What did the IRR look at?
In line with the government's commitment to enhance the UK's ability to attract companies to list and to grow, in March 2023 HM Treasury commissioned an independent review of investment research and its contribution to the competitiveness of the UK's capital markets.
The IRR has now considered responses to its April 2023 Call for Evidence to analyse how investment research interplays with the UK's attractiveness as a listing venue, and to consider the impact of the EU-derived MiFID II research unbundling rules on the amount and quality of research.
The review outcomes: seven key recommendations
We have summarised the IRR's seven recommendations in the table below.
|Recommendation||Summary of the recommendation||Estimated timing|
|1. Introduce a Research Platform to help generate research.||
The IRR proposes a centrally operated research platform to encourage and facilitate the promotion, sourcing and dissemination of research on certain types of companies.
The IRR envisages a roster of research providers (all authorised persons) selected by the operator, from which issuers can select from a shortlist.
Information on the platform would be freely accessible (to both institutional and retail clients). The focus of the platform would be smaller cap companies but it could potentially be expanded to cover larger publicly traded companies and private companies considering listing or which participate in the UK's proposed new intermittent trading venues.
|Medium term – this would be subject to the need to agree an appropriate funding model and potentially launch a tender process for selection of the platform's operator.|
|2. Allow additional optionality for paying for investment research.||
The UK rules on research payments were relaxed in 2022 so that bundled payments are possible for investment research relating to firms with a market cap of below £200 million.
The IRR recommends introducing further amendments to the EU-derived MiFID II unbundling rules to give flexibility, so that buy-side firms have the option of being able to pay for research either:
(i) out of their own resources;
(ii) by making a specific charge directly to their clients in respect of the costs of research; or
(iii) by combining the cost of research with execution charges.
Once introduced, this change will align with the EU's proposals (under the Listing Act package) to introduce re-bundling of research payments. It will also remove the challenges that have arisen for buy-side firms wishing to purchase US research, following the expiry (on 3 July 2023) of the SEC's no-action relief that permitted US broker-dealers to accept separate research payments without having to register as investment advisers.
The IRR also invites the FCA to consider how it could amend other rules or guidance that could act as an obstacle to achieving the necessary changes, such as adjusting the rules around acceptable minor non-monetary benefits, and new guidance on how firms using bundled pricing can comply with the best execution rules.
The IRR recommends that this change is made as soon as practicable.
The Financial Conduct Authority (FCA) has committed to immediate engagement with market participants to inform consultation proposals, with a view to making new rules in H1 2024. The in-force date of these changes would be informed by market and firms' operational capacity to absorb changes.
The FCA has also indicated that it is "open to consider swift actions, if needed, to support firms impacted by changes to regulation in other jurisdictions, based on discussion with individual firms or parts of the market." This suggests that the FCA may take steps in the short-term to alleviate the impact of the expiry of the SEC no-action relief, although it is not yet clear what form this will take, for example a 'no-action' type forbearance statement.
|3. allow greater access to investment research for retail investors.||
The IRR recommends that the FCA should explore where its rules could be amended or guidance offered to facilitate retail investors' access to research.
|The IRR recommends that the FCA undertake this rule review as soon as practicable. FCA may include this element in its consultation process on other related rule changes (see recommendation 2).|
|4. Involve academic institutions in supporting investment research initiatives.||
The IRR seeks to address the perceived shortfall in experienced analysts and/or expertise in innovative or niche markets, by recommending that the operator of the proposed Research Platform should consider how to strengthen the collaboration between academic institutions and the capital markets ecosystem.
Possible areas of collaboration include in relation to:
(i) the provision or support of research;
(ii) providing training for analysts (potentially funded by bursaries); and
(iii) encouraging academic institutions to assist innovative enterprises that seek to develop out of academic study.
|In parallel with the development of the Research Platform.|
|5. Support issuer-sponsored research by implementing a code of conduct.||
The IRR highlights that issuer-sponsored research has an important role to play despite perceptions that it lacks the objectivity and detail of independent research and that it suffers from conflicts of interest. More should be done to support high-quality issuer-sponsored research, particularly given there are wider concerns about insufficient capacity for research.
The IRR recommends development of a voluntary code of conduct – which could be industry led (and potentially recognised by the FCA) - on issuer-sponsored research, which is something providers of such research have also indicated they would welcome.
