FCA’s Proposal to Ban Research Commissions Rejected

European regulator ESMA backs away from full unbundling; U.K. agency could still set higher standard for firms in that country.

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The European Securities and Markets Authority will not ban the use of trading commissions to pay for research, according to Kay Swinburne, a member of the European Parliament for Wales.

“As far as Kay is concerned, there was no agreement to ban research payments in this way,” Rhiannon Price, Swinburne’s legislative assistant in Brussels, tells Institutional Investor. “Therefore it would be outside of ESMA’s mandate to suggest such a ban.”

Many European investment managers, sell-side research houses and national regulators are relieved, as the prospect of a ban was expected to have a chilling effect on European capital markets. But speculation and a degree of worry remain, for two primary reasons. One, ESMA won’t issue its final version of the regulations, known as the Markets in Financial Instruments Directive II, until March. “In my line of work, you never want to count your chickens before they’re hatched,” says Daniel Godfrey, CEO of London’s Investment Management Association, an industry group. “Until ESMA makes a formal announcement, it would be unwise to make assumptions.”

The second concern is that individual member nations of the European Union, including the U.K., could still impose a ban. Its Financial Conduct Authority has been outspoken in its belief that research and execution costs should be separate, noting in a discussion paper earlier this year that “unbundling research from dealing commissions would be the most effective option to address the continued impact of the conflicts of interest created for investment managers by the use of a transaction cost to fund external research.”

The report also noted that “views on the potential negative impacts on the market from unbundling research — such as U.K. firms’ ability to compete internationally, concerns that research coverage may be reduced, and possible effects on the liquidity of U.K. mid- and small-cap company shares ... are likely to be less significant than some have suggested.”

“The way European regulation works is, local regulators cannot do less than they are required to by the pan-European body, but they can do more — what people often refer to as ‘gold plating,’” explains one London-based analyst who spoke on condition of anonymity. “If ESMA’s rule set ultimately ends up not quite where the FCA would really like it to be, the FCA has the ability to ‘gold plate’ and have a U.K.-only rule set, which would obviously apply only to asset managers regulated in the U.K.”

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Lara Joseph, a spokesperson for the FCA, disputes the notion that the regulator has any such intentions. “We support ESMA’s proposals, which do not include full unbundling,” she says.

Skeptics, however, may not be fully comforted. “Martin Wheatley’s current position is clear,” says Godfrey, referring to the FCA’s chief executive. “He believes a ban is justified, but he doesn’t have an intention to put the U.K. out of line with the rest of Europe. That could change, but that is the position that Wheatley has articulated.”

A unilateral ban would, of course, hold U.K. institutions to a different standard from their Continental counterparts. “The competitive disadvantage it would put on U.K. asset managers would be extremely damaging,” says Michael Mayhew, CEO of Integrity Research Associates in Darien, Connecticut, which analyzes the securities research industry.

Those investors are not necessarily out of the woods yet. “We dodged the worst-case scenario,” Mayhew adds, “but that doesn’t mean U.K. asset managers will get off scot-free. Chances are, the FCA is still going to push for more rigorous accounting of research expenses.”

What exactly Wheatley and the FCA plan to do from here remains to be seen. “It is important to ensure that there is a level playing field internationally,” says Joseph. “The FCA’s emphasis is on ensuring that [every] client commission is spent wisely.”

However, it’s not clear which sort of payment model the FCA would support to achieve that goal. “I suspect the FCA is now going to encourage ESMA to, at the very least, ban the use of commissions to pay for corporate access, and encourage more transparency around the issue of pricing,” Mayhew speculates.

But so far, the U.K. regulator is deflecting such details. “It is for firms to devise the most appropriate models,” says Joseph. “On a much broader note, we have a number of tools at our disposal to take action where firms fail to meet our standards.”

No doubt the guessing will continue. For the moment, at least, many stakeholders are more optimistic than they were just a few months ago.

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