The future of unbundling remains undecided
Last month’s UK Financial Conduct Authority review into dealing commissions represents the latest attempt to bring greater transparency into how an investor’s capital is spent. Despite covering some old ground, the review comes at a welcome time for many in the industry. For too long now, it has been unclear exactly how research costs are valued and distributed. As the regulator correctly states, while some asset managers are getting their houses in order, others still have work to do.
However, when reading this review, one can’t help but think there is another motive for the FCA. It appears as if the regulator may be attempting to bring both ESMA and the European Union (EU) around to its way of thinking. Reading between the lines, the FCA seems to be proposing a race to the top, advocating the highest levels of transparency with the view of attracting assets to the UK. Many active managers dislike these policy changes, and fear they will make UK-based managers less competitive. But the FCA hopes that asset owners and plan sponsors will favour the greater protection of their capital, and therefore favour managers subject to the higher standards. Crucially, the FCA wants this argument to play out at a pan-European level, to minimise the competitive risk to UK asset managers.
Looking to attract more assets and talent to the UK is all fine, but it doesn’t get to the heart of the big question – where do unbundling fees actually go? The industry is still waiting with bated breath for the work from ESMA, and concrete facts on how far it is prepared to go with the issue. Questions still remain about the likelihood of a European-wide mandate for unbundling or whether the UK will implement its own rules. Regardless of the final outcome, no asset manager can afford to wait for answers: the issue needs to be addressed today.
Previously, asset managers typically paid their research brokers via a percentage of the execution commission. This approach made it harder for them to control the amount paid for research. Commission sharing agreements (CSAs) can help, by forcing a process of invoicing for research services. Put simply, CSAs enable investment firms to trade with whomever offers the best execution services, while paying other intermediaries through a separate research fee. The benefits are clear; an asset manager can gain far greater control and transparency over research payments.
Instead of waiting for ESMA to respond, many investment firms are turning to CSAs as they re-evaluate their approach to unbundling. Investment managers are starting to consolidate their broker list into a set of specialised CSA brokers. The problem is that the process of managing multiple different brokers can be complex and therefore it is no surprise to see forward-thinking investment managers turning to CSA aggregation, which gives consolidated accounting of CSAs. This is the next logical move for asset managers, as they look for new ways to run operations more efficiently and transparently as their CSA business scales up.
With the ink barely dry on the FCA’s paper and the clock ticking down to the finalisation of ESMA’s proposals, asset managers who are yet to adjust to this new world of unbundling run the risk of getting their fingers burnt. Compliance with regulation is mandatory and firms need to be prepared, but the approach to compliance is not specified by the FCA. From operational and administrative streamlining to the ability to better manage cash, if asset managers adopt CSA aggregation they will find themselves ahead of the pack in the unfolding game of unbundling.