FCA backs separation of research costs from 'dealing commission' after thematic review

Following the publication of the results of its thematic review into the use of dealing commission by investment funds, the Financial Conduct Authority (FCA) is now seeking evidence on the best way to implement the new Markets in Financial Instruments Directive (MiFID II) once in force. According to its review, too few firms are properly weighing up the costs of research against the value of the work to consumers.

"The UK is a global centre for asset management – to keep this position it is crucial that investors are confident that they get a fair deal," said FCA chief executive Martin Wheatley at an FCA conference on dealing commission.

"There is strong evidence to suggest the current model of using dealing commission to pay for research reduces transparency and creates a link between research spend and trading volume, without a clear assessment of the value this offers to investors. I want to see a level playing field across Europe to ensure the market delivers the best outcome for investors," he said.

The FCA announced in May that, following its November 2013 consultation, it was clarifying its rules to make it explicitly clear that firms could only use dealing commission to pay for services directly related to executing a trade or for "substantive" research.

However, its review of 17 investment managers and 13 brokers between November 2013 and February 2014 found only two investment managers met the regulator's expectations. In another 11 cases, the amount of research purchased with dealing commission was linked to the volume of trades carried out as firms did not have research budgets or caps in spending in place. The FCA is also in "active discussions" on potential redress for clients in one case, where a firm had used dealing commission to pay for market data services in full without any attempt at a mixed-use assessment to determine which parts of the service could be paid for with dealing commission and which could not.

The FCA also found that brokers did not explicitly price their research services as a distinct service, leading to price opacity in the market and making it difficult for investment managers to work out how much they were paying for research and execution. Brokers had also not given proper consideration to potential conflicts of interest when arranging corporate access between investors and firms that they were or were considering investing in, although the FCA said that this was "somewhat mitigated" by the corporate clients being aware of the potential conflict.

The European Securities and Markets Authority (ESMA) has proposed banning the use of dealing commission for any form of access to research analysts, including face to face meetings or conference calls. Its draft rules, on which it is currently consulting, would also prohibit the use of dealing commission to buy any bespoke reports or analytical models, investor field trips, corporate access or market data services. The new rules would form part of the MiFID II fund management regulatory regime, which is expected to come into force on 1 January 2017.