New Horizons: Rethinking UK Investment Research Payments

There has been much anticipation surrounding the FCA’s Consultation Paper CP24/7 on Payment Optionality for Investment Research, the paper has outlined a number of proposals that enhance the flexibility for UK buyside entities, such as asset managers, in procuring investment research. The proposed framework introduces the possibility of ‘bundling’ payments for third-party research and execution services, framed within specific ‘guardrails’. These initiatives stem from the UK government’s Edinburgh Reforms initiated in December 2022. In July 2023, under Rachel Kent’s leadership, the panel released the Investment Research Review (IRR), which recommended several improvements. The consultation paper responds specifically to the second recommendation of the UK IRR: “Allow additional optionality for paying for investment research”.

1. Proposed Changes

• • Introduction of Bundled Payments: The FCA proposal for reintroducing the option for asset managers to bundle payments for investment research with trade execution charges. This model had been restricted under previous regulations (MiFID II) to prevent conflicts of interest and ensure transparency.

2. Reasons for the Change

• • Flexibility and Efficiency: The changes aim to provide asset managers with more flexibility in how they pay for research, potentially reducing operational complexities especially for smaller firms.
  • Enhancing Competitiveness: By allowing bundled payments, UK asset managers may be able to effectively compete globally, aligning more closely with payment practices in other major markets like the US.

3. Benefits of the Proposal

• • Operational Simplicity: Simplifying the research payment process, potentially making it easier for new and smaller asset management firms to access high-quality research.
  • Competitive Edge: Boosting the market for UK firms ensuring they remain competitive on an international stage by reducing regulatory barriers that currently might disadvantage them compared to international peers.

4. Risks and Safeguards

• • Potential for Abuse: The primary risk of bundling payments is that it could lead to less disciplined spending on research and influence trading decisions based on research cost rather than client best interest.
  • Guardrails: To counter these risks, the FCA suggests stringent measures like:

• • • Budgeting: Ensuring firms set and adhere to a clear budget for research spending.
    • Cost Allocation: Fairly distributing research costs among clients to prevent any undue cost burden on individual investors.
    • Value Assessment: Regular assessment of the quality and utility of the research purchased.
    • Transparency: Maintaining high transparency of research costs and the methodology behind research billing to clients.

5. Feedback and Implementation

• • Consultation Process: The FCA is open to feedback from stakeholders until 5 June 2024. The feedback will help refine the proposals before final rules are set.

6. Impact on the Market

• • Market Dynamics: Expected to help smaller and newer firms compete more effectively by reducing operational hurdles related to research payments.
  • Market Integrity: Aimed at maintaining market integrity while easing some operational challenges.