‘Slush fund’ risk over pension charges that pay for research

Pension fund portfolio turnover charges are being used to pay for research from asset managers’ brokers in a way that creates conflicts of interest says the FSA.

An FSA paper published earlier this month, Conflicts of interest between asset managers and their customers: identifying and mitigating the risks, found most fund managers did not exercise the same standards of control over research bought through commission paid to their brokers as they did when they paid for it out of their own pockets.
Critics have hit out at the practice of paying commissions for research, arguing these costs should be reflected in higher AMCs, and resulting in lower transaction charges.
Standard Life has published the level of commission paid to brokers that has been used to pay for research. It says out of 13 basis points paid to brokers, on average across its active equity funds, roughly half is apportioned for research from the brokers it deals with. The FSA Conduct of Business rules permit commission being applied to research costs.
The FSA conducted thematic reviews of asset management firms between June 2011 and February 2012, assessing their arrangements for managing conflicts of interest. The review was prompted by evidence from its other supervisory work that some firms no longer saw conflicts of interest as a key source of potential detriment to their customers and had relaxed controls that we had considered to be well-established market norms.
The regulator said it identified that many firms had failed to establish an adequate framework for identifying and managing conflicts of interests. We also identified breaches of our detailed rules governing the use of customers’ commissions and the fair allocation of trades between customers.
The FSA’s report found firms also unable to justify how brokers arranging for access to company managementor providing preferential access to IPOs could be seen as delivering research or execution services.
Some firms did not observe our requirements to disclose to customers details of commission payment.
Andy Cheseldine, partner at LCP says: “Why isn’t the cost of this research taken from the AMC. The obvious way for these expenses to be reflected would be a higher AMC and lower trading costs. The current way of operating creates an unquantifiable fund of money that is used for imprecise purposes, and which is in danger of being look upon as a slush fund.
“Credit to Standard Life for coming out with their figures. I would hope others will follow suit. If they will not, it begs the question how much they are being paid in research.”