Gay Huey-Evans, Director of the FSA's Markets and Exchanges Division said: "Up to 40% of total commission spend is used to acquire services additional to dealing so it is important that investors are clear on how their money is spent. These proposals are designed to do away with distortions in the market and make fund managers more answerable to their clients. Our analysis suggests changes to the regulatory approach should foster competition and ensure a better overall outcome for investors."
At the moment brokers typically provide a range of additional services to fund managers. The main ones are market information technology and investment research. Services are provided under two types of arrangements - 'bundling' and 'softing'. 'Bundling' refers to the provision by brokers of other in-house services, such as research, together with dealing in securities in a single commission charge. 'Softing' is the practice by which a broker agrees to pay for the supply of services from a third party to a fund manager in return for an agreed volume of business at an agreed commission rate. In both cases, the value of the services provided is dependent on how much business the fund manager places with the broker. The costs for these services are included in the commissions which are passed through by fund managers directly as charges to their clients.
In 2000 over £2.3 billion were paid as commission by UK institutional fund managers to UK brokers. It is estimated that fund managers spent between £660 and £880 million of the commission on services additional to dealing. Of this between £500 million and £720 million was spent on investment research. In 2001 at least £90 million was spent on market pricing and information services. These figures are drawn from research undertaken on the FSA's behalf by the consultants Oxera which is also published today. The FSA has taken account of Oxera's research findings in formulating its proposals. A cost-benefit analysis of those proposals was carried out by Oxera, and this is also published today.
Paul Myners' review of institutional investment published in March 2001 suggested that commission costs incurred by fund managers on their clients' behalf should be reflected in the fund manager's fee to investors. The Government subsequently agreed with the FSA that it would examine these issues in the context of its review of best execution. The FSA's proposals deal with the fund managers' conflicts of interest by requiring them to be directly accountable to their clients for the costs of additional services.
The consultation ends on 29 August 2003. Consultation paper 'CP176: Bundled Brokerage and Soft Commission Arrangements' and Oxera's research and cost benefit analysis can be accessed at www.fsa.gov.uk/pubs/cp/ .
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.[…]" Ruth Kelly, Financial Secretary to the Treasury, announced the two year review of the Myners report on 12 March 2003.
- At the end of 1999 most funds under management were institutional funds (85%) and accounted for 2,500 billion. Pension and insurance funds account for around 40% of the overall market each, and collective investment schemes and investment trusts represent 6% of the overall market.
- Investment research bought with soft commissions only competes with broker research to a limited extent. A significant proportion of fund managers also buys independent research with hard cash. So soft commission arrangements may only have a limited impact on the research market.
- Bundled and softed services are treated in different ways under the current regulatory regime. Bundled services are covered by general rules on conflicts of interest and inducements. Softing, on the other hand, is covered by specific rules that impose, among other things, limitations on the types of services that may be included. This is to prevent fund managers being offered personal benefits by brokers. Research has shown that the impact of soft commissions is not limited to those customers who have given their consent to softing, as the commission rate for softing and bundling is often the same. So those that do not want to have softing will be subsidising those that do- and also participating in the benefits.
- Bundling and softing are typical in institutional fund management. But institutional funds also deal with the money of private investors in the form of pension funds, unit trusts, OEICs and the funds on which life policies are based. These proposals therefore affect both wholesale and retail fund management.
- 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; 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.
