In a recent review, the UK Financial Conduct Authority (FCA) says it is pleased with industry progress so far around research unbundling. However, the regulator also indicates that unbundling remains a work in progress for the industry.
As a result, the FCA will be conducting another review in 18-24 months to see how industry practice around this area of the Markets in Financial Instruments Directive II (MiFID II) has evolved.
Progress is being made
The FCA’s Implementing MiFID II – multi-firm review of research unbundling reforms consisted of visits with 40 buy-side firms, and 10 firm visits across the buy-side and sell-side between July 2018 and March 2019. It explored how firms have implemented MiFID II’s unbundling rules, which demand that firms pay for research separately from execution services, either by paying for research themselves or by charging clients. The policy goal was to improve transparency and accountability around how end clients pay for research – previously research costs were often bundled into the transaction fees that clients then had to pay.
According to the FCA, this policy goal is being met -- £70 million of savings for investors in UK managed equity portfolios was achieved within the review sample in the first half of 2018, compared with 2017. In February, the FCA estimated savings of £180m a year for investors with UK-managed equity portfolio from these reforms, amounting to nearly £1bn over 5 years. Now the regulator considers this a conservative estimate.
Regulator suggests areas for improvement
However, the review says that there is “wide variation in how firms evaluate and decide payment for research,” with “a clear gap between best practice and weaker models.” The review provides some detail about which practices the regulator would like to see more firms adopt. For example, the FCA wants to see more sensitivity around the value that firms put on research, with an enhanced focus on assessing value based on quality rather than quantity. The regulator says, “We know that research evaluation models are still evolving and that more robust and refined models are likely to emerge. But we expect firms to continue developing approaches that ensure the way they buy their research is consistent with their duty to act in the best interests of their clients or funds.”
In addition, if there was any doubt around the payment of corporate access, that has now been settled. It’s now conclusively clear that investment managers cannot use their research payment accounts (RPAs) to pay for corporate access – in the review the FCA noted it had found one firm still doing this, and that it is in breach of its rules. The regulator said approaches to corporate access are still “evolving” and that it is beginning to see more direct engagement from issuers with asset managers, which is a “welcome” development.
Our advice for investment management firms is to assume the regulator will be coming back to you in 18 months. To prepare for this, take the examples of good and bad practice uncovered since the unbundling rules came into force and use that knowledge to tighten up your approach to research payments. In particular:
• Focus in on how much your firm is paying for research
• Understand how your investment team is ascribing value to research
• Ensure that your research valuation policy has been implemented in reality and not just on paper.
It’s clear that this will remain a focus for the FCA for some time to come, and so firms should be sure their approaches meet regulatory – and client – expectations.
How ACA can help
ACA’s MiFID II post-implementation review helps you to reduce your regulatory risk. We look at your implementation against what is expected of firms of your size, nature, and complexity. On completion of our review, we issue recommendations and an executive summary for senior management, evidencing your compliance with this significant regulatory change.