Prior to the approaching summer break, the past few weeks has seen fresh momentum in post Brexit U.K. regulatory reforms (aka the Future Regulatory Framework) with proposed changes to current rules on paying for research, short selling disclosures and the much maligned PRIIPs regime. In this short note we summarise the more significant of those proposed changes.
Back to the Future – Bundle Commissions
Remember in the run up to MiFID II, when the FCA were the leading voice in calling for the end of bundling of trading commissions and research payments? We were left with investment managers either paying for research from their own P&L or utilising the new clunky Research Payment Account (“RPA”) mechanism. The administrative and reporting obligations associated with the RPA route encouraged many firms to take the cost on the chin themselves and move on. Well, political and economic winds have changed. The government sees investment in unlisted companies [i] and a vibrant listing environment as a means to generating growth, and that requires improving current research coverage. There is a general acceptance that the MiFID II unbundling requirements have had some adverse impacts on the provision of investment research such as a reduction in research coverage particularly in small and medium size companies and the number and seniority of analysts – denting liquidity in certain stocks.
The new proposals foresee the payment of research being possible by three different routes, namely;
- out of the manager’s own resources (P&L); or
- making a specific charge directly to clients; or
- combining the cost of research with execution charges, so back to bundled
If implemented, and there is every indication that will happen, the UK will be back in step with other major international financial centres, in particular the US, which will help alleviate the issues regarding the recent expiry of the SEC’s MiFID II no action relief, limiting a UK firm’s ability to purchase research from the US. The relief, initially adopted by the SEC in 2017, has been critical to addressing the conflict-of-law problem between US law and MiFID II. On 11 July 2023, the House of Representatives passed a bill to codify the expired guidance from the SEC for a further 6 months which if enacted would coincide with the FCA’s commitment to start immediate engagement with the market on removing the requirement to unbundle research costs by the first half of next year.
Regimes that are broadly consistent and don’t impose a barrier on the research market should be welcomed. It is likely, in their own time, the EU member states will also move away from the unbundled model with the UK ahead of the pack.
For now, watch and see how quickly the recommendations are adopted by the FCA. Even when bundled charges are permissible again, buy side clients may push back given that many have seen the investment manager incur the expense for the past 5 years. If client acceptance is forthcoming then there will be some work to complete: procedures will need to put in place including making sure that research costs are allocated fairly across clients, commission sharing agreements will need establishing to pay research providers, and initial and on-going disclosures to clients will be required.
Short Selling Reforms
The Short Selling Regulation was adopted over a decade ago in the EU and then into UK law. The UK Treasury is now proposing significant changes to the UK short selling rules, in particular: –
- to deter short squeezes or ‘copycat’ trades, the current public disclosure regime based on individual net short positions will be replaced with aggregated net short position disclosure. This means that short sellers, such as UK based hedge fund managers will no longer be required to publicly disclose their individual short positions in UK issuers; and
- it is proposed that the current disclosure threshold for net short position reporting to the FCA is increased from 0.1% to 0.2%. This will see a reduction on the number of reports that need to be filed with the regulator, so is another welcome step.
These common sense changes are due to come into effect by 2024 and should be welcomed by the hedge fund industry in particular. However, take note that short selling regimes will still apply elsewhere – so those with short positions outside the U.K. will need to continue to monitor the short selling rules around the world.
Farewell to UK PRIIPS
Finally, the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, introduced in January 2018 with the aim of providing greater transparency and standardised disclosures for retail investors, is set to be erased from the UK regulatory regime. The existing PRIIPs regime is overly prescriptive with no improved consumer understanding and in striving for comparability has led to misleading information on risks and costs and the compliance burden has dissuaded some from making products available to UK investors.
The FCA will now create a new UK retail disclosure framework which is tailored and proportionate to the UK market. We will wait and see how the FCA determine the format and presentation of these disclosures. There are currently no plans for the EU to revoke the PRIIPs rules and firms who make funds available (including UCITS funds) to retail investors in the EU, must continue to provide a PRIIPs KID.
In Conclusion – Prudent Divergence
In wrapping up, the UK has now truly re-grasped the legislative pen and is targeting some sensible reforms to the EU regulation that was cut and pasted into UK a few years back. Divergence is beginning, albeit within the context of an UK-EU memorandum of understanding which establishes a joint cooperation forum that should help mitigate the risk that divergence is too egregious which would lead to market frustration. It will be interesting to observe the pace at which these changes will be adopted and if the EU follows its former member.
