The FCA has issued Policy Statement (PS14/7) which sets out its revised dealing commission rules. The changes take effect on 2 June 2014.
COBS11.6 (use of dealing commission) currently prohibits regulated investment managers from accepting goods or services from brokers that are paid for through dealing commissions unless they fall within a limited exemption. The exemption requires that 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 customer; receipt of the good or service will not impair their duty to act in the customers best interest; and the good or service will either be directly in relation to execution or amount to the provision of substantive research (set out in the re-drafted COBS 11.6.3R(3)).
The revisions to this rule are intended to clarify the scope of the exemption — in practice, the exemption has been further restricted and in particular the rule confirms that investment managers will no longer be able to pay for “Corporate Access” through dealing commissions.
Evidential Criteria for Substantive Research
The criteria for what constitutes “substantive research” continues to be set out in COBS11.6.5E. COBS11.6.5E retains reference to “meaningful conclusions” based on analysis or manipulation of data constituting substantive research. The intention of this is to distinguish substantive research from more general information services (that should not be paid for through dealing commissions). The criteria for substantive research continue to be neutral in terms of the format in which it is provided (i.e. it does not exclude non-written formats).
The FCA stated in PS14/7 that a good or service that does not meet the criteria in COBS11.6.5E but may feed into an investment managers’ own internal research does not become research by virtue of its later application. For example, a data set that has not been manipulated to reach meaningful conclusions does not become substantive research if the investment manager applies their own conclusion based on that data, where it did not otherwise contain one, or builds it into their own research.
If the investment manager is satisfied that the third party research does meet the criteria of substantive research in COBS11.6.5E, it may be acceptable even if it is mainly used to inform further internal research. The investment manager will need to consider whether the research used to inform the internal research will “reasonably assist” them in providing services to customers to whom they are passing on the charges.
If an investment manager receives research that will never be used at all, even if it could meet the criteria for substantive research, this would not “reasonably assist” the investment manager. Accepting such a good or service in return for dealing commission would be considered inconsistent with the duty to act in the best interests of customers and therefore should not be charged to them.
Corporate Access has been defined as “a service of arranging or bringing about contact between an investment manager and an issuer or potential issuer”. The FCA’s view is that Corporate Access does not meet its criteria for research and therefore should not be acquired in return for dealing commission under its rules.
The FCA acknowledges that there are situations where Corporate Access to an issuer may be provided as part of a wider event or service (i.e. under a “bundled arrangement”). Examples include investor industry conferences or investor field trips arranged by a broker or third party.
Where Corporate Access is provided as part of a wider service that is part of a bundled arrangement, the investment manager will need to identify and separate the discrete element of the substantive research from non-eligible elements (such as Corporate Access). The investment manager will then need to make a fair assessment of what should be charged back to the customer for the substantive research element (COBS11.6.8AG). In making this assessment, firms need to be careful to ensure that they are not cross subsidising the non-eligible elements through charges passed onto the customer. Guidance at COBS11.6.8AG is also relevant to the approach to be taken to the valuation of bundled, unpriced goods or services.
Corporate Access as a Non-monetary Benefit
Investment managers may attend issuer roadshows or meetings with an issuer, where an investment manager genuinely views the meeting as free, but it has been notionally ‘arranged’ by a broker.
The FCA has said that in these situations investment managers must consider and comply with the relevant requirements in COBS 11.6 (use of dealing commission), COBS 2.3 (inducements) and SYSC 10 (conflicts of interest) and be able to demonstrate to the FCA that they have acted consistently with the rules. For example, as a third party, non-monetary benefit under COBS2.3, the investment manager would need to satisfy themselves that the benefit did not impair their compliance to act in the best interests of their clients; disclose it clearly to the client; and ensure the benefit enhances the quality of the service to their clients.
If an investment manager does pay dealing commission to a broker in return for execution and substantive research goods and services, and also attends ‘free’ Corporate Access events organised by the broker, the investment manager may need to consider ways to mitigate and manage risk that they are subsidising Corporate Access that benefits the firm with dealing commissions charged to the client. Systems and controls over dealing commission arrangements will be important in ensuring (and demonstrating) that amounts paid to a broker are justified and compliant with COBS11.6.
The FCA’s stated intention is to “ensure investment managers seek to control costs passed onto their customers with as much rigour as they pursue investment returns”. Investment managers should review the changes to the rules carefully and consider reflecting the changes to the wording of the rules and guidance in their internal policies and procedures. Brokers should consider to what extent and on what basis they will be able to continue offering Corporate Access and other services to investment manager clients. Failure to do so could have serious consequences as the regulator is seeking to achieve behavioural change in the industry, and could be willing to take enforcement action as part of this.