CSAs Under Dispute in European Research Rules

Terry Flanagan

The UK Financial Conduct Authority has endorsed softened guidelines for the payment of research by asset managers but said the industry should move away from commission sharing arrangements.

The FCA said in a paper yesterday that it endorsed the European Securities and Markets Authority’s proposals governing how research will be paid for under MiFID II in order to reduce conflicts of research.

Esma had initially wanted all research to be paid for directly by fund managers and to ban the cost being included in dealing commissions, a stance supported by the FCA.

Last December Esma weakened its proposals by allowing asset managers to either pay for research from their own resources or make payments from a specific research account funded by a client. The size of the research payment account has to agreed by the client, disclosed upfront and is not allowed to be linked to execution volumes or dealing commissions or spreads.

Yesterday the FCA released a paper endorsing Esma’s new proposals.

The FCA said: “The flexibility over how research costs are absorbed by portfolio managers should also reduce concerns over the short-term transition to this new model. It will allow portfolio managers to budget and pay for research that adds value to their clients, while adding scrutiny such that it is unlikely managers will continue to pay for low value, duplicative research, reducing overproduction and inefficiency in resource allocation by providers.”

Pras Jeyanandhan, an analyst at Berenberg, said in a note: “The FCA’s support of this more flexible approach (which allows the cost to be borne by the client) will allay fears that it may have pushed for firms to pay for research out of their own P&L.”

However the FCA also believes that commission sharing arrangements are not compatible with Esma’s new guidelines.

“The research payment account is a new, distinct payment vehicle,” said the FCA. “Indeed, it appears inconsistent with the best interests of a portfolio manager’s customers to continue using CSAs, which still rely on execution commissions to fund research, and do not reflect the focus in ESMA’s proposals on portfolio managers agreeing research charges upfront with customers based on a predicted, budgeted assessment of their research needs.”

Berenberg said: “While both regulators have softened their stance on who pays for the research, the FCA’s interpretation that the CSA framework is not consistent with ESMA’s advice is a setback.”

The analyst warned that unilaterally imposing the new rules in Europe could harm international competitiveness and Sanford Bragg, chief executive of consultancy Integrity Research Associates, also warned of the risks of regulatory arbitrage in a blog.

“If the FCA had the support of its American cousins, perhaps there would be some chance of effective implementation of its brave new world. That, however, ain’t happening,” Bragg wrote.

Bragg suggested that the FCA moderate its position to allow CSAs to be used as a vehicle for the research payment accounts.

“Then it is likely that the controls it desires – budgeting and client engagement – are likely become global best practice,” added Bragg. “However, its latest statement reinforces the impression that it will be the FCA’s way or the highway.”

The FCA also said that conflicts of interest over the provision of research can equally apply to credit markets and applying Esma’s guidance will allow competition firms who are not brokers in the bond markets.

“An independent research provider wishing to supply research on the credit markets currently faces a significant competitive disadvantage compared with brokers, as there is no mechanism such as CSAs to allow a third-party research provider to be paid from transaction costs and no market precedent for ‘hard dollar’ payments in this area,” said the FCA.

The UK regulator also recommended that firms should start considering how they may need to change their controls now rather than waiting until MiFID II comes into force in 2017.

“The wider investment management sector might also wish to start considering the need to create new standard documentation and processes to redefine relationships with clients, brokers and research providers if it is considered more appropriate to drive change at industry rather than firm level (subject to preserving competition),” added the FCA.

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