The FCA publishes its proposals on research payment optionality, but with “guardrails”

The FCA has published its long-awaited Consultation Paper CP24/7 on Payment Optionality for Investment Research (”the Consultation”). This contains its proposals to give UK buyside firms, including asset managers, greater flexibility on purchasing investment research. These will allow the “bundling” of payments for third-party research and execution services, subject to certain proposed “guardrails”.  The proposals result from the UK government’s Edinburgh Reforms launched in December 2022, aimed at boosting economic growth and the competitiveness of UK financial services. They are also directly derived from the recommendations of the Investment Research Review, chaired by Rachel Kent, published in July 2023.

Who does this apply to?

It would appear that the revised rules will continue to apply broadly across all buy-side firms. In the first instance, they apply to MiFID investment firms, including portfolio managers and institutional investors such as pension schemes. However, the Consultation also makes it clear that the FCA proposes to amend the rules in COBS 18, hence extending payment optionality to UCITS managers, full-scope AIFMs and small AIFMs. It also notes that the current list of minor non-monetary benefits in COBS 2.3A (see below) are not mirrored in COBS 18, although its wording is somewhat ambiguous as to whether it proposes to align the two.

The central proposal in the Consultation is a third option (alongside paying through a Research Payment Account, or out of the firm’s own resources) to allow joint payments for research and execution services, provided certain requirements are met relating to the operation of such payments. These so-called guardrails consist of requiring:

1. The adoption of a formal policy on joint payments describing the firm’s approach and how its governance, decision making, and controls operate, including how these are maintained separately from payments for execution-only.
2. Written agreements with joint research and execution providers which establish a methodology for how research costs are calculated and separately identified within the total cost.
3. Establishing a payment allocation structure for payments across joint research and execution providers, as well as providers of research providers not engaged in execution services.
4. Taking full responsibility for the administration of accounts for paying for research from joint payments, ensuring that these comply with FCA requirements and ensure timely payments to providers.
5. Setting a budget for research payments based on need and not the expected volume of execution transactions – at least annually and at an appropriately aggregated level (e.g. across clients with similar investment strategies).
6. Fair allocation of the cost of research purchased through joint payments across clients.
7. Periodic assessments (at least annually) of the value, quality and use of research purchased through joint payments including the contribution to investment decision making, and benchmarking the prices of research purcha against relevant comparators to ensure that these are reasonable.
8. Appropriate disclosures to clients including:
   • the firm’s use of joint payments;
   • the key features of its approach;
   • expected annual costs to the client (part of ex-ante disclosure on costs and charges) and actual costs from prior annual periods:
   • the most significant research providers, and costs incurred:
   • total costs incurred by the client (part of ex post reporting); and
   • any disclosures relating to costs that have exceeded the firm’s budget.

The definition of “acceptable minor non-monetary benefits” (i.e. ones that can be received without being deemed as inducements) is also being amended, as follows:

• The previous exemption for research on listed or unlisted companies with a market capitalisation of less than £200 million is removed.
• Short-term trading commentary, which does not contain substantive analysis and bespoke trade advisory services intrinsically linked to trade execution, are also permitted.

If a firm delegates the administration of a payment allocation structure or joint payments research account, it remains responsible for compliance with relevant rules and must ensure that reconciliation and reporting of such structures and accounts is undertaken with appropriate frequency and timeliness.

Lastly, there is an explicit prohibition on research services being treated as an “execution factor” under the FCA’s rules on best execution.

The FCA promises to publish the final rules on research (assuming its main proposals are accepted) “during the first half of 2024”. As the Consultation closes on the 5^th June, this seems challenging. The FCA also commits to a consultation on amending the rules in COBS 18 “during 2024”.

Cosegic comment

As expected, the FCA has accepted the recommendations of the Kent review to introduce a third joint payment option research – in effect, allowing broking firms to offer Commission Sharing Arrangements (“CSA”) to investment managers who want to go down this route. However, the so-called guardrails around rebundled payments are onerous and, arguably, very similar to the current requirements for Research Payment Accounts that Kent deemed “unnecessarily complex and therefore rarely used”. It remains to be seen therefore, how many managers will take up the new joint payment/CSA option.

The other main observation is that the FCA have chosen not to address any of the other recommendations of the Kent Review at this stage – there were six other recommendations, mainly focused on improving retail access to original. Although further work on these recommendations is promised, there is no indication of priority or timing.