Asset managers have attacked proposed European regulations aimed at banning the practice of paying for research with dealing commissions.
The proposal from the European Securities and Markets Association (ESMA) – part of the EU – aims to stop them using commissions from buying stocks and bonds to pay for research from external firms.
But asset management firms have united in condemnation of the proposals, which they say may lead to poorer returns for investors and significant damage to small and medium-sized enterprises (SMEs).
Currently, asset managers gain access to research from brokers and investment banks through paying slightly higher dealing commission when executing trades, receiving the research as a cross-subsidy.
The FCA had previously consulted on the subject and UK managers are scrutinised to make sure they do not over-trade, or ‘churn’, with a view to gaining access to more research.
But ESMA viewed the whole concept of commission subsidising research as an “inducement” and stated in its latest guidance on the Markets in Financial Instruments Directive (MiFID II) that it should be banned.
In response, France-based Axa Investment Managers said the proposals were “not in the best interests of investors”. It stated that any such regulation would result in less research being published and was likely to lead to poorer investment outcomes for clients.
It also said asset managers would have to bear the increased costs for doing their own research, potentially driving some of them out of business and stifling competition.
Another fear is that asset managers will start to avoid SMEs – many of which rely on the capital markets for money – if access to research becomes too hard and too costly.
Axa IM said such damage to the SME sector “would be wholly inconsistent with the EU’s dependence on SMEs as a major element of its publicly stated growth strategy”.
A deterioration of the sector would also hit investors in smaller companies, as fewer market participants would lead to lower liquidity and soaring bid-offer spreads, raising costs.
Vanguard Asset Management said its European business was unlikely to suffer significantly because it runs only passive funds and does not need to pay for research. But it said the proposal could “cause major disruption to well-established and well-functioning relationships to the ultimate detriment of investors”. It also warned that such a move would give US firms with European divisions – which could access research using dealing commission in the US – an advantage over European firms.
BlackRock said it was “not aware of evidence having been uncovered that research ‘induces’ portfolio managers to trade or to ‘churn’ or to agree higher execution rates”.
Why is ESMA so concerned?
While asset managers have questioned the scope and timing of ESMA’s proposals, there is a consensus that access to research is something that needs to be looked at and potentially regulated.
Baillie Gifford said it was clear that the “use of dealing commission to pay for research can give rise to conflicts of interest between the investment manager and its clients”.
The Scottish asset manager said it was “concerned” by ESMA’s proposals but said it would support a “fuller debate of the issues and potential solutions” and a “clearer assessment of the impacts of any changes”.
As things stand, it is incredibly difficult to put a value on the research provided to a firm. Investment banks and brokers do not provide asset managers with a fixed figure for each piece of research, which has led to what one respondent described as the “woolly” practice of using percentage-based commission.
Any fuller debate on the issue would also need to establish whether the cost of research should be borne by the asset manager or the investors.
Vanguard Asset Management argued that “its receipt and use is arguably solely for the benefit of underlying investors”.
But in the current climate of downward pressure on costs, it is debatable whether investors would stomach paying higher costs to subsidise manager research.
