The Financial Conduct Authority has published a policy statement and final rules that introduce payment optionality for research and trading commissions. The unbundling of research costs from execution commissions has been a controversial topic since the requirements were introduced in 2018 by the second Markets in Financial Instruments Directive. It is widely accepted that these measures have led to a substantial decline in research coverage, in particular for small and medium sized companies. Both the U.K. and the EU had tried a quick fix for the issue by introducing an exemption for SME research, however, that did not improve the research market. The unbundling of research and trading commissions also caused major challenges for U.S. broker-dealers who have had to either register under the Advisers Act or take complex operational steps in order to continue providing research to European investment companies. Following the Investment Research Review, the FCA consulted earlier this year on its proposals for introducing payment optionality and, taking account of feedback, has adjusted the details of some of the guardrails that will apply where firms opt to apply joint payments.

Under the revised U.K. rules, from August 1, 2024, third-party research will not be an inducement if it is received in return for one of the following:

1. direct payment from a firm's own resources; or
2. payment from a firm's separate research payment account, provided the firm satisfies the conditions for operating the RPA; or
3. joint payment for third-party research and execution services, provided the firm complies with the requirements for bundled payments.

Where a firm chooses the joint payment option, the FCA will require the firm to:

• have a written policy on joint payments that describes the firm’s approach to joint payments and how it complies with the FCA’s rules;
• have arrangements detailing the methodology for how the research costs will be calculated and identified separately within total charges for joint payments;
• have a research provider payment allocation structure for allocating payments between different research providers. The structure must cover third-party providers of research and execution services and independent research providers;
• establish operational procedures for administering the accounts for purchasing research using joint payments;
• annually set a budget for the purchase of research using joint payments;
• allocate the costs of research purchased using joint payments fairly between clients;
• periodically, but at least annually, assess the value, quality, and use of research purchased using joint payments and its contribution to the investment decision-making process; and
• disclose information to its clients, including the firm's use of joint payments for research, and if a firm also uses other options, how the firm uses the different types of payments.

The FCA has removed SME research from the list of minor, non-monetary benefit exemptions on the basis that it is no longer necessary with the re-introduction of bundled payments. Short-term trading commentary that does not contain substantive analysis and bespoke trade advisory services "intrinsically linked" to the execution of a transaction in financial instruments has been added to the list.

The FCA has confirmed that research services are not a factor in assessing best execution. The best execution requirements oblige investment firms to obtain the best possible result for their clients when executing client orders. The FCA's best execution rules still apply, unchanged.

The FCA's rules respond to one of the recommendations of the Investment Research Review for improving the U.K. research market. The regulator is expected to continue engagement with both buy-side and sell-side to implement some of the Review's other recommendations, including consulting on proposals for UCITS managers and AIFMs, and to address industry concerns relating to the operation of the FCA's rules on corporate access, FICC macro-economic research, trial periods, and the definition of research.

The EU is also intending to allow joint payment for research and trading commissions under its Listing Act package. These changes are very similar to those of the FCA's; however, the EU is not proposing that all of the same conditions must be met before a firm can apply joint payments.

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