Bundled Commissions, FCA Sustainabilty Disclosures and more

Dear clients and friends

A mix of news for you in this alert, from bundled commissions to the FCA’s SDR and labelling regime to the proposed updates to the FCA Financial Crime Guide and finally a few statistics from the results of the FCA’s financial resilience survey.

Back to the Future – Part II – Bundled Commissions

In April the FCA, entirely expectedly (and as our alert in July of last year referenced), released Consultation Paper CP 24/7 ‘Payment Optionality for Investment Research’.

Despite being vociferous supporters of the unbundling of research payments during the MiFID II legislative process, the FCA is now proposing that firms may, once again, pay for research by way of bundled commissions. The FCA has recognised that research payment accounts are operationally complex and seemingly only benefit larger managers, and that forcing managers to pay for research by methods other than bundled commissions make it tricky to purchase research from other jurisdictions (the US being the oft quoted example); perhaps contrary to the FCA’s objective to promote effective competition, a theme which runs throughout the Paper.

With that said, the Consultation Paper is also consulting on “appropriate guardrails”, the purpose of which is to protect investors and comprise the following requirements (among others):

1. Establishing formal policies and procedures on the use of the new option (including allocation of cots across clients and operation procedures for the administration of accounts used to purchase research);
2. Setting budgets (at an aggregated level) for third-party research to be purchased; such budgets must not be linked to expected volumes or transactions executed on behalf of clients (and research services are not to be treated as an execution factor in relation to best execution). This will need to be reviewed annually;
3. Ongoing assessment as to the value, price, use and contribution to investment decision making of research purchased, alongside an annual benchmarking exercise;
4. Fair allocation of the costs of research across relevant clients (though the specific cost of individual investment research items need not be discreetly attributable to individual clients);
5. Client disclosure as to the approach to bundled payments, most significant research providers, costs incurred and any changes to the budget.

However, has the damage already been done? The FCA had mentioned in its Paper that they have had extensive engagement with sell side and buy side firms, as well as research providers and representatives of end investors, but will investors be willing to go back to a world where they pay for research, or where they lose the transparency associated with the unbundled approach? In a fund-raising environment as tricky as the present one is, will managers even want to start such discussions? Our clients are telling us they will not return to bundled payments for research.

As such, it’s perhaps a good thing that the FCA is not proposing to do away with the other research payment methods – so managers paying out of their own resources or making specific charges directly to clients in respect of the costs of research (i.e. research payment accounts) remain viable options.

The Consultation close on 5^th June 2024 with the timeline for follow up actions dictated by the amount strength and breadth of feedback the FCA receives on the Paper.

What next? No action required at the moment but please let us know if you have any questions.

FCA Sustainability Disclosure Requirements and investment labels regime

The anti-greenwashing rule – which applies to all UK authorised firms from 31^st May 2024 – requires that sustainability-related claims about a firm’s products and services must be fair, clear, and not misleading.

Pursuant to the Guidance (FG24/3), the FCA’s expectations are that sustainability references should be:

1. Correct and capable of being substantiated;
2. Clear and presented in a way that can be understood;
3. Complete – i.e. important information should not be omitted or hidden, and should consider the full life cycle of the product; and
4. Fair and meaningful in their comparisons to other products.

The FCA have also published a consultation paper ‘Extending the SDR regime to Portfolio Management’. In this Consultation the FCA proposed extending the regime to those firms who perform portfolio management services. ‘Portfolio management services’ for this purpose includes managing investments (i.e. with discretion) or advising on investments or managing investments on a recurring or ongoing basis. However, given that the proposed scope “…does not include services where the clients are based overseas (i.e., those that either normally reside outside of the UK or have their registered office (or head office) outside of the UK). It also does not include portfolio management provided to a client that is a fund, or an Alternative Investment Fund Manager or management company for or on behalf of a fund (i.e., where the portfolio manager acts as a delegate)…” we have not explored this development in detail in this edition, but suffice it to say that the requirements largely mirror those introduced for asset managers in November 2023.

What next? Make sure marketing material has been reviewed for compliance with the new rule. This includes websites, pitch books, investor newsletters, DDQs etc

In other news –

Financial Crime Guide:

The FCA are proposing to update their Financial Crime Guide update with a focus ensuring robust and appropriate on governance arrangements within regulated firms to mitigate financial crime risk. This includes encompassing senior management accountability and oversight of outsourced functions. The updated guidance will also include the significance of transaction monitoring as a fundamental and necessary control.

What next? More to come on this from us and its impact once the FCA publish their amended text.

Financial Resilience Survey

Finally, the FCA’s financial resilience survey, pulled together nearly 14,000 responses (as of November 2023). including 1660 responses from the buy side, including alternatives and asset management firms.

Among other statistics, buy side firms reported the highest:

1. Expected cash inflows (median) at c. £700k, and the highest estimated cash needs at c. £526k based on forward looking estimated for a three-month period. This led to the highest expected cash inflows less estimated cash needs (at approximately £185k)¹;
2. Net profit (median firm) at c. £95k²;
3. Median revenue at just under £3m.

Buy side firms also had the second highest total liquidity resources (median) at c. £1m³.

Buy side firms had the second lowest percentage of firms that have negotiated extensions with creditors or delayed payments and reported the lowest take up of government backed loan schemes.

Overall, 74% of buy side firms taking part were profitable, based upon their P&L for the three months ending 29^thSeptember, against a backdrop of 80% of all respondents across sectors being profitable. However, around 16% of asset management respondents expected reduced profits, with the majority of firms (approximately 57%) expecting decreases of between 1-25%.

Finally, buy side firms were, generally, neutral as to the impact of the macroeconomic environment at the time of the survey (c. 78% of respondents), with 20% feeling negative – though negative, neutral, and positive are inherently subjective – broadly agreeing to the overall all respondent consensus (72% and approximately 24% respectively).

What next? Thankfully, no actions required, but we thought it might be interesting food for thought, and perhaps something that the FCA will take as evidence that the AIFMD, MiFID and (maligned) Investment Firm Prudential Regimes are working effectively.