Last week the FCA published its final rules which will update the UK’s Use of Dealing Commission (‘Softing’) regime. The changes are, as anticipated, very similar to those the FCA proposed in its consultation paper of November 2013 and form part of the FCA’s wider initiative to ensure that asset managers are acting in the best interests of their customers. A central principle underpinning this work is that investment managers must control costs as keenly as they pursue investment returns and that expenses borne by customers must deliver real value.
Whilst the FCA insists that the changes are primarily a clarification of their existing expectations, it is hard to escape the conclusion that the updated regime, which becomes effective on 2 June 2014, represents a shift in approach. The FCA argues that its existing rules had been stretched to the point of abuse by many investment managers, and expects that the new rules will put this right. Services that are eligible for purchase via dealing commissions must be those where the regulated firm can show positive evidence of compliance with the FCA’s definition of research or execution services (“eligible services”), and were in the best interests of their customers.
In this client alert we focus on a couple of the more significant new rules that must be considered by investment management firms when spending and allocating their customer dealing commissions;
Corporate access - when the original proposals were published the headline grabber was the prohibition on using dealing commissions to pay for corporate access. It is no surprise that the FCA have proceeded with those original proposals as intended, with corporate access defined as, “a service of arranging or bringing about contact between an investment manager and issuer or potential issuer.” Corporate access itself is not prohibited but it must be paid for by means other than dealing commissions.
The FCA have tried to address the question of corporate access being provided as part of a wider or ‘bundled’ service1 by expecting investment managers to undertake a disaggregation or ‘unbundling’ of any such non-eligible services (such as corporate access) and only use dealing commission to pay for the components of the service which are eligible. The FCA have declined to set out a precise methodology for quantifying eligible and ineligible elements but nonetheless require the investment manager to make a good faith assessment of the cost, which may include using reasonable proxies, such as comparable goods and services available elsewhere on the market, or making an estimate of their own costs in taking the service in-house. The concept of bundled and mixed-use services clearly applies not just to corporate access and such analysis should also be employed with other goods such as services provided by Bloomberg.
Substantive research – although the definition of substantive research remains largely unchanged, in addition to meeting the existing definition, two further conditions are that the investment manager must have reasonable grounds to be satisfied that it will reasonably assist them in the provision of services to its customers; and that the receipt of that research is not likely to impair the investment manager’s obligation to act in the best interest of its customers. There is a presumption of a rule breach should those conditions not be satisfied.
By way of reminder, substantive research must, amongst other criteria, “...present the investment manager with meaningful conclusions…” The FCA states that the research does not need to be written and the investment manager does not necessarily need to agree with the conclusions as presented. The regulator has included a new explicit requirement to keep clear records of the basis on which firms consider a particular good or service as eligible to be paid for through dealing commissions.
It is hard to agree with the FCA that this is a mere clarification, and it is clear that this change of approach will have an impact on investment management firms making use of dealing commissions in how they manage and disclose such arrangements. Such firms should review their current approach and make sure that only eligible services are being purchased by this means and that those services are genuinely for the benefit of the firm’s customers. Some practical steps to consider include:
- Review all the goods and services that are purchased through dealing commissions to ensure they meet the requirements of the updated guidance. Ensure that this assessment is documented in a reviewable form and periodically check that all goods and services are included;
- Speak with the trading and investment team - your questions could include: are they still using goods and services being paid for? How valuable is certain research to them in forming their trading decisions? Has the use of that service changed over time so that it is no longer a permitted service, for example certain Bloomberg services used historically under the banner of research may, with the further clarity on what amounts to substantive research, clearly fall outside this exemption?
- Is your investment team receiving any form of corporate access? If so, how often, in what form and how is it being paid for? You may need to ascribe a reasonable value to that access, and any other non-eligible services, and disaggregate these from the cost of other eligible services provided by the broker. Can you ask the broker to price certain non-priced components of bundled services to make this process easier and more transparent?
- Do you have a broker review committee? Is it meeting on a regular basis (e.g. monthly)? It should not be allocating dealing commissions based upon corporate access provided by a broker - review the criteria that is being used and make sure that compliance is represented at those meetings. Note also: the payment and allocation of dealing commissions to different counterparties should go hand in hand with the firm’s monitoring of best execution.
Please contact Adam Palmer or your regular ACA compliance consultant with any questions on this Alert.
 The FCA examples include an investment manager attending an investor conference arranged by a broker, which involved both meetings with corporate issuers (corporate access and therefore not eligible) and presentation of substantive research (eligible).
ACA Compliance (Europe) Limited