The tone of the call for evidence suggests that controversial research separation rules may be ripe for reform.
On 3 April 2023, HM Treasury published a Call for Evidence as the first step in the independent review of investment research and its contribution to the competitiveness of UK capital markets.
The review has the stated key objectives of:
- Assessing the relationship between research levels and the attractiveness of the UK as a listing destination
- Assessing opportunities to improve the UK market for investment research and providing recommendations to this end
The review was announced as part of the reforms in Edinburgh in December 2022. The chancellor noted at the time that “the review is part of the government’s wider commitment to improving the UK’s ability to attract companies to list and grow”.
The Call for Evidence seeks views on 12 questions, which are usually quite broadly worded and act as an information-gathering exercise — similar to what we’ve seen recently with the SMCR Call for Evidence and Short Selling Call for Evidence.
In an effort to better understand the investment research landscape, the Call for Evidence questions cover (among other things):
- How UK investment research regulations compare or are perceived to compare internationally
- How important investment research is to the attractiveness of UK public markets to listed companies and their investors
- What steps (legislative and non-legislative) can be taken to improve the provision and quality of UK listed and quoted company research
- What impact does the current UK legislative and regulatory environment have on the provision and quality of research, including (but not limited to) the MiFID II unbundling rules
This last question (and the other closely related questions) suggests that there may be an appetite for revising the rules of unbundling. The current unbundling rules require firms providing both execution and exploration services to price and provide those services separately and also to ensure that delivery and charges for other benefits or services are not affected or conditioned by the levels of payment for performance services.
How investment research should be paid for has long been a complex and controversial issue. During implementation, the FCA concluded that separating research from transaction fees would be the most effective way of addressing potential conflicts of interest where investment managers use transaction costs to fund external research. However, the unbundling rules have been criticized from the start as having an impact on the competitiveness of the European research market. Stakeholders have raised concerns about the quality and quantity of investment research done in Europe compared to other jurisdictions, such as the United States, where unbundling is not required, along with previous changes to the UK and EU rule.
Interestingly, in a speech on 29 March 2023 at the Global Investment Management Summit on Capital Markets Ecosystem Reform, FCA Chief Executive Nikhil Rathi noted that “regulation is only part of the answer” and that “ real change requires both financial and ongoing sustained commitment from all parts of the ecosystem, an infrastructure that oversees exchanges, trading, clearing, settlement, corporate boards, buyside and research (italics added)”.
Taking all these developments into account, and in an environment where the government appears focused on making UK markets as attractive as possible, it would not be surprising if there were moves to review the demerger rules.
Meanwhile, in the US, the SEC’s no-action relief is set to expire on July 3, 2023. Currently, US broker-dealers can rely on this relief to ensure they don’t face additional regulation for accepting separate research payments from managers of UK assets (Please see Latham’s client alert for more information on this topic). However, even if the demerger rules change in the UK after the investment case review is completed, they will not come into force in time to prevent the loss of relief without action. What happens after 3 July 2023 remains to be seen and it will be interesting to see to what extent the US and the UK will interact to provide a workable solution for businesses on both sides of the Atlantic.
The review is due to continue until June 2023. A set of recommendations will then be presented to the city minister. The call for evidence is open until 24 April 2023.