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The FSA set out its findings on soft and bundled brokerage commissions in a policy statement earlier this year. This concluded that fund managers' use of commission should be limited to the purchase of 'execution' and 'research', and the FSA committed to clarifying the scope of these terms.
Hector Sants, Managing Director of the FSA's Wholesale Business Unit, said:
"We set the industry a challenging timetable and the three industry bodies - IMA, LIBA, and NAPF - have engaged well to develop a solution that meets the need. They now need the FSA to deliver on its commitment to clarify execution and research so they can meet the year end deadline."In this document we have set out for brokers, fund managers and customers what services may not be paid for from commission and the key characteristics of execution and research. I am confident that this work will aid the industry in the development of a disclosure-based solution, working with the grain of the market and bringing greater transparency."
Non-Permitted Services
The FSA view is that all services currently regarded as being outside the soft commission regime, as well as some of those within it, should not be paid for from commission. This is because they are not sufficiently connected with particular investment management decisions or transactions. Examples include:
- services related to the valuation or performance measurement of portfolios;
- dedicated telephone lines;
- subscriptions for publications;
- most custody services; and
- travel, accommodation or entertainment costs.
Execution
The FSA has formed the view that 'execution' includes all services provided by a broker which meet the following criteria:
- they are demonstrably linked to the arranging and conclusion of a specific transaction; and
- arise between the point at which the fund manager makes an investment decision and the point at which the transaction is concluded.
These execution services would include booking and processing of orders, related costs arising directly from trading and activities which would constitute active order management, i.e. advice on order handling, programme trades etc.
Research
Following discussion with the industry the FSA concludes that 'research' embodies the concept of rigorous, 'value-added' analysis, with clear intellectual content that assists fund managers to make investment decisions in relation to their clients' portfolios. Research will include original written research, discussions between fund managers and research providers and possibly 'artificial intelligence'. This will not include raw data feeds.
Industry Progress on Disclosure
The industry has taken up the challenge to develop improved disclosure on the costs to clients of 'execution' and 'research'. The Investment Management Association (IMA) has been working closely with the National Association of Pension Funds (NAPF) and the London Investment Banking Association (LIBA). The FSA is encouraged by the progress made to date. Although subject to broader consultation with fund managers and their clients following pilot studies, the IMA/NAPF proposals look to have the potential to deliver the improvements in transparency and accountability that the FSA seeks, and which would drive greater efficiency in fund managers’ decisions on 'execution' and 'research'. FSA is also confident that IMA and LIBA will develop robust mechanisms which differentiate execution within overall commission in a way that will support a disclosure regime of real substance.
Next Steps
The industry has committed to meeting the FSA's timetable to provide proposals on disclosure by the end of 2004. The FSA plans a consultation paper with draft rule changes in Spring 2005 with a view to finalisation by Summer 2005.
Background
- HM Treasury published a report by Paul Myners entitled “Institutional Investment in the United Kingdom: A Review" in March 2001 and endorsed its key findings. It was announced in a Treasury statement in July 2001 that the FSA had agreed to bring forward its own review of soft commission arrangements and bundled broker services, in connection with its work on best execution. In the review Paul Myners said “[…] There is an a priori case that this system creates an artificial bias for fund managers to have services provided by the sell-side, distorting competition, since the costs for these will not be scrutinised by the client and are not a direct charge to the fund manager’s profit.[…]”.
- The FSA published CP 176: Bundled Brokerage and Soft Commissions in April 2003 and its Policy Statement 04/13 Feedback on CP176 in May 2004
- Retail Fund Governance - The FSA's work on strengthening the corporate governance of retail funds is continuing and will examine the practical implications of proposals which arise from the current IMA review alongside our own information gathering. We expect to release our findings and recommendations in Spring 2005.
- The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
- The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.
