Introduction to CP24/7
In July 2023, the UK government published findings from the Investment Research Review (“Review”) as part of the Edinburgh Reforms, aimed at boosting research production to stimulate activity in the UK capital markets. A key recommendation was to permit asset managers to combine payments for investment research with execution charges.
Currently, under the EU’s MiFID regulations, bundled payments for research and execution services are prohibited unless the research relates to issuers with market capitalisations below €1 billion. The FCA has mirrored this rule, permitting bundled payments for issuers with market capitalisations under £200 million. However, the Review now suggests removing this prohibition entirely.
On 10 April 2024, the FCA published consultation paper CP24/7 (“Consultation”), detailing its approach to eliminating the prohibition on bundled payments. The Consultation, closing on 5 June 2024, aims to introduce new rules or guidance by mid-2024.
FCA’s CEO Nikhil Rathi highlighted that the current options available to UK asset managers are either operationally complex or favour larger firms, hence impacting competition. The proposed changes aim to align UK rules with those in other jurisdictions, facilitating the provision of cross-border research.
Background
MiFID’s Article 24 stipulates that payment for investment research cannot be combined with other charges, necessitating that it be either self-funded by the investment firm (“P&L model”) or charged separately through a client agreement (“RPA model”). This aims to prevent conflicts of interest where combined fees might lead to suboptimal trade execution due to included research services. It also promotes accountability and transparency of costs.
However, this unbundling has led to a significant decline in investment research production in the UK. In response, the EU amended rules in 2021 to allow bundling for issuers with market capitalisations of €1 billion or less, under specific agreements. The FCA followed suit in 2022, permitting bundled payments for research on issuers with capitalisations under £200 million, limited to fixed income, currency, and commodity instruments provided by independent research providers.
Proposals under the Review
The Review concluded that MiFID’s prohibition on bundled payments has adversely impacted investment research provision in the UK and potentially harmed UK equity capital markets and asset managers’ competitiveness. The Consultation proposes amending COBS to allow firms to bundle payments for third-party research and execution services universally, adding this as a third option alongside the P&L and RPA models.
The proposed changes align with the US approach, permitting “soft commissions” where execution and research payments are combined. The Consultation also proposes a new “non-monetary benefit” category for MiFID and insurance-based investment products, covering short-term trading commentary linked to trade execution.
However, these changes are not mirrored in COBS 18, applicable to UCITS management companies and UK AIFMs. The FCA plans to consult on necessary amendments to COBS 18 later in the year.
Requirements for Bundled Payments
Firms must meet several requirements to use bundled payments, including:
- Bundled Payments Policy: A formal policy detailing the approach, governance, decision-making, and control mechanisms, ensuring compliance with Consumer Duty for retail customer services.
- Agreement with Research Providers: An agreement outlining the methodology for calculating and identifying research costs, similar to existing MiFID requirements.
- Allocation of Payments and Costs: Structures to maintain competition among third-party research providers and ensure proportionate cost allocation to clients.
- Operational Procedures: Procedures for account reconciliation, prompt payments, and risk management related to unspent surplus amounts and provider concentrations.
- Budget and Periodic Assessment: An annual budget for third-party research, with an action plan for exceeding the budget and periodic assessment of research value and cost benchmarking.
- Client Disclosure: Policies on bundled payments, key features, combination with other payment options, primary research providers, and incurred costs must be disclosed to clients.
Conclusion
The changes proposed aim to increase activity and liquidity in UK equity capital markets and enhance market integrity by facilitating UK asset managers’ ability to purchase investment research globally. Whilst bundled payments would ease research access, firms would face stricter requirements to ensure transparency and accountability.
These reforms are part of broader efforts to boost UK equity markets and support the asset management sector. The impact of these proposals remains to be seen, but they are expected to contribute significantly to ongoing market reforms.
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