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FCA Review: Implementing MiFID II Research Unbundling Reforms & Best Execution

MiFID II Reearch Unbundling Reforms: Progress Review

23rd September 2019

Last Thursday (19 September 2019) the Financial Conduct Authority (FCA) published a multi firm review that they have undertaken between last July and March.

This review looked at a range of firms in relation to the second Markets in Financial Instruments Directive (MiFID II) that required asset managers to explicitly pay for third party research, and brokers to price and provide research separately, as has been implemented since January 2018.

MiFID II: Unbundling Requirements

As the FCA notes, MiFID II introduced ‘unbundling requirements’ which were seen to be a dramatic shift from previous industry practices, whereby brokers provided research and asset managers accepted it as part of a bundle of services, without a specific charge.

However, the new rules under MiFID II aimed to improve accountability relating to the costs passed to customers as well as improve price transparency for both research and execution services. This meant that Asset Managers were required to explicitly pay for third party research and brokers to price and provide research separately.

As set out in COBS 2.3A and COBS 2.3B, specifically, MiFID II banned:

• The receipt of all monetary and non-monetary benefits by portfolio managers in relation to their services to clients, other than:

•  minor non-monetary benefits; and
•  with the exception of third party research provided it is paid from either a firms’ own resources or a separate research payment account (RPA) that is transparently funded by charges to clients and is subject to oversight requirements

In addition the new rules also aimed to reduce any conflicts of interest in asset managers by fully unbundling research-buying decisions from trade execution decisions thus under COBS 2.3C, MiFID II required:

• Brokers to price and supply execution services separately from research or other services to ensure that the pricing of other services are not conditioned or influenced by execution payments.

Conflicts of Interest in this area had previously been of concern to the UK regulator, with the FSA in November 2012 having issued a Dear CEO Letter to Investment Management Firms following findings from a thematic review on conflicts of interest between asset managers and their customers.

Latest FCA Review Findings: MiFID II Research Unbundling

The latest review, post MiFID II implementation, by the FCA was undertaken during July 2018 and March 2019 whereby they surveyed 40 buy-side firms and undertook 10 firm visits across the buy-side and sell-side, with sample firms consisting of:

• Traditional asset managers
• Alternative fund managers
• Wealth managers; and
• Independent Authorised Corporate Director (ACD) providers.

Their findings found a number of changes in the asset management and research market since the implementation of MiFID II, which the regulator believes to indicate that the new rule have “steered the market towards the intended outcomes. But it is clear that research valuation and pricing are still evolving.”

The FCA note that accountability and scrutiny over both research and execution costs has improved due to the way most buy-side firms have implemented the new rules, whereby most firms have chosen to absorb research costs themselves, however there has also been an overall reduction in research expenditure. In summary the FCA’s findings were:

 Research budgets are shrinking

 Best execution and order routing are improving

 There is wide variation in how firms evaluate and decide payment for research

 There is limited evidence of a decline in research quality and coverage

 Firms have concerns about consensus forecasts

 There is some uncertainty about non-monetary benefits outside research agreements

 There are wide variations in oversight of delegation arrangements

 Firms do not commonly share research intragroup

 Firms' approaches to corporate access services are evolving

 Sell-side research pricing models remain highly varied

 Independent research providers have concerns over competition

More in depth findings can be read in the full copy of the FCA’s multi-firm review.

Action & Next steps:

While the regulator is aware that the implementation of the MiFID II research unbundling rules is still at a fairly early stage, the FCA has seen broadly positive changes in behaviours by firms in response to the reforms.

However, they note that firms are continuing to develop their arrangements and a market for separately priced research is still emerging. In addition, whilst the regulator is aware that research evaluation models are still evolving and that more robust and refined models are likely to emerge they continue to expect firms to develop approaches that ensure the way they buy their research is consistent with their duty to act in the best interests of their clients or funds.

With these continuing evolvements in mind, the regulator has informed it intends to undertake further work in this area in 12 to 24 months’ time to continue to assess the impact of these reforms.

It is therefore likely that further regulatory reviews will be undertaken towards late 2020 and throughout 2021.

Read our latest articles, news and views affecting compliance and regulation in the UK Financial Services Industry.