The FCA wants to allow rebundling in order to support the ‘health and dynamism’ of the UK capital markets. EU legislators announced the same plan back in February. Final rules are expected to be published in ~3 months.
'Rebundling' means that asset managers can include payments for investment research in the dealing commissions they pay brokers/banks. MiFID II stopped this longstanding practice across Europe; the supply of research had to be negotiated and paid for separately.
Moreover, the allowed mechanism for an asset manager to charge the costs of research directly to its clients was so onerous, that the majority moved to paying for research from their own resources, becoming ~15% of an asset manager’s overall cost base. Ouch.
As asset managers began to swallow this cost, they started slashing the amounts they paid research providers - to the extent that total payments are now ~50% lower than in 2017. Ouch.
Whilst brokerage firms & asset managers felt the pain, their clients, e.g. pension funds, made big savings... or did they?
Whilst the £ numbers quoted were large, total research costs even in 2017 only represented ~0.02% of total AUM. The FCA finally realised (1) this benefit to investment returns was de minimis, (2) the US had no intention of following suit, and (3) the resulting diminution in the breadth and quality of research inputs might well be hurting investment returns overall.
So this raises 3 questions for ESG ratings firms like ours:
❓ Can ESG ratings be paid for as research?
Yes – ESG ratings meet the definition of investment research if there is clear analysis, and the rating acts as a form of conclusion likely to influence investment decisions.
(Why else is the FCA now proposing to regulate ESG rating agencies?)
❓ An asset manager will be able to pay for research within trading commissions, but how does that help independent research providers who don’t offer trade execution?
The asset manager can create a 𝗖𝗦𝗔 (‘Commission Sharing Agreement’) with an investment bank.
It tells the bank that “x% of all the commissions charged when we trade, need to go into a research payment pool. We will then give you a list of research providers, and amounts that we want you to pay them for the research they’ve given us.”
❓ Will asset managers actually go back to using CSAs to pay for research?
We asked this question to our network, and 74% said 'YES' - a huge majority.
The FCA proposal, to reduce friction, is that an asset manager no longer requires ‘consent’ from its clients to charge them for research, it just needs to ‘inform’ them. And with asset managers’ margins under structural pressure, most are very keen to charge the cost of research directly to the funds they manage.
Some new funds are already being charged directly for research, and we expect this to spread to existing funds if some of the huge asset managers are prepared to lead the way.
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