UK moves towards optionality for payment for investment research

Earlier this month saw the UK Chancellor, Jeremy Hunt, confirm in his Mansion House speech that the UK Government has accepted all of the recommendations made in the Investment Research Review. Perhaps the headline recommendation from the Review was that asset managers should be allowed to pay for research on a bundled basis, relaxing the much stricter MiFID II regime which (with certain exemptions) requires firms to effectively “unbundle” their pricing of investment research (as part of giving investors greater transparency on the costs of investment research and avoiding conflicts of interests) so that it can only be paid for by asset managers from either (i) the manager’s own resources; or (ii) by using a “Research Payment Account” mechanism (which is generally considered to be unnecessarily complex and as a result is used infrequently). The greater flexibility afforded to asset managers under the recommendations is part of ensuring asset managers remain able to access research from jurisdictions (such as the US) where the bundling of research fees (i.e. payments in “soft dollars”) is common practice, as well as maintaining the UK’s competitiveness as a centre for investment research. The Review recommends that the changes should be implemented by the FCA as soon as practicable, which has led to suggestions that a new regime could apply from as early as H1 2024.

The UK proposals are particularly welcome given the recent expiry of the SEC’s No Action letter on 3 July 2023 which previously provided a safe habour for US broker-dealers to accept “hard dollars” or unbundled payments for investment research from asset managers without triggering the requirement to be regulated as an SEC registered investment adviser. Under this no-action relief, asset managers were able to comply with their MiFID II unbundling obligations in respect of their EU/UK business whilst not jeopardizing commercial relationships with their US broker-dealer counterparties. Whilst the UK’s proposals will be welcomed by US managers, there are still challenges to navigate during the interim period before the UK’s changes are implemented and payment for research will remain an issue for some US managers providing services to EU clients.

The recommendation to allow greater flexibility in how asset managers pay for investment research is one of seven recommendations proposed by the Review – the remaining six recommendations are as follows:

1.  Introduce a Research Platform to help generate research coverage of smaller cap companies in the UK. The Review highlights how the introduction of a central facility for the promotion, sourcing and dissemination of research on issuers (particularly in relation to smaller cap companies) would support broader coverage of investment research, promote greater market interest in smaller cap companies and liquidity in their shares, and ultimately boost the attractiveness of the UK as a listing venue.

2.  Allow greater access to investment research for retail investors. The Review recommends that the FCA should consider whether rules could be amended or guidance offered to allow retail investors to access investment research more easily. Broadening the availability of investment research to retail investors is highlighted as facilitating the Reviews other recommendations more broadly – in particular the establishment and effective operation of the Research Platform, which would aim to include retail investors.

3.  Involve academic institutions in supporting investment research initiatives. As part of the process of establishing the Research Platform, the Review recommends that the operator of the Research Platform should consider exploring mechanisms to strengthen the collaboration between academic institutions and the capital markets ecosystem in relation to (i) the provision or support of research; (ii) providing training for research analysts; and (iii) encouraging academic institutions to assist innovative enterprises that develop out of academic study.

4.  Support issuer-sponsored research by implementing a code of conduct to boost the UK’s attractive as an IPO venue. The Review recommends the creation and adoption of a voluntary code of conduct for issuer-sponsored research, to add structure to the issuer-sponsored research market and enhance the integrity of issuer-sponsored research as a potential source of information.

5.  Clarify aspects of the UK regulatory regime for investment research and consider introducing a bespoke regime for investment research. 

6.  Review the rules relating to investment research in the context of IPOs. The Review highlights how amendments could be made to simplify the UK’s IPO timetable, while continuing to ensure adequate and timely access to investment research, as part of boosting the attractiveness of the UK as an IPO venue.

The Review culminates the Government’s independent review of investment research and its contribution to the competitiveness of the UK’s capital markets as part of a package of reforms (known as the Edinburgh Reforms) announced in December 2022.