FCA’s Proposals to Reform its MiFID Regime for Research and Best Execution

On 28 April 2021, the FCA published a Consultation Paper CP21/9 on Changes to UK MiFID Conduct and Organisational Requirements. In this paper, we examine the main proposals, the rationale behind them and the implications for investment firms.

The main proposals

Research: The FCA proposes to exempt the following research services from the inducement rules in COBS 2.3A by treating them as “minor non-monetary benefits”:

• Research on listed and unlisted SME’s (small and medium-sized enterprises) with a market capitalisation below £200 million¹.
• Research focusing on fixed income, currency and commodity (“FICC”) investment strategies.
• Research from independent research providers who are unconnected, either directly or with other group entities, to execution or brokerage services.
• Written research that is openly available² to other firms or to the general public.

Best execution: The FCA proposes to drop the following disclosure requirements:

• The obligation on execution venues (including brokers) to provide quarterly metrics on execution quality (“RTS 27 reports”).
• The obligation on investment firms carrying out portfolio management or the reception and transmission of orders to provide annual reports on execution outcomes, including the top five execution venues used in each asset class (“RTS 28 reports”).

Background

The unbundling of commissions to pay for research and best execution were amongst the more radical measures introduced by MiFID II, which came into force across the EU at the beginning of 2018. As part of the process of leaving the EU, the UK has on-shored all relevant legislation onto its own statute book, including what is now known as “UK MiFID”. On-shoring effectively leaves the UK with the option of reforming these rules to further its own objectives.

The EU has made its own changes to these rules in the form of a “quick-fix”, itself a response to its Capital Markets Recovery Package to support post-Covid economic recovery. These focused on two measures: the re-bundling of commissions in relation to companies with a market capitalisation of less than €1 billion; and the suspension of RTS 27 reports for two years from the end of February 2021.

The FCA’s current proposals should be seen in the context of both these developments.

Rationale for reform

Ironically, the FCA was one of the main proponents of the complete unbundling of commission payments in the run-up to MiFID II. Payment for research services since 2018 has generally been well received by buy-side firms in mainstream equity sectors, with effective costs falling (by some 20-30%) and much duplication of effort eliminated. 

The case for unbundling FICC services was always less clear-cut, with many sectors embedding costs in dealing spreads rather than commissions, and the benefits of sell-side analysis less obvious. Pricing of research in these sectors has seen a race to the bottom so arguably the proposals go not much further than reflecting current reality.

The FCA’s arguments for re-thinking the rules on SME research are interesting, particularly in the context of proposing a lower threshold (£200 million versus €1 billion). The FCA sees little evidence of a decline in research coverage for companies below the €1 billion threshold since 2018. However, it has noted an absence of coverage particularly at the lower end of this spectrum.

MiFID II’s disclosure regime around best execution were seen as supporting competition amongst execution venues as well as giving end-users of financial products with the information needed to challenge execution outcomes. The task of providing RTS 27 and 28 reports is onerous without any obvious benefit.

Is this the start of regulatory divergence from the EU?

There is not, we would argue, a simple answer at this stage. The FCA’s proposals are a clear response to the EU’s quick-fix package and may be seen as the UK regulator ensuring that no significant competitive advantage is ceded to EU firms. At the same time, they demonstrate a willingness to consider a rationalisation of the rules based on the principles of high standards, proportionality and supporting economic growth through open competition. The elimination of RTS 28 reports should be seen as a clear example of the FCA prepared to go its own way.

Implications for firms and next steps

The FCA’s Consultation is open until 23 June 2021 and will be followed by a Policy Statement in the third quarter second half of 2021 confirming the final rules. Given the relatively uncontroversial nature of the proposals, it seems likely that these will be implemented more or less in their entirety. The EU’s Quick-Fix comes into force on 28 February 2022, so it seems reasonable to assume the FCA will want to mimic that.

Buy-side firms with SME, fixed income, commodity or macro strategies will want to start engaging with their counterparties on how they wish to change their current arrangements. It seems unlikely that they will want to continue paying directly for macro or economic research (rates for these services have been low in any case), but sell-side firms may seek to recoup these costs through dealing commissions or spreads once more.

Multi-national managers operating in the FICC space may also be able to unwind arcane arrangements for circumnavigating the rules for research across multiple jurisdictions.

Independent research providers will be encouraged by their increased freedom to distribute their services in the larger company research sector.

Few tears are likely to be shed for the end of the best execution disclosures, but the exact timetable for halting these is unclear. MiFID portfolio managers may hope that they will be relieved of the obligation to report RTS 28 for calendar year 2021 but would be advised to continue to record the relevant data for now.

How we help

ACA can provide you with an FCA review, compliance health check or mock exam to help identify regulatory gaps, failings or weaknesses and reduce organisational risk.

We look at your compliance programme against what is expected of firms of your size, nature, and complexity. On completion of our review, we issue recommendations and an executive summary for senior management, evidencing your compliance with this ongoing regulatory change.

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Footnotes

1. For listed companies, the market capitalisation threshold is calculated by reference to year-end quotes for the preceding 36 months before the provision of research. For unlisted companies, firms may reasonably rely on third party estimates of market capitalisation.
2. “openly available” means no barriers or conditions to receiving it, for example through log-ins or submission of user information before access is granted.