FCA to probe £1bn soft commissions used for research

The FCA is to consult asset managers over its concerns at the practice of using soft commissions to pay for research.

Opening its 2013 Asset Management Conference today, FCA chief executive Martin Wheatley will call for greater transparency in the asset management sector, and is demanding a frank and open discussion on how and where dealing commission is spent.

The FCA will consult with asset managers to see what changes need to be made to the existing regulations, which have been in place since 2006. A specific concern is that some asset managers are pushing the definition of ‘research’ by using client commissions to cover non-eligible costs and services.  

Corporate Adviser has been pushing for greater transparency around soft commissions being used to pay for research since November 2012 and earlier this year reported figures from Frost Consulting that estimated in 2011 $22bn of client funds was spent globally on research paid for through soft commissions and other expenses, effectively manipulating downwards fund manager charges. Frost Consulting puts a figure of £1bn on UK fund soft commission payments across research and corporate access.

Wheatley will say: “This is a critical period for the industry; a crossroads. So today we ask some challenging questions.  Are we internationally competitive?  Are charges and fees transparent? Are there inherent conflicts within the system?  Today we start a debate.

“We need to be confident that managers are putting their clients’ value for money, good returns, and transparency at the heart of how they do business.  Then the discussion is about how best to get there – is evolution enough or do we collectively need to be more revolutionary?

There are two persistent problems.  Firstly, services are being ‘bundled’ together, with eligible and non-eligible services being mixed.  Secondly, when this information is provided back to the client, there is a lack of clarity or adequate transparency around how their commissions have been spent.

”Examples of this poor practice include firms allocating significant sums of their Bloomberg and Reuters subscriptions, not all of which could be justified as viable research.  Or a firm we looked at that paid nearly double the amount of commission it had paid for research than the year previously, simply because it had traded more year-on-year. 

”The amount of research received, however, had remained relatively the same. Of most concern is that firms are pushing the definition of ‘research’ by using client commissions to cover non-eligible costs and services.  This includes a significant chunk of clients’ commission being paid for ‘corporate access’ services from investment banks and brokers.

”We estimate that anything up to £500 million of dealing commission was spent in 2012 to facilitate corporate access.  As an example, last year we discovered a firm that was rewarding brokers predominantly based on the corporate access they provided. This averaged out to each individual investment manager paying over £100,000 just to gain access to the management of companies they wanted to invest in.  We believe this is just one area where firms are allocating commission to ineligible services and paying more for services than they would if they had to pay for them out of their own money.

This practice transfers the firm’s costs onto the client, which clearly works against the client’s interests.  This raises a concern because asset managers do not control these costs with the same rigour as costs they incur directly.  These costs are indirectly borne by the client and do not affect the manager’s profits. 

”Likewise, on the other side of the transaction, Chief Executives and Investor Relations officers have learned, sometimes to their surprise, that their time is being billed to the industry by brokers. As a result of these findings, industry members and representatives, including the Investment Management Association (IMA), have recognised that certain practices need to change. This recognition will also need to extend to the sell-side providers of these services. But let me be clear, we accept that investors want to engage with the businesses they invest in and practise good corporate stewardship.  We have no particular concerns with the purchase of corporate access. And we need a market for good quality research that benefits both the asset managers and their clients. But asset managers should be using their own funds if they wish to purchase access.

The prevalence of bundled services, combining eligible with non-eligible services, can also disguise overpayments for eligible services.  This cross-subsidises services that asset managers should pay for from their own funds. And, in turn, it sustains business models that would quickly fail under increased global competition. Besides, the link between volume of trading and research expenditure appears to be flawed. It creates ‘pots’ of research commissions the fund manager is then incentivised to spend regardless of the added value of the services. 

“This creates a potential conflict of interest. And we are not seeing great value in regards to domestic competition either. Investment banks appear to sell or provide additional services such as corporate access to the highest bidder. This favours high degrees of trading. This also distorts the market and causes asset managers to pay increasingly more for ‘research’ even if they receive very little value from it. In a nut-shell, this type of outdated bundled charging system and use of dealing commissions to purchase research lacks the transparency that has attracted a global consumer-base, distorts competition, and supports unsustainable business models.”  

The FCA has set out a ‘roadmap for change’ that will include:

Working with asset managers in the UK and policy makers in Europe to find a balanced regulatory solution;

Launching a consultation paper in November to clarify rules on research, including guidance around corporate access; and

A thematic review that follows up on the FCA’s earlier work looking at conflicts of interest within asset management. 

IMA chief executive Daniel Godfrey says: “The IMA has been conducting a significant review of this market for some months and we expect to be able to report our conclusions early in the New Year.   Our clear objective is to ensure we deliver the greatest possible value for money, transparency and accountability to our customers and we will explore all possible avenues to make sure we do just that.”