New UK rules on how dealing commission payments can be used may present opportunities for independent research providers to undercut investment banks.
But the extent to which Asian regulators follow suit will determine how independent research houses in the region fare, said industry participants.
Last month, the UK’s Financial Conduct Authority (FCA) issued rules on the use of dealing commissions*, which will take effect next month.
They narrow the scope for managers to pass brokers’ research bills to clients, and put the onus on managers to use commissions to pay only for research that is “substantive”. To be substantive, research must contain new insights and meaningful conclusions based on analysis or manipulation of data.
“While the UK regulatory regime is more favourable to independent research as the use of commission-sharing agreements [CSAs] is possible with independent research providers, in many Asian jurisdictions investment firms are allowed to do more with their dealing commission, which may not benefit independent research providers,” said Richard Wallace, chief executive of Hong Kong-based independent research manager IND-X.
Portfolio managers will be forced to be more transparent about how much they pay for research, he added.
CSAs are mechanisms that allow investment firms to pay research providers via funds from their CSA credit pool kept at their execution brokers. The more a manager uses CSA credits to pay for non-research services, the less is left for independent research providers.
Last year in the UK, dealing commissions totalled £3 billion ($5 billion), while in Asia equity commissions (excluding Japan/Australia) were $3.75 billion, according to research firm Greenwich Associates.
It is common in Hong Kong and Singapore for local managers to use credit in their CSA research pool to pay for market data feeds, such as Bloomberg, or exchange data feeds.
The FCA rules say price feeds and historical price data are not substantive research because they aren’t analysed or manipulated.
“In many other Asian jurisdictions, CSAs are still not allowed at all, which further curtails the scope for payments to independents in the region,” Wallace added.
In Asia, managers with UK clients, or those operating in multiple jurisdictions who want to follow a consistent approach to regulation or demonstrate global best practices, are sizing up the implications of the rules.
Independent research providers will likely face constraints because of the rules’ effects on Asian clients’ budgets.
The new UK rules will have an immediate impact on smaller managers less able to pay for research services that are not deemed “substantive”, said Stephane Loiseau, Société Générale’s head of cash equities for Asia Pacific and deputy global head of execution.
“Size will be an investment manager’s competitive advantage, if you have bigger AUM, you have the ability to pay for more services out of the company’s own expenses," he noted. "And small managers will be limited by their inability to pay for services outside of client commission."
Moreover, Loiseau expects brokers’ overall commission levels to fall because some research would not be compliant with the UK rules.
“Managers, especially smaller ones, will become more stringent on how they use their own budget to pay for services," he said. "The reality is that the market will become more bifurcated – the bigger sell-side brokers will still be able to be all-service brokers, and the smaller independent brokers will face constraints from managers’ limited budgets."
Because there is over-supply of research and fund managers’ budgets are constrained, the pricing of research will be driven by the buy-side, he added.
*A feature article on this area will appear in the June issue of AsianInvestor magazine.