- FCA aims to rev up research with the reverse of unbundling rules
- Rachel Kent's report also argued for retail access to research
The Financial Conduct Authority (FCA) has been rarely out of the news of late. Whether that’s a good thing depends on your perspective, but those in favour of the post-Brexit liberalisation of capital markets would have applauded the regulator’s recommendation to roll back a controversial restriction brought in under the MiFID II regulations in 2018.
The FCA has decided to allow asset managers to combine payments for third-party investment research and trade execution. "We are proposing to provide more options on how to pay for such research, helping boost competition and making it easier to buy research across borders," said Sarah Pritchard from the FCA.
The proposal, which is still in the consultation phase, follows on from Rachel Kent’s UK Investment Research Review published last year. Kent, who was appointed as the Financial Regulators Complaints Commissioner at the start of this year, set out several other related recommendations in her review, including the introduction of an industry research platform, specifically “a central facility for the promotion, sourcing, and dissemination of research on publicly traded companies”.
Said platform would be open to all but would certainly improve the lot of small and medium-sized enterprises (SMEs). Other recommendations would allow greater access to research for retail investors and facilitate changes to the regulations governing investment research in the context of initial public offerings (IPOs).
The primary aim of the MiFID II regulations in this area was to provide transparency into the cost of both research and trading commissions, by requiring payments for these burdens to be unbundled. But troubles were apparent right from the get-go. In 2022, the European Commission released a proposal to amend the MiFID II framework, but by then it was obvious that the regulations had made the production of independent research untenable from a financial angle — a point not lost on US broker-dealers which were also negatively affected by the regulation.
An exemption for research on SMEs had been put in place to stimulate interest in this end of the market, but investment providers and brokers chose not to introduce separate systems for research invoicing, if for no other reason than it entailed significant administrative costs. Sell-side firms would have needed to build an infrastructure capable of processing direct- and commission-based payments and providing aggregate cost reporting to clients. In short: more red tape.
In keeping with the law of unintended consequences, the compulsion to unbundle charging mechanisms resulted in a dearth of quality research covering SMEs – generally the preserve of mid-tier brokers/analysts. There have been fewer incentives for research providers to continue with their activities linked to UK small caps because mutual funds, life insurance companies, hedge funds, and pension providers are less inclined to pay for analysis outright.
This reluctance on the part of the buy side disproportionately affects smaller companies trying to get their message out to the market. By extension, this could place additional strain on secondary markets, although that hasn’t necessarily been in evidence, at least judging by London’s Aim – notwithstanding the heightened trading volumes during lockdown. However, an uninformed market does little to boost prospects for IPOs, as institutional investors remain in the dark over potential opportunities in the higher-growth end of the market.
Exodus response
The FCA’s green light on Kent’s proposal is doubly significant given the seeming exodus of UK companies from public markets and the persistent discounts on offer compared to US valuations. Meaningful reforms to the financial services sector can’t come quickly enough, although unwinding existing regulatory restrictions is invariably a drawn-out process.
At the end of last year, a progress report on the Edinburgh Reforms published by the Treasury Committee of the House of Commons indicated a “lack of progress or economic impact”. By that point, nine of the 22 reforms had been delivered, although some hadn’t been implemented fully. Nonetheless, there has been some progress linked to local government pension scheme asset pooling, along with the possible repeal of retained EU prospectus regulation and the implementation of a new regime for public offers and admissions – the latter would dovetail nicely with the FCA change.
It's now well over two years since the then newly-in-post Chancellor, Jeremy Hunt, delivered his cri de Coeur on the urgent need for financial services reform. Unfortunately, regulators are faced with a difficult balancing act in that they must either repeal or alter existing regulations governing capital markets, without compromising the UK’s reputation for financial probity, hence the preference for incremental reform.
The Chancellor did get some encouraging news after press reports emerged that Phoenix Group (PHNX), one of a core group of pension providers that make up the so-called “Mansion Compact”, is planning to launch a new multibillion-pound fund to invest in high-growth companies. The pension providers, which also include L&G (LGEN) and Aviva (AV.) were effectively corralled by the City of London Corporation in a bid to improve access to institutional capital for SMEs and give the UK stock market a much-needed shot-in-the-arm.
