The European Securities and Markets Authority (ESMA) promises a shake-up of the UK’s £3bn dealership commissions market, with the publication of a report that paves the way for an unbundling of commission fees and research costs.
As things stand, portfolio managers and independent investment advisers pay fees to brokers that cover both the execution of orders and the provision of third-party research.
This raises the possibility of money managers acting in their own interests, rather than the interests of their clients, when placing trades.
In a bid to stamp out such practices, ESMA argues that research should be paid for separately and makes this proposal in a 1,600-page report submitted to the European Commission (EC) as its contribution to the framing of the second Markets in Financial Instruments Directive (MiFID II).
“The key purpose of this proposal is to make clear how the receipt of third-party research by portfolio managers and independent investment advisers interacts with the prohibition to accept and retain inducements, except for minor non-monetary benefits,” it says.
“There should be no payment for third-party research linked to the payments made for execution of orders.”
The overall aim, it adds, is to “create more transparency over spending on research to improve outcomes for consumers.”
While the MiFID II regime is aimed primarily at investment firms managing individual portfolios of clients, rather than those covered by the Undertakings for Collective Investment in Transferable Securities and the Alternative Investment Fund Managers Directive, ESMA advises the EC to consider bringing the latter two within the regulations – although a timescale for these consultations is not given.
While UK regulators have insisted for some years that it is made clear to investors exactly what they are paying for, these rules have been honoured more in the breach than in the observance.
A consultation paper from the Financial Conduct Authority (FCA) last year reported on a thematic review of commission arrangements involving 17 investment managers and 13 brokers.
It concluded that, although there had been improvements as a result of previous reviews and guidance, only two of the firms were operating at the level the FCA expects.
ESMA’s five main demands can be summarised as follows: 1) The research payment account must be funded only by a specific research charge to the client.
2) Firms should set a research budget based on a “reasonable assessment” of the need for third-party research.
3) The budget must be agreed with each client, as must the frequency with which the costs will be deducted from the client's funds.
4) The quality of research purchased must be regularly assessed “based on robust quality criteria and its ability to contribute to better investment decisions.”
5) Firms must have a written policy, which they are required to provide to their clients. This should address how the research may benefit portfolios and how costs will be allocated.
The original version of this article was published in the March 2015 print edition of the Review.