FCA Relax Research Rules (through gritted teeth)

It is no secret that the research payment restrictions in MiFID II were supported by the FCA at the time. It is unsurprising that they have not relaxed these to the extent the EU has. The net is a compromise position that might be called CSA+, i.e. back to the future with modern furnishings. 

This means that bundled COMMISSION payments are allowed – but fund managers will still have to: CREATE budget, monitor costs and REVIEW research provider disclosures. For the sell side, there is still an agreement or mechanism necessary to identify research from execution costs (this can be a basis point agreement as with CSAs). 

Background

The FCA has confirmed that it is introducing payments optionality in research. This follows an April 2024 consultation paper (see our briefing here) where the FCA proposed allowing bundled payments (alongside the existing options of paying out of P&L and using a research payment account), provided a firm complied with certain requirements. The  FCA's proposal was in response to recommendation in the UK investment Research Review report (see our briefing here). 

The regime will require:

• A written policy describing the firm’s approach to joint payments, including with respect to governance, decision-making and controls.
• An arrangement setting out the methodology for calculating and separately identifying the cost of research.
• A structure for allocating payments between research providers, including IRPs.
• An approach for allocating the costs of research purchased through joint payments, appropriate to the investment process, product, services and clients of the firm.
• Periodic assessment (at least annually) of the value, quality, use and contribution to investment decision-making of the research purchased, and a way to ensure research charges to clients are reasonable against relevant comparators.
• Disclosure to clients on the firm’s approach to joint payments, including how joint payments are combined with any other payment option, the most significant research services purchased, and costs incurred.
• Operational procedures for administration of accounts used to purchase research, and for the delegation of these responsibilities to others.
• A budget on the amount needed for third-party research, reviewed and renewed (on an annual basis at least), and based on expected amounts needed to purchase such research as opposed to volumes or values of transactions.

Other proposals

• The FCA is removing the option for combined payments to purchase research on companies with a market capitalisation below £200 million in COBS 2.3A.19R(5)(g). It however states that the new option for joint payments can apply to research on companies of any size, including the companies formally captured by COBS 2.3A.19R(5)(g).  The FCA is retaining COBS 2.3A.19R(5)(h) to (k) which includes treating corporate access in relation to companies with a market capitalisation below £200 million as an acceptable minor non-monetary benefit.
• Short term trading commentary and advice linked to trade execution will be added to the list of acceptable minor non-monetary benefit for all payment options to COBS 2.3A.19R(5)

Industry response

According to FCA, some wanted further alignment of FCA rules with those in the other places (e.g. the US) and more flexibility on accompanying requirements (especially those on budgeting, cost allocation, and benchmarking).  The FCA notes that some respondents felt that the UK approach was more restrictive than that proposed under EU Listing Act, with some noting that the EU proposed framework allowed firms to go for a fully bundled form or with a CSA-like mechanism. The FCA states that there are many similarities between its proposals and that of the EU and that full unbundling would lead to "opacity of prices paid for research services, challenge the ability to compare prices paid across research providers, and not preserve competition in the separate markets for research and trade execution."

Changes that the FCA has made since the consultation paper include the following:

• Budgeting: More flexibility introduced in relation to level of aggregation, to suit a level of firm’s investment process, products, services, and clients. Disclosures on budgets being exceeded need to be made as soon as reasonably practicable, and can be part of a firm’s next periodic report on costs and charges.
• Research provider disclosures: There is now a requirement to disclose the types of providers selling the research services bought (instead of the requirement to disclose the most significant research providers). The FCA has also given guidance making clear how the requirement can be met. The level of aggregation at which disclosures are to be made has been amended to mirror those set out in relation to budgeting.
• Price benchmarking: The requirement to undertake benchmarking of prices paid for research services against relevant comparators has been relaxed so that firms are required to make sure that research charges to clients are reasonable (with guidance stating that benchmarking of prices paid for research services is one way of complying).
• Cost allocation and disclosure: Flexibility introduced in relation to the level at which costs are allocated, as long as these are appropriate to a firm's investment process, products, services and clients. Asset managers can also calculate expected annual costs to clients using one of two methods available.
• Separately identifiable research charges: Firms will be required to establish arrangements that set out the methodology for how such research costs are separately identified. FCA had proposed that there should be written agreements with research and execution providers to establish a methodology for how research costs are identified separately within total charges for joint payments.

The changes are set out in appendix 1 to PS24/9 Payment Optionality (Investment Research) Instrument 2024 (FCA 2024/29) and come into force on 1 August 2024. The FCA plans to consult on updating COBS 18 to reflect the new rules in COBS 2.3B in the autumn of 2024.