The Financial Conduct Authority (FCA) plans to permit asset managers to pay for sell-side research and trade execution in a single all-in fee, reversing MiFID II ‘unbundling’ rules.
The regulator has set out proposals and launched a consultation today to seek feedback from the investment industry, which will close on 16 December. If it chooses to proceed, any rules or guidance will be published in the first half of next year.
The proposals follow recommendations from the UK Investment Research Review in July 2023, which highlighted the “paucity of research coverage of smaller-cap companies” and argued that ‘bundling’ has enabled the US to produce superior research to the UK.
As a first step, institutional investors were granted greater flexibility on how they purchase investment research in July. The FCA said it now wants to make it easier for fund managers to “buy insight and analysis across borders”.
Before the financial crisis, it was standard practice for asset managers to receive investment research from the broker/dealers they used for trade execution. Brokers would charge buy-side firms a margin on top of the actual costs of executing trades and would provide additional services such as research or technology.
According to the UK Investment Research Review, UK regulators were concerned that this system made the cost of transactions opaque and that it gave rise to conflicts of interest because fund managers might use a broker to benefit from its additional services rather than because it provided the best trade execution for their clients.
Between 2006 and 2018, the FCA banned bundled payments for anything other than research and introduced further restrictions.
Then in 2018, the EU’s revised Markets in Financial Instruments Directive (MiFID II) required asset managers to pay for sell-side research separately.
In the US, however, bundled pricing is still permitted. The UK Investment Research Review argued that this system has enabled US research to become superior to the UK because banks and brokers have been able to invest more in research, retain more senior analysts and develop broader coverage, extending to small-caps.
“There is a widely held (but not uncontested) view that the decline in research budgets for sell-side research following the introduction of MiFID II appears to have led to a ‘juniorisation’ and reduction in the number of sell-side investment analysts, which has impacted the quality of research in the UK, both by reason of the experience of analysts and the number of companies they are expected to cover,” the review stated.
This is what the FCA’s proposals now seek to address. Jon Relleen, director of supervision, policy and competition at the FCA, said: “We want UK markets to be efficient and to support economic growth. Putting more information in the hands of investors and giving investment firms greater access to research to inform their strategies will bolster UK markets.”