Investment Management Update
The Investment AFCA has issued a statement that Investment managers continue to fail to meet its expectations on the use of dealing commission.
The FCA visited a number of firms to assess their dealing commission arrangements, including how they had responded to the examples of good and poor practice from its discussion paper on the use of dealing commission regime, published in 2014. Previously the FCA carried out a thematic review of conflicts of interest in asset management firms published by the FSA in November 2012 and a policy statement on the use of dealing commission rules published in May 2014.
In its latest statement, FCA highlights good and poor practices. Despite identifying some good practices, however, FCA states that a majority of firms it visited are still falling short of its expectations. In subsequent reviews FCA indicates that it will seek confirmation of boards demanding satisfactory management information on the subject.
Poor practices includes how firms:
- assess whether a research good or service received is substantive;
- attribute a price or cost to substantive research if they receive it in return for dealing commission; and
- record their assessments to demonstrate they are complying with COBS 11.6.3R money than necessary.
Specific examples in the press release include:
- firms show little thought or consideration behind how research budgets are set and managed. "Budgets are frequently linked to historical research spending levels - a factor of past trading volumes rather than an assessment of the amount of substantive research required."
- firms had adopted a research poll where analysts and portfolio managers allocated votes that generated research payments based on percentages of the total research pot rather than specified monetary amounts. These firms’ spending levels were closely correlated to trading volumes. Voting based on a percentage meant that analysts and portfolio managers were typically unaware of the value they were attributing to the research they had voted for. They were therefore unable to assess value for money and couldn’t demonstrate they were paying research providers appropriately using their clients’ funds.
- arrangements to demonstrate that only ‘substantive’ research is paid for using dealing commission (as required by COBS 11.6.5E) were generally poor or missing.
- challenge and validation from front line management and control functions over the compliant use of dealing commission was commonly missing.
- the majority of firms continued to treat the receipt of corporate access from brokers as a free provision.
- some firms failed to record details of corporate access meetings and in some cases, had to rely on estimates when responding to FCA questions. The FCA says that this suggest that the potential conflict and inducement risk is not being identified, monitored or managed effectively.
- while many firms use commission sharing agreements (CSAs), the majority of research commission in the FCA’s 2015 sample was still spent on a ‘fully bundled’ basis (i.e. the executing broker was also the direct research commission recipient). In some instances, firms were also unable to demonstrate that research and execution were treated as distinctly separate services. In some cases, the FCA was particularly concerned to find that trading counterparties were selected on the basis that they should be rewarded for research, raising potential issues about the ability to demonstrate best execution.
More generally, the FCA raises concerns that firms with overseas operations and those that delegated investment management services failed to implement controls and oversight structures to ensure the activities they outsourced complied with FCA rules.
FCA has issued a statement that Investment managers are still failing to ensure effective oversight of best execution.
This follows recent supervisory work, and FCA warns it will revisit best execution in the course of 2017 to see what steps investment management firms have taken to assess gaps in their approach to achieving best execution and how they can evidence that funds and client portfolios are not paying too much for execution. If there continue to be failings, FCA will consider further action, including more detailed investigations into specific firms, individuals or practices. The conduct of investment managers is particularly topical in the context of the asset management market study.
In its recent supervisory work, FCA identified that most firms had failed to take on board the findings of its thematic review on best execution and payment for order flow. In particular, FCA notes that most firms have not conducted a robust gap analysis in response to that review and that the pace of change to improve customer outcomes is slow.
The press release gives questions firms should be asking themselves as part of a review of their best execution procedures and highlights some good and poor practices. For example:
- while firms had appropriate management information, some firms could not evidence any improvement to their execution process based on this data and the review of it was largely a ‘tick box’ exercise.
- best execution monitoring in fixed income was less sophisticated than in equity trading. More meaningful steps can be undertaken to ensure best execution even in less transparent markets such as these.
- to ensure MiFID II readiness and future compliance with FCA rules, firms will need to improve current practices when trading in OTC products.
- in some cases compliance staff were not empowered by senior management to provide effective challenge to the front office on execution quality. "Sometimes they lacked access to the data used by the dealing team or they didn’t use data already available such as gifts and entertainment logs. This led to a ‘tick box’ monitoring process where failings were unlikely to be discovered."