FCA Feedback Statement on the use of dealing commission regime

Summary

On 19 January 2015, the Financial Conduct Authority (FCA) published its Feedback Statement on its Discussion Paper on the use of dealing commission regime. It summarises responses received to potential reforms to the current dealing commission regime, which are linked to proposals under MiFID II.

Importantly, the FCA has stated it will not make changes to the proposed EU rules dealing with payments to brokers by fund managers for the provision of their investment research. This means that the FCA will implement the requirements under MiFID II that ban bundled commission and will require investment firms to pay for research either at their own cost or through the use of "research payment accounts". Key messages from the Feedback Statement include the FCA's views on the use of commission sharing agreements with MiFID II rules, which the FCA sees as incompatible and which will lead to a major change in current market practice, and what it expects investment firms to be doing in the run-up to MiFID II implementation.

The Feedback Statement spells yet another regulatory development that asset managers need to worry about. Following on from the FCA's thematic review on asset managers' controls over market abuse which was published the same week (and which we summarised in our newsflash found here), together these reflect an increased scrutiny from the regulator on this industry.

Background

In July 2014, the FCA published a Discussion Paper (DP 14/3) in which it presented its findings on its review of the UK's dealing commission regime. Our briefing from July 2014 discussed this paper as well as other issues on dealing commission, and can be found here. DP14/3 followed thematic supervisory work and policy analysis by the FCA, including the European Securities and Markets Authority's (ESMA) draft advice proposals to the European Commission on the delegated acts to support the revised MiFID II which were published in May 2014.

ESMA published final advice to the European Commission in December 2014 (Final Advice) which altered ESMA's position in relation to its proposals on research and inducements. This Final Advice, which was not published by the time DP14/3 closed for comments, has been taken into account by the FCA in this Feedback Statement.

ESMA's approach in its Final Advice requires portfolio managers to separate (or "unbundle") the purchase of research from execution arrangements and costs. Under ESMA's Final Advice, an investment manager can purchase research only if it is paid for either:

• directly by the investment manager out of its own resources; or
• through a "research payment account" funded by a specific, separate charge to their client, agreed and disclosed upfront and which is based on a research budget set by the investment manager and is not linked to execution volumes or value (i.e. dealing commissions or spreads).

Key issues

The FCA has said that it "strongly supports" ESMA's final proposals on research and inducements, and considers that they will "better align [investment firms'] incentives to control costs and procure research in the best interests of their customer and will improve competition in the market for research". The FCA also believes that the research payment account option addresses some of the concerns expressed by industry.

The FCA gives its views on the interaction of ESMA's position in the Final Advice and commission sharing agreements (CSAs). Here the FCA says that "current CSA approaches would seem incompatible with the intention of ESMA's proposals and specifically the view that there should be no link between execution and research". The FCA believes that ESMA's Final Advice intends to create a "hard dollar" research market with the option for research invoices to then be paid either by the investment firm itself or from a research payment account.

Interestingly, the FCA says that it believes that ESMA's proposals allow for the costs of research to be allocated across several research payment accounts on a pro rata basis, where more than one client portfolio benefits from the common consumption of that research. However, the FCA goes on to suggest that firms should have standard written policies to govern such arrangements, which should be used to obtain client consent to upfront charges and the allocation policy for costs. The FCA expects that the use of such policies will not be too burdensome for firms and will lead to transparency for clients.-

The FCA believes that some current market practices and tools used in relation to CSAs could be transferable to the new research payment account, such as software platforms and existing valuation processes. Nevertheless, the FCA's message on the use of CSAs signifies a major change in current market practice and will be a significant change for investment firms.

What happens next? FCA expectations of investment firms

The European Commission is now considering ESMA's Final Advice. This will then be scrutinised by the European Council and European Parliament, who will have a maximum of six months to review and object to the acts before the European Commission can adopt the final measures.

In the interim, the FCA makes it clear that it expects investment managers to continue to comply with the existing rules in COBS 11.6, to ensure that they are acting in the best interests of their customers when purchasing external research and to manage any associated costs passed to clients.

The FCA suggests that investment firms may need to consider now the changes to be made prior to 2017, when MiFID II takes effect. For example, firms should consider how their controls may need to be changed to adapt to MiFID II rules and the new standard documentation and processes that will be required for their relationships with clients, brokers and research providers.

The FCA has stated that its preference remains to implement any further changes to the UK inducements and dealing commission rules in line with the final reforms under MiFID II.

Key MiFID II timeline

• Late Q4 2015 – FCA's intended date for publication of a consultation of their overall implementation of MiFID II, including inducements requirements.
• No later than January 2016 – final MiFID II Delegated Acts will be adopted.
• 3 July 2016 – date by which Member States must adopt the delegated acts into domestic law and regulations.
• 3 January 2017 – MiFID II takes effect.