ARTICLE
18 April 2024

FCA Proposes 'New' Option For Investment Research Payments – Back To Bundled Payments?

KM
Katten Muchin Rosenman LLP

Contributor

Katten is a firm of first choice for clients seeking sophisticated, high-value legal services globally. Our nationally and internationally recognized practices include corporate, financial markets and funds, insolvency and restructuring, intellectual property, litigation, real estate, structured finance and securitization, transactional tax planning, private credit and private wealth.
On 10 April 2024, the Financial Conduct Authority (FCA) published a consultation paper proposing the introduction of a "new" option for investment research payments alongside the existing two options.
United States Finance and Banking
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On 10 April 2024, the Financial Conduct Authority (FCA) published a consultation paper proposing the introduction of a "new" option for investment research payments alongside the existing two options (CP24/7). In essence, the FCA is proposing to reintroduce the concept of bundled payments for both research and execution services, which long existed in the UK before being prohibited in 2018 by the Markets in Financial Instruments Directive, as revised in January 2018 (MiFID II).

Background

In the UK, currently FCA-regulated asset managers may only purchase investment research either (A) from the firm's own resources (e.g., its profit and loss account) or (B) through a research payment account funded by the firm's client(s) and managed in accordance with strict FCA rules (RPA). The restriction to just these two options originates from MiFID II and was intended to manage conflicts of interest, improve accountability over costs passed to clients, and improve price transparency for both research and execution services.

CP24/7 arises from the FCA's consideration of the recommendations set out by the Government-commissioned Investment Research Review (IRR), launched as part of the Edinburgh Reforms. Specifically, the IRR concluded that the previous unbundling requirements under MiFID II adversely impacted the provision of investment research in the UK and recommended that an additional optionality for the payment of investment research be introduced – i.e., that once again, UK firms should, if approved, be allowed to "bundle" payments for third-party research with those for execution services.

To whom will CP24/7 be relevant?

CP24/7 states that the proposals are potentially relevant for: (i) investment firms and market operators in the UK; (ii) asset managers; (iii) institutional investors such as pension schemes; (iv) insurance firms; (v) banks providing investment services; and (vi) persons providing research that are not authorised by the FCA.

In addition, the FCA states that CP24/7 may be of interest to individuals who use the services of the above-mentioned firms, as well as firms not authorised to provide investment services but that use the services of firms providing investment services (e.g., pension funds and corporates). The FCA provides that CP24/7 is expected to be relevant to issuers whose shares are traded on public markets.

Key Proposals

CP24/7 proposes to allow firms (such as asset managers) who wish to buy investment research to use bundled payments for third-party research and execution services provided that they meet certain requirements. Most notably, a firm would have to:

  1. have a formal policy on joint payments describing the firm's approach to joint payments, including: (i) how the firm's governance, decision-making and controls operate; and (ii) how such payments are maintained separately from those for trade execution.
  2. enter into written agreements with research and execution service providers that establish a methodology for how research costs will be calculated and identified.
  3. have a research provider payment allocation structure to allocate payments between different research providers, including independent research providers.
  4. have operational procedures in place for the administration of accounts used to purchase research from joint payments, and for the delegation of such responsibilities to others. CP24/7 states that this includes ensuring that the reconciliation and reporting for such accounts is undertaken with an appropriate frequency and timeliness; that timely payments are made to research providers; and that risks arising from unspent surplus amounts and research provider concentrations are monitored and managed. However, the FCA is clear that this would not include "RPA-like arrangements" in which monies are periodically swept to a bank account controlled by the asset manager.
  5. set a budget for the purchase of research using joint payments. Such budget to be reviewed and renewed at least annually, and to be based on the expected amount needed to purchase such research (instead of such need being linked to the expected volumes or values of transactions executed on behalf of its clients). CP24/7 states that if the research charged to clients exceeds this budget, or the budget is increased, the firm's policy must set out the relevant actions to be taken and information to be disclosed to clients.
  6. allocate the costs of research purchased using joint payments fairly between clients, and as appropriate to the business model of the firm. The FCA further provides that the firm must ensure that its outcome is fair such that the relative costs incurred by clients are commensurate with relative benefits received. The specific cost of individual investment research items need not be discretely attributable to individual clients, but that the approach "should be reasonable and its outcome fair" across all clients.
  7. periodically (and at least annually), assess the value, quality and use of the research purchased, and its contribution to the investment decision process. In addition, the firm must benchmark the prices paid for the research purchased using joint payments against relevant comparators to ensure the amount of research charged to clients is reasonable compared to those for comparable services.
  8. disclose the following information to its clients: the firm's use of bundled payments; the key features of its approach to implementing this payment option and meeting the relevant requirements; if and how bundled payments are combined with any other payment option; the most significant research providers; and costs incurred.

Next Steps

CP24/7 states that the FCA's "policy intention" is to make changes that ensure consistency across all the rules on research and inducements for investment firms and collective portfolio managers. In addition, the FCA has highlighted that it is aware that the proposed changes should also apply to fund managers, including UCITS managers and alternative investment fund managers, under COBS 18. The FCA is planning to set out the necessary rule changes to achieve this alignment in a future consultation during the course of 2024.

The FCA has also highlighted that the changes it are proposing to the list of minor non-monetary benefits in COBS 2.3A and the addition of payment optionality in COBS 2.3B are not, at this stage, mirrored in changes to the list of minor non-monetary benefits in COBS 18 Annex 1 relevant to: (i) UCITS management companies; (ii) full-scope UK Alternative Investment Fund Managers (AIFMs); and (iii) small authorised UK AIFMs and residual Collective Investment Scheme operators.

The deadline for comments on CP24/7 is 5 June 2024. The FCA aims to produce final rules thereafter – taking into account the feedback it receives, but says the timetable will be determined by the amount, strength and breadth of the information gathered in CP24/7.

CP24/7 is available here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

ARTICLE
18 April 2024

FCA Proposes 'New' Option For Investment Research Payments – Back To Bundled Payments?

United States Finance and Banking

Contributor

Katten is a firm of first choice for clients seeking sophisticated, high-value legal services globally. Our nationally and internationally recognized practices include corporate, financial markets and funds, insolvency and restructuring, intellectual property, litigation, real estate, structured finance and securitization, transactional tax planning, private credit and private wealth.
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