FCA Regulation Proposals Have Money Managers on Edge

Research is in the eye of the beholder, or so it seems from the varied reactions to the Financial Conduct Authority’s proposed regulations prohibiting U.K.-based asset managers from using dealing commissions to finance corporate access, data feeds and other brokerage-­sponsored services, among other changes.

“From what I hear the regulator’s logic is that the asset manager should pay these costs, not the client,” observes one portfolio manager, speaking on condition of anonymity. “I do not agree with this. For me the corporate access service is at least as valuable to my decision-­making and investment process as the research. This is why we pay the brokers to provide the service.”

Another buy-sider who also requests that his name be withheld claims the proposal to itemize such fees would result in “needless paperwork” that would be of little interest to his clients. “What investors really care about is performance,” this money manager insists.

The FCA, a successor organization of the Financial Services Authority, accepted public comment on its proposals through late February and is currently reviewing the suggestions it received; it will issue an updated policy statement next month. However, both the Investment Management Association, a London-­based trade organization for institutional and retail money managers whose members collectively oversee some £4.5 trillion ($7.5 trillion), and the CFA Society of the U.K. have already published responses to the FCA’s proposals. Each organization expressed general support for the regulator’s goals of improving market integrity and promoting fair competition but criticized various aspects of its approach.

“We think there are some issues that could bring inadvertent negative consequences,” explains Daniel Godfrey, chief executive officer of the IMA. However, his group agrees that corporate access fees should be unbundled from dealing commissions and believes that reactions to the regulator’s proposal have been overstated. “I don’t think the FCA’s direction of travel on corporate access is going to result in fund managers’ leaving the U.K.,” he says. “What they’re trying to do is improve the governance of that service.”

But it could also significantly reduce the amount of money flowing to sell-side research operations. The FCA estimates that corporate access fees accounted for roughly £500 million of the total £3 billion that U.K.-based buy-side firms paid in dealing commissions in 2012. A sharp downturn in revenue could prompt many brokerages to cut stock coverage and reduce research department head counts, critics warn.

Greater understanding of the FCA’s position may help ease market anxiety, according to Simon ­Greenwell, director of research for Europe, the Middle East and Africa at Bank of America Merrill Lynch in London. “We recognize that concierge service is not something that should be paid for out of commission dollars,” he says. “But we would argue that arranging a trip or an industry conference is valuable to investors, and we should get some recognition for putting it together.”

Europe's Top Corporate Access

Providers of 2014

Money managers certainly recognize the firm’s efforts. Institutional Investor asks buy-siders who vote in the annual All-Europe Research Team survey to indicate which sell-side firms excel at arranging meetings with the region’s top executives, and this year we received responses from more than 700 investors at 422 institutions that collectively manage an estimated $3.6 trillion in European equities. BofA Merrill leads the lineup of Europe’s Top Corporate Access Providers this year after finishing in second in 2013, bumping Deutsche Bank down to share second place with last year’s No. 3 firm, UBS. ­Morgan Stanley slips from third to fourth, and J.P. Morgan Cazenove holds steady at No. 5.

The FCA has stated that it has no objection to sell-side firms’ arranging corporate meetings or money managers’ paying for the service — or even passing the costs along to clients — provided those fees are disclosed. “The goal is to ensure that managers manage conflicts of interest,” Godfrey explains. “They may have a lot of clients that benefit from a single piece of research, and it’s important that they all share the costs of that research fairly.”

A key concern among market participants is that other new regulations could place U.K.-based money managers at a competitive disadvantage to their global peers, especially if the FCA insists on a more comprehensive menu-­pricing approach. “The overarching issue is to make sure there is rigor in the process around commission payments and to challenge the connection between research payments and trading,” Greenwell explains. “For example, if a firm trades twice as often as others, then it should get twice as much research even though it may not need that much. The regulator seems keen to address the one-to-one linkage between research and trading.”

Philip Middleton, who composed BofA Merrill’s response to the proposed regulations (and also captains the crew that captures third place in Specialty & Other Finance on the 2014 All-­Europe Research Team), points out that packaging execution and research costs is a global phenomenon. “If the U.K. or even Europe were to modify regulation unilaterally to break apart the existing bundled landscape, this could push many competitors to reorganize their businesses,” the London-­based analyst contends. “In an extreme scenario we estimate that applying full unbundling in the domestic market could put the U.K.-based asset management community at up to a 30 to 40 percent disadvantage when running equity mandates relative to non-U.K.-based competitors.”

The IMA voices similar concerns. Its report also imagines the impact of a market structure under which dealing commissions would not be used to purchase research. The potential consequences include “loss of international competitiveness for U.K. financial services firms (unless change is internationally coordinated), a major reduction in research coverage of small and medium-­size enterprises, and the raising of a barrier to entry for investment management start-up firms,” among others.

“These concerns need to be examined thoroughly to ensure that they can be successfully addressed before any final conclusions can be reached,” Godfrey maintains. “We do agree that a significant concern would be fragmentation of regulatory regimes that would reduce the economies of scale available to firms that can trade on a global basis.”

If a wholesale restructuring of the research business model were to be undertaken, the IMA argues, it should be done on a global basis — with the Madrid-­based International Organization of Securities Commissions coordinating the effort. Such an approach would solve a lot of problems, Greenwell agrees, but that’s not likely to happen.

“Servicing the U.S. buy side is what will drive the sell-side business model, because that’s where the majority of equity investors emanate from,” the BofA Merrill research director notes. “The U.S. is the single-­largest market, with a larger pool of commissions because it’s a higher-­turnover market.” So far, however, the U.S. Securities and Exchange Commission has shown no interest in this issue of unbundling, and neither IOSCO nor any other international organization can compel it — or any other securities regulator — to submit to a global standard.

While those in the U.K. financial services industry await the next word on new regulations, Godfrey says it’s important to remember that the FCA “does not have the appetite to damage the competitiveness of the London market — but if they believe there is a right way forward, then they would have an appetite to try to achieve a global solution. We look forward to working closely with them in the coming months and years.” • •