Such a voluntary code has already been developed in France, and the EU's Listing Act package includes a proposed framework for issuer-sponsored research under which sell-side firms would follow a code of conduct and ensure that issuer-sponsored research is clearly labelled so as to prevent conflicts of interest.
|The IRR recommends that development of a code should be explored in the short-term, potentially led by one of the sector's trade bodies.|
|6. Clarify aspects of the UK regulatory regime for investment research and consider introducing a bespoke regime.||
The IRR recommends that the FCA consider whether a bespoke regime for investment research is warranted. In the absence of a bespoke regime the existing regime should be simplified and/or clarified.
Particular areas the FCA should consider clarifying include:
(i) when research providers need to be FCA-authorised;
(ii) the extent to which investment research can be provided by non-authorised persons; and
(iii) when is investment research capable of amounting to a financial promotion caught by the financial promotion restriction.
In addition, the FCA should explore where its rules should be simplified and made to apply more consistently in like situations.
The IRR recommends that the FCA undertake this analysis as soon as practicable. FCA may include this element in its consultation process on other related rule changes (see recommendation 2).
HM Treasury may need to lay secondary legislation if changes are needed to the UK regulatory perimeter.
|7. Review the rules relating to investment research in the context of IPOs.||
The UK IPO timetable was extended in 2018, due to FCA rule changes that were designed, among other things, to encourage "unconnected" analysts (not connected with the financial institutions mandated on the IPO) to produce research in connection with IPOs.
Some respondents to the IRR's Call for Evidence argued that this 'lag' in the IPO timetable puts the UK at a competitive disadvantage, while not having brought about a noticeable increase in the publication of unconnected research.
In addition, the competitiveness of the UK may also be impacted by its stricter rules than the US or EU relating to engagement between connected investment analysts and potential IPO candidates in advance of banks being mandated on IPO transactions, in particular in the context of pitches.
The IRR recommends that the FCA undertake a review of the rules on IPO timetabling, connected analyst research and the limitation on connected analysts being allowed to meet with potential IPO candidates prior to a mandate.
|The IRR recommends this review be conducted on the same timescales as the FCA's ongoing work on delivering the outcomes of the Listing and Secondary Capital-Raising Reviews.|
Impact of the new research payment flexibility on buy-side firms
The IRR notes that, while the decline in investment research provision started before the advent of MiFID II, and is attributable to a number of factors, since the MiFID II unbundling rules entered into force, buy-side firms have tended to fund investment research out of their own P&L rather than use a Research Payment Account. One consequence of this shift has been an overall reduction in research budgets.
The recommendations put forward by the IRR will in a sense 'future-proof' these stretched budgets, which will likely come under greater pressure due to increases in the need for ESG-related research as well as a likely increase in demand for investment research following government proposals to boost investment by pension funds in smaller cap companies.
The IRR sets out a number of obligations with which buy-side users of investment research will need to comply. These include ensuring fair allocation of research costs between their clients, putting in place a formal policy with regard to how they approach and pay for investment research, conducting periodic benchmarking in relation to the research the firm uses, and making appropriate client disclosures.
Impact of research payment flexibility on sell-side firms
Many sell-side firms operate their research business on a global basis and will welcome the IRR's recognition of the importance of international alignment.
As noted above, the IRR recommends that the FCA consider changes to various other aspects of its rules, many of which relate to the production and dissemination of research so will hit sell-side more than buy-side, e.g., the IPO rules, potential changes to reduce the regulatory burden of allowing retail clients to receive research, and potential changes to the MAR provisions on investment recommendations. These could be helpful in the long run, but means more consultations to monitor and engage with and potentially more rule-changes to implement, at a time of significant regulatory change across the board.
Sell-side firms might also start thinking about what, if any, role they would like to play in relation to the proposed Research Platform, for example whether they might want to provide research to the platform and what use they could make of the research that will be made available through it.
It is too early to say whether the proposed changes will have the intended positive impact on research spend, which is ultimately what will allow sell-side firms to invest in and grow their research business in the UK.
The IRR has clearly listened to the concerns of the industry and put forward pragmatic proposals. It will be a particular relief to the industry that the proposals seek to prioritise international alignment. Several of the proposals are very similar to proposals being put forward in the EU, in particular the proposal for the European Single Access Point and the Listing Act package.
One abiding concern is that delivery of the proposals will add further strain to the FCA's workload, which may make the proposed timescales ambitious, given that the FCA is engaged in other significant reviews and deliverables under the December 2022 Edinburgh Reforms and the Mansion House Reforms announced on 10 July 2023.
Firms should be alert to further announcements from the FCA as to how it proposes to take this work forward. We can expect more detailed cost benefit analysis for rule change proposals following the new requirements on the regulators that have been brought in by the Financial Services and Markets Act 2023.