Only two firms out of 11 asset managers and 17 brokers are operating at the level the Financial Conduct Authority (FCA) would expect in relation to how they use dealing commission.
In light of the FCA's findings, the regulator has put its support behind European proposals to further separate research from dealing commission, to encourage greater competition and transparency over the price of research
The FCA reviewed how firms use the charges paid by consumers for executing trades and external research, worth around £3 billion per year. The financial watchdog found too few firms properly assess the value-added and cost of research paid for using client dealing commission. The review also found that the practice of brokers bundling execution and research services makes it harder for investment managers to assess the value of research.
FCA chief executive Martin Wheatley said: 'The UK is a global centre for asset management – to keep this position it is crucial that investors are confident that they get a fair deal. There is strong evidence to suggest the current model of using dealing commission to pay for research reduces transparency and creates a link between research spend and trading volume, without a clear assessment of the value this offers to investors.
'I want to see a level playing field across Europe to ensure the market delivers the best outcome for investors.'The review found that in 11 investment management firms, the amount of research purchased with dealing commission was linked to the volume of trades carried out as they did not have research budgets or caps on research spend. One firm was also found to be using dealing commission to pay for market data services with no attempt at a mixed use assessment to determine which parts of the services were eligible to be paid for out of dealing commission and which were not.
In relation to the brokers who were reviewed by the watchdog, the FCA found they did not explicitly price their research as a distinct service, leading to price opacity and contributing to difficulties for investment managers’ when ensuring they are paying an appropriate amount for research and execution. They also concluded that brokers had not given adequate consideration to their potential conflicts of interest when arranging corporate access, with some being unclear who they were acting for, the company or the investment manager. This was somewhat mitigated by the corporates being aware of the potential conflict, the FCA said.
Following a consultation in November, the FCA clarified its rules on dealing commission in May. The regulator said firms should only pay for services directly related to executing a trade or substantive research out of dealing commission.
The FCA said it will work closely with the industry and other regulators to ensure that the new European rules deliver the best outcome for investors.
New European regulations - Markets in Financial Instruments Directive II (MiFID II) will affect the use of dealing commission.