FCA unbundling proposal: the unintended consequences

The FCA has lost faith in the ability of the buyside to properly handle their payments for equity research and manage associated conflicts. As a result, the UK's financial regulator has proposed an outright ban on funding equity research from client commission payments.

This prospective enforced unbundling results from the regulator’s recent “thematic review,” which found that the vast majority of surveyed asset managers failed to meet the standards expected.

There is now real concern within the industry about the potential unintended consequences threatening the equity research market if the FCA goes through with the ban.

Despite the inevitable impact of this potential seismic shift on the equity research market, no official study into the impact of the FCA’s proposal has been carried out.

Market commentators have reported that the ban could wipe up to 20% to 30% off buyside profits. In addition, if forced to pay for research out of their own wallets we are likely to see smaller asset managers struggle to afford good quality equity research, resulting in a less competitive, more consolidated industry. We are also likely to see reduced coverage on the more niche sectors and small cap firms.

A further issue raised by the prospect of unbundling payments concerns brokerage commissions, which are exempt from VAT. If separate payments had to be issued for research payments these would be subject to VAT - further increasing costs.

There are also clear challenges in adopting CSAs globally. US and Asian-based firms with UK businesses already have significant issues trying to align their policies towards the treatment of corporate access. There is a risk of regulatory arbitrage, as the US is unlikely to go down the same nuclear route proposed by the FCA.

It is imperative for the regulator to properly assess the impact of its unbundling proposal before compelling the industry to take decisive action. Rather than taking this "nuclear" approach, there is an alternative solution, which will be discussed in my blog next week.