Today marks the UK deadline for the ban on the payment of corporate access with client commissions and a broader set of new commission requirements. Asset managers have been scrambling to comply with new regulatory language requiring a more thorough valuation of research, in addition to other changes. Investment banks, after their initial shock, have been revamping their corporate access services. Meanwhile the UK regulator threatens more actions later this year.
When the Financial Conduct Authority (FCA) published its new guidance on research commissions it set a deadline giving less than a month for implementation with the haughty statement “We believe firms that are already compliant with our existing rules and have sufficient systems and controls to demonstrate compliance should not need to make material systems changes under the amended provisions.”
The reality is that even the most diligent asset managers were blindsided by the extensive new provisions requiring asset managers to proactively value research services, including bundled research from investment banks.
Under the new guidance, investment managers are encouraged to perform “fact-based analysis” to price research services. This includes comparing unpriced bundled services to priced services such as independent research and/or estimating the cost to internally perform the service.
The FCA also ‘reminded’ asset managers of the duty under general regulatory provisions to keep commission management records, ‘clarified’ the definition of research by requiring that it be substantive, and nixed corporate access as research.
A mad scramble
Asset managers are grappling with questions such as whether every piece of research needs to be ‘substantive’ or whether is sufficient if the overall service is ‘substantive’. One asset manager has reportedly implemented a regime to label whether each piece of research is substantive or not.
Many asset managers are reviewing all their research services to ensure that they meet the new ‘clarified’ definition of research. We are told that some international long-only firms are planning to implement the UK guidelines globally. Large European-based asset managers are also querying whether to adopt the UK guidelines.
No wonder then that the buy-side trade association, the Investment Management Association (IMA), is reportedly miffed, particularly after its close collaboration with the FCA during the rule making process.
The IMA’s annoyance pales in comparison to the shock experienced by the investment banks, which expected the FCA to soften its final rules in response to numerous meetings and comment letters. Instead, the FCA tightened the final provisions further, adding language which pressures banks to begin pricing their research services.
For corporate access, the bank response is damage control. All research providers have been bombarded with client letters requesting that if they are charging for corporate access, stop doing so. The investment banks still intend to offer corporate access, since it is an important part of relationships with issuers. However, the direct costs will need to come down, which will mean downsizing teams dedicated to UK corporate access.
Even so, there is a gaping bid/ask spread between what banks expect to be paid and what asset managers are willing to pay out their own pockets. As we have reported in the past, the going rate in the US for management access is around $4,500 for access during a conference and $7,500 to $10,000 for non-deal roadshows. That varies with the scarcity of the senior management, and, as the Financial Times has breathlessly reported in the past, it can go as high as $20,000 for hard-to-get executives.
UK asset managers have a different perspective now that the money comes out their pockets. The values they are offering are reportedly an order of magnitude less than what the banks expect. One asset manager is said to be sending out checks for £100 after each meeting to prove to regulators it is paying out of its own pocket. The checks barely cover the cab fare.
Some banks have put a moratorium on UK corporate access, shepherding their corporate clients to other domiciles. Others are exploring workarounds. Unlike corporate access, conferences appear to meet the ‘substantive’ guidelines (as we have noted, the average fee for conference participation in the US is $35,000.) Banks are organizing virtual conferences with 5-6 issuers and around 15 investors, with analysts acting as moderators.
As we suggested earlier, technology will also play a role. Video conferencing reduces the costs for all involved, as well as allowing UK managers to piggyback on meetings organized by colleagues in other domiciles. Technology also offers the possibility to dis-intermediate the banks altogether, although we don’t expect to see this happen anytime soon.
The FCA has made it clear that it may take further steps to reduce or eliminate the ability to pay for research with client commissions. It is reportedly waiting until November to release the results of its recently completed thematic review of commission practices, to give time to monitor asset manager compliance with its new guidelines.
Asset managers are also concerned with regulatory fallout from MiFID II, which is currently addressing provisions which will impact research commissions. The FCA is a party to those negotiations.
The new FCA guidelines are much more than a mere clarification, and are causing turmoil for asset managers and investment banks. The FCA expects research commissions to decline on the order of £500 million (US$800 million) which is its estimate of corporate access spending by UK managers. We doubt spending will shrink that much, but the FCA’s focus on the bottom line will keep pressure on asset managers to better manage their research budgets.
Corporate access will continue, albeit in truncated or virtual forms. Similarly, investment banks will continue to offer waterfront research coverage. There may be more pricing transparency on the order of service levels (platinum, gold, etc.) with ample opportunity for negotiation on what is included in each level of service.
Some observers expect independent research firms to benefit from the changes. It is true that independent research is a useful benchmark as asset managers try to value bundled research. And it is also true that the cost of independent research is frequently an order of magnitude less than what investment banks are typically paid.
Independent research firms also know, however, that uncertainty and confusion are not ideal sales environments. And then there is the ongoing fear of further regulatory restrictions which may impact all research firms, independent or not. The frenetic scramble to comply with PS 14/7 may only be a start of a long slog for UK asset managers.