On February 19 2015 the Financial Conduct Authority (FCA) published Feedback Statement FS15/1, summarising the feedback that it had received in response to Discussion Paper 14/3 (published on July 1 2014). The discussion paper sought industry views on future reforms to FCA rules on the use of dealing commissions, which were last modified in June 2014.
In the discussion paper, the FCA endorsed the position that had been taken by the European Securities and Markets Authority (ESMA) in its May 2014 consultation paper on advice to the European Commission on the Level 2 measures that should be adopted by the commission under the EU Markets in Financial Instruments Directive II (MiFID II). The view expressed by ESMA in the consultation paper was that all research (and similar 'value add' services such as preferential access to analysts and their models) other than generic, widely distributed research should be viewed as a "non-minor" non-monetary benefit, and therefore something which should be paid for by the MiFID investment management firm that receives it only from its own resources. In contrast, existing arrangements often involve the investment manager:
- paying for such items from commission pools or soft dollar accounts that have been funded by trading commissions that have been paid to brokers by the investment management firm's clients; or
- receiving such items from the broker on a 'bundled' (ie, free-of-charge) basis.
In the discussion paper the FCA also sought views on a fully unbundled model, where even generic, widely distributed research would be prohibited from being paid for out of commission pools or soft dollar accounts, or being received on a bundled basis.
In December 2014 ESMA published its final report to the European Commission on the MiFID II Level 2 measures, including its final advice on the Level 2 measures relating to research and inducements in the context of dealing commissions. The FCA feedback statement takes into account the ESMA final report.
In the feedback statement the FCA has endorsed the position taken by ESMA in the final report. The FCA has confirmed that the ESMA final report abandoned the distinction between generic and bespoke research and that ESMA is advocating a fully unbundled model (a point that may not have been immediately apparent from the text of the final report).
The FCA has also endorsed the use of 'research payment accounts', a concept that was introduced in the ESMA final report. Research payment accounts are accounts that would be pre-funded by a MiFID investment management firm's clients. Balances on these accounts could then be used by the firm to pay for research. The requirements for such accounts are that:
- they are funded by a specific and separate charge to the manager's clients, such charge being agreed with, and disclosed to, those clients upfront;
- the funding is based on a research budget set by the firm and is not funded from, or otherwise linked to, execution volumes (ie, not funded via dealing commissions or spreads); and
- there are periodic and transparent disclosures of the associated research costs by the manager.
The FCA has commented as follows: "We welcome ESMA's final advice on inducements and research, and would support it as the basis for the final delegated acts to support MiFID II Level 1."
There is also a suggestion in the final section of the feedback statement that, in relation to undertakings for collective investment in transferable securities (UCITS) management companies and alternative investment fund (AIF) managers, the FCA may consider extending the reach of the inducements rules in MiFID II so that (in addition to MiFID investment firms) they would apply to such firms in relation to their AIF/UCITS management activities.
The FCA has recommended that firms consider adopting sound practices, such as setting fixed research budgets (in monetary amounts) based on a careful assessment of their research needs and having robust valuation processes for substantive research sooner rather than later. Adopting such practices now will bring such firms into line with the examples of good practice that were cited by the FCA in the discussion paper and, according to the FCA, such firms will be better placed to adapt to the final changes under MiFID II.
The FCA is aiming to consult on its implementation of MiFID II towards the end of the last quarter of 2015. MiFID II will apply from January 3 2017. The FCA also intends to make required changes to domestic laws (as they relate to inducements and dealing commissions) in line with final MiFID II reforms.
For further information on this topic please contact Darren Fox at Simmons & Simmons LLP by telephone (+44 20 7628 2020) or email (firstname.lastname@example.org). The Simmons & Simmons LLP website can be accessed at www.simmons-simmons.com.
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