The Review recommends scrapping research unbundling, but also proposes a range of other changes to the UK research landscape.
On 10 July 2023, HM Treasury published the final report produced by the independent UK Investment Research Review (Review). The Review was launched on 9 March 2023 to examine the link between levels of research and the UK’s attractiveness as a destination for companies to access capital (please see Latham’s previous blog post for the background to the Review).
The report makes seven recommendations which the government has committed to taking forward. While the recommendation to remove the research unbundling requirements was expected, the Review has taken a more holistic approach and the report puts forward wide-ranging suggestions for improving the UK investment research landscape. The recommendations are summarised below.
1. Allow additional optionality for paying for investment research
This recommendation is the headline that market participants were expecting. The report suggests building flexibility into the rules so that research unbundling is no longer compulsory, and buy-side firms can pay for research in the following ways:
- Out of their own resources
- By charging clients directly
- By combining the cost of research with execution charges
The report explains that, although research unbundling has had some benefits, many firms do not wish to use research payment accounts due to their additional complexity and so choose to pay for research themselves. However, limited budgets for research have meant there is less demand and so research coverage has shrunk (although it acknowledges that the unbundling rules are not the only reason for the decline in research coverage). The report also highlights that the incremental changes made to the rules in 2022 have had little positive impact, suggesting that a more radical approach would be needed to achieve meaningful change.
A key anticipated benefit of removing the requirement to unbundle is that the flexibility it would introduce would ensure that UK rules do not clash with EU or US rules. Given that the US SEC’s no-action relief expired on 3 July 2023 with no extension, this flexibility would solve a key issue that the introduction of the MiFID II rules on research unbundling created. US broker-dealers were able to rely on this relief to ensure they did not face additional regulation for accepting separate payments for research from UK asset managers.
The report emphasises that the UK should seek to “remain aligned” with other key jurisdictions, to avoid being at a competitive disadvantage. This is a very generous interpretation given that the UK put itself in a position in which its rules did not align with the generally accepted approach elsewhere, first on its own and then by influencing the EU MiFID II rules. Therefore, conceptually, it is more accurate to say that this recommendation would “realign” the UK with other jurisdictions such as the US. The report also states that, even if the FCA does not introduce the full flexibility the report recommends, the UK should remove any barriers to UK asset managers paying for research on a bundled basis in other jurisdictions where that is standard practice.
The report also makes various suggestions for how buy-side firms using investment research should ensure clients are properly protected, including, for example, the disclosures they should make to clients. The report does not propose that a firm would need its client’s specific consent to the more flexible payment arrangements, but it states that the firm should disclose such arrangements. The report is inconclusive as to whether firms should disclose who they have purchased research from and the proportion of their research budget spent on research produced by sell-side firms versus independent research providers. The report suggests the FCA consider this issue further. It also recommends that the FCA consider clarifying the interaction between bundled payments and best execution. The report suggests that changes to the FCA’s rules are implemented as soon as practicable, subject to the usual consultation process.
2. Introduce a Research Platform to help generate research
One of the report’s key suggestions is to create a central facility to promote, source, and disseminate research, particularly in relation to smaller companies. The idea behind this suggestion is that it would improve research coverage and potentially increase interest in smaller companies, and reduce the disparate availability of research on larger versus smaller companies. The report envisages that the Research Platform would be open to all publicly traded issuers, but could also be used to initiate research on private companies that are contemplating listing, or on specialist sectors with less research coverage. It anticipates that the Platform may not need to be a permanent measure if it successfully helps to reinvigorate the market.
Participation in the Platform would not be compulsory, and the research it produces would be freely available, which would help with the recommendation to assist retail access to research (see point 6 below). The report envisages that it would be operated through a constitutional framework by one or more third parties. A key question around the creation and running of such a Platform would be how its operating costs would be met. The report sets out a number of options for how the Platform could be funded, including initial government funding, and/or levies on issuers, exchanges, firms, or market participants.
The idea comes from looking at similar models used in other jurisdictions. However, interestingly the report states that it is difficult to find evidence of the success of these enterprises, but holds the view that creating the Platform would improve the UK market. The report also suggests that the Platform should include a function under which it acts as a central repository for information. As a Research Platform would take some time to establish (and fund), the report envisages that this recommendation would be implemented in the medium term.
