Results of the Investment Research Review: what next for producers and consumers of investment research?

On 9 March 2023, HM Treasury launched a call for evidence and an independent review of investment research and its contribution to the competitiveness of the UK’s capital markets (the “Investment Research Review”). The Investment Research Review forms part of the UK Government’s wider Edinburgh Reforms package and took place amid concerns that the UK has lower levels of investment research in comparison to other jurisdictions and especially in relation to key growth sectors such as tech and life sciences. On 10 July 2023, the outcome of the Review was published in the form of a report (the “Report”) containing a number of recommendations to the Government, the Financial Conduct Authority (“FCA”) and industry.

High level summary of recommendations in the Report

1. Introduce a Research Platform to help generate research

The first recommendation is for the creation of a “Research Platform” to serve as a central facility for the promotion, sourcing and dissemination of investment research on publicly-traded companies, with a focus on small-cap companies. The Research Platform would be operated by one or more private sector third parties, who would be chosen following a Government-led tender process (similar to the proposals for the UK consolidated tape). Research would be freely available and various funding models are discussed in the Report, including funding by issuers, sponsoring exchanges, Government support, market participants and/or funding through an industry levy. The timeline for implementation will depend on whether the approach requires legislation (which would be the case in connection with any Government tender process and/or financial support), which would lead to implementation in the medium term at the earliest.  

2. Allow additional optionality for paying for investment research

The second recommendation is that the FCA rules should enable buy-side firms to decide how to pay for research, whether:

• out of their own pockets;
• by making a specific charge directly to their clients in respect of the costs of research; or
• by combining the cost of research with execution charges (i.e. “re-bundling” the costs and returning to the pre-MiFID II position in full).

If implemented, the FCA should require firms to take certain steps to protect the interests of clients, including by giving appropriate disclosures as to how research costs are funded and ensuring that costs are fairly allocated among clients. Sell-side firms would not be required to facilitate payments on a bundled basis or be able to require buy-side firms to pay bundled charges. In practice, assuming the buy-side adopt different approaches to funding research, this approach would mean that investment research providers will be required to accommodate a range of different charging models for their investment research, depending on client demand. It should also solve the issue caused by the fact that US investment research providers typically cannot accept “hard dollar” payments for their research.

The Report recommends that this change is made as soon as practicable. Given the rules currently sit in the FCA Handbook, the FCA should be able to make changes in relatively short order.

3. Allow greater access to investment research for retail investors

The third recommendation is that investment research should be made more readily accessible to retail investors, by recommending the FCA to review and improve its rules and guidance where necessary. However (and this issue is linked to recommendation 6 below), distributing investment research to retail investors may substantially increase the compliance burden for firms producing investment research and could potentially increase a firm’s exposure to third party claims. The Report recommends that ideally the FCA would undertake this review as soon as practicable (taking into account its current workloads and priorities). However, we anticipate that a relatively radical change in approach would be required to persuade firms to allow their research to be made available to retail investors, in particular where they do not face retail investors directly and so may not benefit directly from wider distribution.

4. Involvement of academic institutions and bursaries in the provision of investment research

The fourth recommendation is to take steps to increase the involvement of academics and their institutions in the capital markets ecosystem, including to participate in the provision of research through the Research Platform. The implementation of this reform is linked to the creation of the Research Platform (discussed above).

5. Support issuer-sponsored research by implementing a code of conduct

The fifth recommendation is that the industry should collaborate to support the creation and adoption of a voluntary code of conduct that would apply to all issuer-sponsored research, to add structure to the issuer-sponsored research market and to enhance the integrity of issuer-sponsored research. The Report suggests that one or more of the relevant trade bodies could lead the process for creating the code of conduct and that this could be done in the short-term.

6. Clarify aspects of the UK regulatory regime for investment research and consider introducing a bespoke regime

The sixth recommendation is that the regulatory regime for investment research should be simplified and clarified, especially in relation to when a research provider needs to be authorised, when an unauthorised person can produce and disseminate investment research, and when investment research amounts to a financial promotion. While the UK regulatory perimeter is relatively complex, as it stands firms that are authorised to provide advice and to carry out other regulated activities can avoid giving investment advice so long as their research reports do not amount to personal recommendations. In addition, although this is a grey area, it is understood that provided investment research is objective/independent and does not have any promotional element to engage in a specific investment service, an investment research report should not in itself constitute a financial promotion.

Greater clarity would be welcomed by producers of investment research, provided that it does not lead to an expansion in the scope of the financial promotions regime. Although not specified, the delivery of this recommendation could potentially be met by the FCA updating its Perimeter Guidance manual (in line with the approach recently taken in relation to the trading venue perimeter). The recommendation should be implemented as soon as practicable (taking into account its current workloads and priorities). 

7. Review the rules relating to investment research in the context of IPOs

The seventh recommendation is that the initial public (“IPO”) offering timetabling changes introduced in 2018 should be reviewed and, where possible, simplified. The UK rules are stricter than those in the US or the EU and this may put the UK at a competitive disadvantage. The recommendation is that implementation takes place in conjunction with the wider work being undertaken in relation to the Listing Review and the Secondary Capital Raising Review.

Key takeaways and next steps

The introduction of the requirement to “unbundle” the cost of investment research from commission payments for order execution as part of MiFID II implementation in 2018 is widely understood to have had a negative impact on the provision of investment research. However, the Report recognises that the structural issues with the UK’s investment research market and research ecosystem pre-date MiFID II and have not materially improved since the limited exceptions to the unbundling rules were introduced in 2022.

One of the other themes brought out in the Report is the fact that the current legal and regulatory regime is overly complicated and perceived as onerous, disincentivising firms from producing investment research in the first place and/or making their investment research available to retail investors.

It seems unlikely that technical reforms will, in and of themselves, stimulate the growth of investment research on UK issuers. In addition, any regulatory reforms will need to be simple, to ensure that they have their intended impact and are adopted by both producers and consumers of investment research.

Also on 10 July 2023, as part of the so-called “Mansion House reforms”, the UK Chancellor of the Exchequer welcomed the Report and accepted all of its recommendations. However, before the recommendations can be implemented, there will be a need for further consultation by HM Treasury and the FCA in relation to the legislative and rule changes required.

If you or your firm would like further guidance on the Report and how your business could take advantage of the potential reforms, please speak to one of our experts.