The FCA is proposing to allow asset managers to rebundle payments for third-party research and trade execution.
On 10 April 2024, the FCA published its much-anticipated Consultation Paper on payment optionality for investment research (CP24/7). The Investment Research Review made a series of recommendations in the summer of 2023 to help boost the UK investment research market, which the government committed to taking forward (see this Latham blog post). One of the key recommendations was that the FCA should amend its rules on research unbundling to allow buy-side firms more flexibility in how they pay for research, including enabling the “rebundling” of research and execution charges.
While the FCA committed to taking this forward and is proposing rule changes to implement this recommendation, the change signifies a reversal of the FCA’s prior policy position. Interestingly, the Consultation Paper includes the FCA’s analysis of the market for investment research, in which the FCA continues to firmly defend its previous policy stance on unbundling, while simultaneously suggesting that the evidence supports its current proposals.
The FCA’s Proposals
The FCA is proposing to introduce additional optionality for buy-side firms by permitting them to use bundled payments for research and execution services. This would be achieved by including a specific carve-out from the inducement rules, rather than by adding to the list of acceptable minor non-monetary benefits. Existing payment options would also remain in place, meaning that buy-side firms could still choose to pay for research out of their own resources, or using a Research Payment Account (RPA).
However, firms that choose to rebundle research payments would need to meet the following conditions (which the FCA refers to as “guardrails”):
- Establish a formal policy on the firm’s approach to bundled payments, including with respect to governance, decision-making, and controls
- Set a budget for the amount of third-party research to be purchased, which should be renewed and reviewed at least annually
- Undertake ongoing assessments of research price and value, including price benchmarking, at least annually
- Set out a structured approach to allocating costs across clients, and payments across research providers
- Put in place agreements with research providers on the methodology for calculating and identifying separate costs for research
- Establish operational procedures for the administration of accounts used to purchase research
- Make appropriate disclosures to clients on the firm’s approach to bundled payments, the key features of its approach to implementing this payment option, if and how bundled payments are combined with other payment options, their most significant research providers, and costs incurred
These guardrails are designed to ensure sufficient discipline around budgets for research spending, fair allocation of costs to clients, value assessment, price benchmarking, and cost transparency. The FCA also highlights that firms to which the Consumer Duty applies would need to consider whether their policies and arrangements for bundled research meet the requirements of the Duty. Firms might need to consider aspects such as price and value, as well as customer communications about research.
The overall effect of the guardrails is to create a limited additional carve-out for buy-side firms prepared to use a Commission Sharing Arrangement (CSA) with brokers who are prepared to offer it. This is much more restrictive than merely permitting the rebundling of research, which will be the likely approach in the EU to its reforms in this area. This raises the question — given the limited take-up of the RPA model identified by FCA, why would firms choose a similarly complex CSA approach instead? It appears that the FCA’s priority is to defend unbundling, and to permit only a CSA model that is similar to the existing RPA model, rather than to go back to a pre-unbundling approach where CSAs are permitted but not required. The FCA attempts to bolster its position by describing its proposals as compatible with research payment rules in other jurisdictions, particularly the US, which it says should allow UK firms to access global research and compete internationally. This point is important for the FCA given its new international competitiveness and growth objective. The FCA is also proposing to add commentary and advice linked to trade execution as a new acceptable minor non-monetary benefit, to ensure the UK regime is compatible with practices in the US.
Overall, the FCA wants to remove any unintended consequences of the existing regime, while ensuring that the harms which the original rules were designed to prevent will not reemerge. Clearly the FCA is anticipating that its proposals will strike the right balance between adding enough flexibility that firms that have put significant resources into their existing arrangements would not be discouraged from taking up the new optionality, whilst trying to ensure that there are appropriate controls around the use of bundled payments. The accuracy (or otherwise) of this anticipation will be shown (or not) by the take-up rate of the new CSA model, which would likely be just as complicated to administer as an RPA. The FCA also warns that it could introduce further guidance and more prescriptive standards if firms do not implement the new option in a satisfactory way.
Next Steps
Comments are requested by 5 June 2024. The FCA previously indicated that it plans to introduce new rules swiftly, and states that it still aims to publish final rules in the first half of 2024, subject to the responses it receives to the consultation.
The FCA has not proposed equivalent changes to its rules for fund managers at this stage, but intends to propose the relevant changes in another consultation in 2024 to ensure consistency in the regime.
The FCA also notes that it will continue to work with the government on taking forward the Investment Research Review’s other recommendations. Other areas for the FCA to consider include allowing more access to investment research for retail investors, clarifying aspects of the UK regulatory regime for investment research, and reviewing the rules on investment research in the context of IPOs.