3. Clarify aspects of the UK regulatory regime for investment research and consider introducing a bespoke regime
The report cites the difficulties in determining when a research provider requires authorisation in the UK and when a piece of research might amount to a financial promotion. The complexity of the regulatory perimeter in this area means that firms often struggle to understand what is regulated. Therefore, the report recommends that the FCA should review the regime as soon as practicable, and revise areas that are unclear, unnecessarily complex, or difficult to justify. The report does not advocate changing the regulatory perimeter (unless the FCA thinks this is necessary to achieve clarity), but considers that ensuring the rules are more intelligible would help to make the UK a more attractive place to do business.
However, the recommendation that the FCA review the rules is almost being made rather apologetically on the basis that, as many of the rules in this area are being examined as part of the Review, it would be remiss to leave these out. The report does not provide any specific examples of which rules might be clarified, and how. Whilst the rules are complex, they are not unduly so (or at least not more so than in other areas of regulation), so it is interesting that they have been identified for review.
4. Support issuer-sponsored research by implementing a code of conduct
The report explains the perception that issuer-sponsored research is seen as less objective, and subject to inherent conflicts of interest, but emphasises that this research has great value, especially as research coverage has declined. Consequently, it recommends that more should be done to encourage the production of high-quality issuer-sponsored research. The report considers that one way to do this would be for the industry to support the creation and adoption of a voluntary code of conduct for issuer-sponsored research. It envisages that the code would be prepared by an industry body, but could be recognised by the FCA using its formal process.
5. Review the rules relating to investment research in the context of IPOs
The report recommends that the rules relating to research production in connection with an IPO, introduced in 2018, should be reviewed as part of efforts to help increase the UK’s attractiveness as a listing venue. It emphasises that the rule changes in 2018 had the effect of extending the IPO timetable in the UK (comparing less favourably with other jurisdictions) but do not appear to have led to a noticeable increase in unconnected research. The report recommends in particular that connected analyst research on an IPO could be made available on a similar basis to the company’s prospectus. It also recommends that the rules limiting connected analysts from meeting with potential IPO candidates prior to their bank being mandated on the IPO should be reconsidered. The report envisages that the FCA could review these rules in conjunction with its existing work on implementing the Listing Review and the Secondary Capital Raising Review.
6. Allow greater access to investment research for retail investors
The report suggests that the FCA should review the current regulatory regime as soon as practicable to consider how it may prohibit or discourage access by retail investors to investment research. This suggestion ties in with a general theme across the Edinburgh Reforms of facilitating retail investment in financial markets. It recommends the FCA consider what changes to its rules and guidance might be necessary to facilitate retail access to investment research.
However, it also acknowledges that research providers would be concerned about being subject to more onerous regulatory requirements and about potential additional liability if research were made available more widely. There could well be unintended consequences to the laudable aim of enabling retail to benefit from access to a wider array of investment research if the industry were put off by the potential consequences. Depending on what is proposed, this recommendation may impact on the preparedness of research providers to produce investment research. How this will help increase the level of quality research available when it may well disincentivise research production will likely be a central part of lobbying on this recommendation.
7. Involve academic institutions in supporting investment research initiatives
Finally, the report suggests that the operator of the Research Platform could oversee collaboration with academic institutions, harnessing their expertise to help bolster the UK research market. It envisages that academic institutions could provide or support with the production of research, provide training for analysts (to be paid for via bursaries funded from the Research Platform’s resources), and assist innovative enterprises that seek to develop out of academic study. The report highlights that this could be a helpful way for demand for research to be met if that demand increases because of the proposed changes, as currently there is a lack of analysts. This recommendation is expected to be implemented on the same timescale as the Research Platform, given their interaction.
Next Steps
The government has stated that it accepts all of the Review’s recommendations and will take them forward. Some would need to be implemented by HM Treasury and others by the FCA, including changes to the rules on research unbundling. The FCA issued a statement welcoming the report and setting out its next steps. It plans to start engagement with market participants immediately with a view to putting together a consultation. The FCA intends to consult “on an accelerated timetable” on potential changes to its rules, and potentially to make final rules in the first half of 2024.
The FCA also states that “Pending any regulatory reform, we are open to consider swift actions, if needed, to support firms impacted by changes to regulation in other jurisdictions, based on discussion with individual firms or parts of the market”. This statement suggests that the FCA may be amenable to assisting firms facing difficulties following the expiry of the US SEC’s no-action relief.
