The Financial Conduct Authority (“FCA”) has published final changes to its rules on the use of dealing commission. The changes take effect on 2 June 2014.
FCA thematic supervisory work found that some firms were failing to make appropriate judgements and apply adequate controls in their use of dealing commission, especially in relation to research goods and services. The FCA identified, in particular, that some investment managers were paying brokers for corporate access, and that some firms were paying for market data services out of dealing commissions when only limited components of these services met the FCA’s criteria for exempt research.
The changes to the rules clarify and reinforce the existing requirements (i.e. that investment managers should only use dealing commission to pay for substantive research or for execution-related costs; and that the use of dealing commission to pay for corporate access is prohibited). There is new guidance on when investment managers can pass on charges to their clients through dealing commission, including in relation to the provision of substantive research bundled together with services which cannot be paid for using dealing commission.
The FCA has stated that firms that already comply with the rules should not need to make significant changes, although they may wish to reflect the changes and new guidance in their internal policies and procedures. However, firms that may not be compliant in their current practices should take steps to ensure they meet the rules from now on.
The key changes to the rules (which are found in the Conduct of Business Sourcebook within the FCA Handbook (COBS 11.6)) are:
- The exemption to the use of dealing commission rule is redrafted to make its three components more explicitly clear: (i) an investment manager must have reasonable grounds to be satisfied that a good or service paid for with dealing commissions will reasonably assist them with the service provided to their customers; (ii) receipt of the good or service must not impair their duty to act in their customer’s best interests; and (iii) the good or service must either be directly related to execution, or must amount to the provision of substantive research. The overall exemption is more stringent because, whereas under the current rules each component of the exemption can be established where an investment manager has “reasonable grounds” to be satisfied it is the case, under the new rules it is a matter of fact whether components (ii) and (iii) are established.
- The evidential provisions explaining when a good or service will be directly related to execution (COBS 11.6.4E(1)) or when it will amount to the provision of substantive research (COBS 11.6.5E(1)) are clarified and reinforced. As above, the test will no longer be whether an investment manager has “reasonable grounds” to be satisfied that the evidential provisions are met; instead, the evidential provisions “must be” met. The criteria for substantive research are amended. The changes to the evidential provisions make clear that failure to meet them will tend to establish a contravention of the FCA’s use of dealing commission rule.
- There is new guidance (at COBS 11.6.8A G) on firms acting in the best interests of their clients when passing on charges through dealing commission and on mixed use assessments; i.e. how firms should assess research goods or services when they are bundled together with non-research goods or services. This will also be relevant where goods or services are bundled with corporate access.
- “Corporate access service” is newly defined in the FCA Glossary, as arranging or bringing about contact between an investment manager and an issuer or potential issuer; and “corporate access services” are explicitly included in the list of goods and services (at COBS 11.6.8G) relating to the execution of trades or the provision of research, which the FCA does not consider satisfy the requirements for being directly related to the execution of trades, or amounting to the provision of substantive research.
- There is new guidance (at COBS 11.6.20G) providing that an investment manager should keep records of the basis on which it concludes that a particular good or service may be received under the exemption at COBS 11.6.3(3) in return for dealing commission. This is to ensure that firms can demonstrate compliance with the FCA’s requirements.
The FCA is conducting further supervisory work and debate in this area, and has indicated that there may be wider reforms to the regime. Any such reforms will take into account the work of trade bodies, in particular that of the Investment Management Association (“IMA”) which published a report in February 2014 on the use of dealing commission for the purchase of investment research, calling for further work on benchmarking, conflicts of interest management, price discovery and disclosure, and for an international approach towards reforming the current regime. Reforms will also take into account the EU negotiations on MiFID II, as part of which there has been discussion of options for improving the transparency and efficiency of investment management, including implementing unbundling across the EU.
The FCA intends to report back later this year. No further changes to the rules are expected before the introduction of MiFID II (anticipated around 1 January 2017).
The final changes to the rules and feedback to the FCA’s consultation are found in FCA policy statement PS14/7, which is available here.