Buy Side Looks to Unbundle Research

Shanny Basar

Nearly a third of fund managers said they intend to pay for research themselves as the UK regulator said the majority of the buy side is failing to adequately monitor the use of commissions.

MiFID II, the regulations coming into force in the European Union in 2018, requires the unbundling of payments for research from trading commissions. Fund managers can either pay for research themselves or from a research payment account, where the budget has been agreed with the client.

A poll of attendees at the FIX EMEA Trading Conference last week found that 30% intend to use their P&L to pay for research, although 30% are still undecided despite the unbundling rules coming into force next year. A poll also found that only 19% have no plans to change the way they access research after unbundling.

The Financial Conduct Authority, the UK regulator, said in a report last week that some asset managers already pay for research from their own revenues rather than using dealing commission. As a result, the regulator said, they mitigate conflicts of interest, provide greater transparency on charges to their clients, are better placed to demonstrate that their dealing teams only execute trades with counterparties that provide best execution and only purchase research that represents value for money.

For example, the UK-listed asset manager Jupiter Fund Management has said it will begin to pay for research itself.

Maarten Slendebroek, chief executive, said in Jupiter’s results statement: “We will take a consistent approach to the costs of research we use, by taking it all through Jupiter’s accounts from 2018 with no change in the management fee, adding around £5m of costs from 2018. During 2017, we will work with our service and research providers to implement these changes. These are important steps in simplifying our unit trust pricing structure as we diversify and grow.”

Slendebroek noted that the FCA’s interim report into competition in the UK fund management industry last  November was a thoughtful study and Jupiter welcomed the push towards transparency in fees and focus on client value.

The FCA added that fund managers have also made material reductions in research spending through improved management and oversight. “If more firms implement either of these approaches, it should drive better quality research across the market,” added the regulator.

However the FCA said the majority of asset managers did not meet the regulator’s expectations on assessing research. “We identified poor practices at the majority of firms we visited and several could not demonstrate meaningful improvements in terms of how they spend their customers’ money through their dealing commission arrangements,” added the regulator.

At the extreme end, some firms used dealing commission to purchase non-permissible items, such as corporate access and market data services, which is contrary to the rules.

However the FCA also found that 79% of organisations used research budgets compared to just 34% in 2012, so some progress has been made. The regulator also saw instances where proposed research payments were benchmarked against various external sources to validate that investors were getting value for money and firms that switched to execution only trading as soon as periodic research budgets were met.

“More work needs to be done by investment management firms to ensure they spend their customers’ money with as much care and attention as if it were their own.” warned the FCA. “Despite some progress being made, much of the poor practice we’ve highlighted previously is still commonplace. This is concerning considering the majority of the rules on the use of dealing commission have been in place for over a decade.”

Some firms are turning to technology to monitor their research consumption and payments. For example, last month Euclid Opportunities, NEX Group’s financial technology investment business, said it had invested in RSRCHXchange, a cloud-based marketplace and MiFID II workflow solution for accessing institutional research.

Jeremy Davies, co-founder of RSRCHXchange, said in a statement: “The asset management community is on the cusp of unprecedented change as research and execution costs unbundle in less than 12 months when the MiFID II requirements come into effect. We are now providing over 1,00 buy-side firms with a MiFID II solution for buying, managing and procuring investment research.”

The FCA also reviewed asset managers’ oversight of best execution and  found that most firms failed to take on board the findings of the regulator’s 2014 thematic review. The regulator said the pace of change in improving client outcomes in best execution was slow, with few firms having a cohesive strategy for improving client outcomes. MiFID II also introduces new requirements for the buyside to provide evidence to their clients on how they have tried to achieve best execution across a range of asset classes, not just equities.

“MiFID II places a specific obligation on firms to check the fairness of prices proposed to clients when executing orders or taking decisions to deal in over-the-counter products,” said the FCA. “Therefore to ensure MiFID II readiness and future compliance with our rules, firms will need to improve current practices in relation to these types of trades.”

The regulator said it found instances where compliance staff lacked access to the data used by the dealing team or they didn’t use data already available such as gifts and entertainment logs which led to a ‘tick box’ monitoring process where failings were unlikely to be discovered.

However, the FCA added that it did see some good practice in firms where best execution was considered throughout the investment decision making process and some dealing teams provided feedback to portfolio managers on their preferred trading strategies. In addition, these firms had an effective governance process in place that challenged the overall costs of execution, renegotiated commissions and identified trends that helped improve future execution, which fed into a high level trading strategy.

In equities the FCA said there had been improvements where some firms  decreased the cost of trading by using low cost trading venues such as broker-supplied algorithms, direct market access and the increasing use of crossing networks for appropriate trades. However, monitoring was less sophisticated in fixed income.

“We recognise there are particular challenges for this asset class, but some firms have been more proactive in how they meet their obligations than others,” said the FCA. “This highlights that meaningful steps can be undertaken to ensure best execution even in less transparent markets.”

The FCA said it will be revisit best execution this year to see what steps investment management firms have taken to assess gaps in their approach to achieving best execution and how they can evidence that funds and client portfolios are not paying too much for execution.

“If we find that firms are still not fulfilling their best execution obligations, we will consider appropriate action, including more detailed investigations into specific firms, individuals or practices,” added the FCA.

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