The FCA recently published its final rules on payment optionality for investment research (PS24/9). It consulted on these changes in April 2024 (see this Latham blog post), proposing to introduce additional optionality for buy-side firms by permitting them to use bundled payments for research and execution services.

However, the FCA further proposed to make rebundling subject to a series of “guardrails”, which would effectively require the use of commission sharing arrangements (CSAs). This proposal drew significant criticism from industry as imposing too many conditions on bundling payments (thereby almost defeating the purpose of permitting rebundling), and as being out of line with the approach in Europe, where rebundling is being permitted subject to far less extensive and granular conditions. (See also on GRIP FCA consults on payment optionality for Investment Research – a new ‘bundled’ approach)

Changes following consultation

Despite this criticism, the FCA reports that the feedback received to the consultation was “broadly positive”, citing a strong level of support for the introduction of increased optionality for buy-side firms. Therefore, it remains committed to implementing its proposals largely as consulted on.

However, it does acknowledge that “some raised concerns about the precise specification of certain accompanying guardrails”. The regulator explains that respondents raised concerns from different perspectives, such as ease of implementation, international alignment, and ultimate likelihood of take-up. In light of this feedback, the FCA has made some adjustments to the proposed guardrails. Key changes include:

Budgeting

The FCA has clarified that the rules provide flexibility to accommodate a level of aggregation (appropriate to a firm’s investment process, products, services, and clients). Further, firms can make disclosures on budgets being exceeded as part of their next periodic report on costs and charges, rather than having to issue a separate communication to clients within that research budget period.

Research provider disclosures

The rules will no longer require disclosure of the most significant research providers. Instead, buy-side firms will need to disclose the types of providers, such as including a breakdown of independent versus non-independent research providers. The FCA is also permitting greater aggregation (appropriate to a firm’s investment process, products, services, and clients).

Price benchmarking

The FCA will no longer require buy-side firms to carry out benchmarking of prices paid for research, but instead will require them to ensure research charges to clients are reasonable, with benchmarking being just one way of demonstrating this.

Cost allocation and disclosure

The FCA will permit flexibility regarding the level at which costs are allocated (again, appropriate to a firm’s investment process, products, services, and clients), and will provide more flexibility on how to estimate expected annual costs to clients. Firms will be able to choose from the budget-setting and cost allocation procedures and the actual costs for prior annual periods, rather than having to base their estimates on both of these.

Separately identifiable research charges

Rather than requiring written agreements with research providers to stipulate how research costs are to be separately identified, the rules will simply require arrangements to be in place that stipulate the methodology for how such research costs are separately identified.

Practical implications

While the FCA claims that “Following careful consideration of responses to the consultation, significant changes have been made to the conditions attached to using the new payment option”, the changes feel more like tweaks around the edges than a fundamental shift in approach. The amendments are no doubt helpful for any firms considering taking up this option; however, they certainly have not brought the UK position much closer to the amended EU rules, nor the practice in the US.

Notably, the guardrails remain more prescriptive in places and contain additional elements that are not present in other jurisdictions, such as the requirement to have a separately identifiable research charge. These changes are unlikely to make the rebundling option significantly more attractive for global firms with existing practices. The FCA may have misunderstood this point, as its statement that it is not impossible to meet the FCA’s standards whilst complying with the requirements in other jurisdictions does not address the question of whether the additional requirements will nonetheless be a commercial disincentive to doing so.

The FCA remains of the view that more buy-side firms may take up the new option over time after having properly assessed the final rules.

The FCA also reports that: “Of the individual asset managers who responded, a reasonably sized cohort indicated that they would use the new option, whilst a larger cohort either had no view or would not”, and it would be surprising if this response were to change in light of the adjustments the FCA has made to the guardrails. However, the FCA remains of the view that more buy-side firms may take up the new option over time after having properly assessed the final rules and other commercial considerations. It also re-emphasises that the new rules are designed to provide further optionality, and that firms are not obliged to take up this option if they decide it is not suited to their business.

The FCA has maintained its proposals to remove the current exemption for SME research (on companies with a market capitalisation below £200m ($257m), and to add an exemption for short-term trading commentary and advice linked to trade execution. It reports that, of those who expressed a view, a substantial majority of respondents were in favour of these changes.

Interestingly, in its response the FCA admits that “the costs we reported in our CBA are not as robust as we would like”, and, “We do agree that there may be some additional ongoing costs to firms of maintaining the guardrails that we did not account for in the CBA”. However, this does not seem to have affected the FCA’s overall approach.

Next steps

The changes took effect from August 1, 2024, so firms will now be able to take advantage of the new optionality if they wish to. Therefore, it will be up to firms as to if, or when, they choose to rebundle payments for research. It will be interesting to see how widely this option is taken up in practice.

The FCA has not provided any further updates as to when it or HM Treasury might look to take forward any of the other recommendations made by the Investment Research Review. It reports that it received feedback on a number of issues not addressed in the consultation, some of which appear to be relevant to other recommendations of the Review. While it does not address this feedback in PS24/7, hopefully it will take this feedback into account in its future work.

The FCA also notes that it still intends to consult on equivalent rule changes for fund managers, and plans to do so in the autumn.