MiFID II overhauled the way in which firms pay for, price and provide research – in large part, aiming to reduce conflicts of interests and ensure that firms are acting in the best interests of clients. Sell-side brokers are now required to unbundle research from other services (notably execution) and buy-side firms are required to purchase research from their own resources or by using a separate research payment account (RPA) funded by clients.
In the lead-up to the introduction of MiFID II, these proposed changes were an area of key focus and hot debate. Over a year later, the FCA has published its findings following a review of the implementation and impact of those new rules.
Overview of the FCA’s findings
In general terms, the FCA found that there had been “positive changes in behaviours by firms” in response to the new MiFID II rules and that, overall:
- most firms have absorbed the costs of research themselves, resulting in significant savings for investors;
- buy-side firms are still able to access the research they need – the FCA found only “limited evidence of a decline in research quality and coverage“;
- buy-side research evaluation models and sell-side pricing models differ – the FCA expects firms to “refine models to ensure they are acting in the best interests of their clients” and will monitor the market for “potential competition concerns“; and
- some firms are unclear about how the new rules apply to certain circumstances, eg in relation to trade association events, marketing research services or contributions to consensus forecasts – the FCA clarified its expectations in its findings.
Some key areas of attention
The FCA provided more detailed discussion on a number of specific areas in its findings. Some of the key areas are addressed below, although firms affected by the research unbundling rules should consider the FCA’s findings in full.
- Evaluating and deciding payment for research: the FCA identified various more “sophisticated” models that firms are using for valuing research and deciding payments for research, and sets out a summary of some of those models in its findings. Buy-side firms may find these examples instructive when refining their research valuation models.
The FCA identified that some asset managers are focussing “too much on measuring quantity, using a fixed rate card with prices based on volume” rather than focussing on quality, and stressed that:
“Assessing research quality and value requires judgement. As long as firms can show their approach is rational and consistent, we would not expect them to assign specific payments to every single interaction, or justify small variations between similar providers. But we would query extremes in payments or other patterns that have little or no clear justification. This could indicate that research providers are offering inducements or that asset managers are not sufficiently managing conflicts of interest.“
- Clarifying non-monetary benefits: the FCA found that some asset managers were taking cautious approaches to the inducements rules, for example “blocking all marketing material or free trials from new research providers“, “not accepting ‘issuer-sponsored’ or house-broker research“, or “refusing to attend trade association member events“.
Although inducements should always be assessed on a case-by-case basis, the FCA clarified its general expectations in these areas. In particular:
- trial periods are acceptable as long as they “meet the relevant conditions“;
- issuer-sponsored materials are generally “acceptable ‘minor’ benefits“;
- “reasonable marketing material, or attending ad hoc meetings where research products are promoted” is acceptable, and “[s]erving or accepting refreshments at events like these does not breach inducement rules, though unduly lavish hospitality could“; and
- “[g]enerally, trade association events can be treated outside the inducements framework” – the FCA emphasised that members typically pay their own fees to attend such events.
- Delegation arrangements: as part of its review, the FCA also identified that some buy-side firms did not have appropriate control over external services providers for delegation or outsourcing arrangements, and that some firms were making the external services providers “completely responsible for compliance” without retaining oversight – which is not consistent with the FCA’s rules on outsourcing. The FCA stressed that it expects “firms delegating portfolio management services to seek an equivalent level of client protection under delegation arrangements as those required by MiFID II“.
- Intragroup research sharing: the FCA found that firms are not routinely sharing research between entities in the same corporate group. Cases where the FCA did identify research sharing typically involved limited material and / or research flowing to and from entities (ie research flows ‘both ways’). The FCA considers that this is reasonable, as long as it does not influence how firms place orders or their ability to act in the best interests of their clients.
- Competition concerns: various firms, in particular independent research providers (IRPs), have raised competition concerns. Some IRPs indicated that multi-service firms were cross-subsidising research and other firms were taking an over-cautious approach to the new rules (including limited take-up of the FCA’s 3 month trial period for research). Some IRPs indicated that, as a result, they are finding it difficult to compete. The FCA noted that this would be an area of focus in its further work in 12 to 24 months’ time.
- FCA’s 3 month trial period: importantly, the FCA indicated that it would not extend the 3 month trial period to 6 months. Some IRPs had suggested the 3 month period was too short – but the FCA found that there was not sufficient evidence that extending it would “materially improve uptake by asset managers” and that, in any event, extending the trial period might stop the benefit from being classified as “minor” (for the purposes of the new ‘minor non-monetary benefits’ rule).
The FCA acknowledged that implementation of the research unbundling rules is still in its early stages and highlighted that it intends to undertake further work in 12 to 24 months’ time. In the meantime, firms should consider the FCA’s findings – in particular, in relation to research valuation and pricing models – and ensure they are acting consistently with the FCA’s expectations. Implementation of the research unbundling rules by firms – in a way that is consistent with the FCA’s expectations – is likely to be a key focus of the FCA in the future.