealing commission and encourage greater competition and more transparency over the price of research.
The review includes a discussion of the potential costs, benefits and competition impacts of potential changes to the relevant European legislation (Mifid II) that could significantly restrict the use of dealing commissions. The FCA will work closely with industry and other regulators to ensure that the new European rules deliver the best outcome for investors.
Speaking at conference on dealing commission, FCA chief executive Martin Wheatley said: “The UK is a global centre for asset management – to keep this position it is crucial that investors are confident that they get a fair deal. There is a strong evidence to suggest the current model of using dealing commission to pay for research reduces transparency and creates a link between research spend and trading volume, without a clear assessment of the value this offers to investors. I want to see a level playing field across Europe to ensure the market delivers the best outcome for investors”.
The regulator’s key findings
- Many of the firms that visited had made improvements since Nov 2012, which should have resulted in better outcomes for their clients, but only 2 firms were operating at the level expected
- In 11 investment management firms, the amount of research purchased with dealing commission remained linked to the volume of trades carried out as they did not have research budgets or caps on research spend
- 1 firm was using dealing commission to pay for market data services in full with no apparent attempt at a mixed use assessment to determine which parts of the services were eligible to be paid for out of dealing commission and which were not
- Brokers did not explicitly price their research as a distinct service, leading to price opacity in the market, contributing to investment managers’ difficulties in ensuring they are paying an appropriate amount for research and execution
- Brokers had not given adequate consideration to their potential conflicts of interest when arranging corporate access with some being unclear who they were acting for, corporate or investment manager. This was somewhat mitigated by corporates being aware of the potential conflict