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May 12, 2014

FCA spending rule may cut equity research revenue by half

Restrictions on charging clients for research costs may catch on in Europe and abroad, FT reports

Equity research revenue could decline by as much as half at UK investment banks and brokers because of regulations restricting how investment managers can spend clients’ money, according to media reports.

The announcement last week by UK financial regulator the Financial Conduct Authority (FCA) that, from June 2, asset managers can charge clients only for ‘substantive research’ that is both original and adds value to trading decisions could further hit an activity that has already declined sharply since the financial crash of 2008 and may affect investment managers beyond the UK’s border’s, the Financial Times says.

‘It would be sensible for banks to expect their revenues from research to halve, at least,’ Richard Phillipson, principal at fund consultancy Investit, tells the FT. He says ‘fund managers will become more discriminating about what they pay for’ in terms of research, and defined budgets for research spending will have to be created for the first time.

The newspaper cites a series of sources stating that similar regulation may be adopted in Europe and further abroad, restricting an industry that has seen equity research spending plunge globally from $8.2 bn in 2007 to $4.8 bn last year. The number of equity analysts has fallen by about half at the same time.

Neil Shah, director of research at Edison Investment Research, predicts the regulation will also be adopted by the European Union and says international asset managers would likely change their research spending patterns globally rather than attempt to operate under one set of rules for the UK and another set for other countries and regions. ‘This is a client-protection measure,’ the FT cites Shah as saying. ‘It is entirely possible that some of the other regulators may want to have [similar measures].’

On May 8 the FCA clarified its rules on the issues, saying ‘investment managers should use client dealing commission only to pay for substantive research or costs related to executing trades.’ The regulator added that the ruling is meant to ensure that asset managers ‘spend their clients’ money as though it were their own, seeking to manage costs with as much tenacity as they pursue returns’ and that ‘clients are given easily understood information on the risks and costs of the service, and investment decisions reflect their stated objectives.’