On the 3rd of March 2017, the Financial Conduct Authority (FCA) published their summarised findings from a review of dealing commission expenditure across thirty-one investment firms between 2012-2015. The FCA appears to have been very disappointed with their findings and stated that most of the firms failed to meet their expectations, especially with regards to:
- Assessing whether a research good or service received was substantive
- Attributing a price or cost to substantive research if the firm received it in return for dealing with the commission
- Recording assessments to demonstrate the firm was meeting COBS 11.6.3R and not spending more of its customers’ money than necessary.
Unfortunately, for investment management firms it doesn’t end there. The FCA’s publication has seven sections in which further criticism and advice is offered to the sector. Below are summaries of each area:
- Paying for Research
Most of the firms reviewed did not cover the cost of externally produced research from their own resources, instead they utilised a dealing commission. Three firms did cover the cost of their externally produced research and only utilised a dealing commission were praised for their approach as it:
- Mitigated the conflicts of interests associated with utilising a dealing commission to pay for external research.
- Provided greater transparency about the charges their customers pay.
- Demonstrated that their dealers only execute trades with counterparties that provide the best execution services.
- Incentivises investment management firms to purchase research that presents value for money.
The FCA concludes this point by stating that if more firms adopted the approach of the few outliers it would drive up the quality of research in the market.
- Research Budgets
The FCA is unflattering when it comes to the reviewed firms’ approaches to research budget practises stating that “some [were] showing little thought or consideration”.
It criticised the linkage of budgets to historical spending and the occasional firm that failed to limit expenditure to appropriate levels without a reason. The latter issue could be in breach of COBS 2.1.1R (to act in the clients’ best interests).
- Research Polls and Voting
It is noted that several firms adopted a voting system for allocating a percentage of research money in lieu of a defined figure. As such, the FCA said it appeared that those voting in some cases had little idea of what was value for money or how much they were spending on research. It is probable that such absent-minded spending on the part of investment managers would be a cause for alarm among their clients.
- Systems, Controls and Record Keeping
“Arrangements to demonstrate that only ‘substantive’ research is paid for using dealing commission (as required by COBS 11.6.5E) were generally poor or missing.”
If records were kept, they typically didn’t contain sufficient information to establish the firm had undertaken substantive research. The FCA also took the opportunity to remind firms of SYSC 3.2 and SYSC 9 (to have adequate systems and record keeping processes).
Additionally, managers were noted to have little appetite to challenge or validate the work of their teams.
- Conflicts of Interest
Many of those surveyed continued to view the receipt of corporate access from brokers as a free service. If these same firms failed to carry out adequate record keeping or appropriate controls over research expenditure they may become exposed to the risk that improper factors may influence the allocation of dealing commission expenditure.
- Further Issues
The FCA was disappointed that some firms with overseas operations and those that delegated or outsourced investment management services failed to institute controls and oversights to ensure they were complying with regulations. COBS 11.6 requires that ‘global’ commission models must meet their requirements on their investment management activities that take place in the UK.
The FCA firmly believes more needs to be done by investment management firms. They go as far to state that they should “ensure they spend their customers’ money with as much care and attention as it were their own”. They do note some examples of good practise and state that should these be adopted on a wider scale it will enhance the UK investment management sector for potential investors.
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