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The debate about soft commissions and bundling arrangements
rumbles on in the UK, with fund manager and pension fund bodies at
loggerheads over whether the Financial Services Authority should
regulate arrangements.
The Investment Management Association says it does not support the
FSA's proposed regulation of soft commissions and bundling. The
National Association of Pension Funds, however, welcomes regulation.
IMA's stance is unsurprising given that fund managers would be expected
to absorb much of the extra costs for research and information services.
Fund managers receive soft commissions, such as Reuters and Bloomberg
screens, by directing business to particular brokers. They also get away
with passing the cost of research - bundled with transaction costs -
through to clients. Chris Angell, fund secretary for the London Regional
Transport pension fund, says: "I think the IMA is trying to protect an
untenable position. There's a lot of money involved for their
members."
NAPF feels that regulation would help build momentum as there has been
little change since 1986 when UK brokerages were opened to foreign
competition and commission rates were deregulated. David Gould, director of
investment at NAPF, says: "Little has happened over the last 17 years
so the time has come for a gentle shove."
The FSA, in consultation paper CP176 has proposed a limit on services that
can be acquired through soft commissions and a curb on fund managers
automatically passing on the cost of services such as research to clients.
In particular the FSA proposes a ban on brokers providing fund managers
with market pricing and information services, such as screens, in return
for their business. This accounts for between 50% to 57% of soft
commissions, says the FSA.
The concern with soft commissions and bundling is that pension funds are
not able to see exactly what services they are being charged for. Bundled
research also means that fund managers receive more than they would if they
were paying for it directly and soft commissions create incentives for fund
managers to route orders through particular brokers rather than look for
best execution.
Although IMA and NAPF disagree on the regulation issue, they share a
concern about unintended consequences. One example is the impact unbundling
will have on the demand for, and therefore supply of, sell-side research.
The IMA believes the decrease in readily available information would impair
market efficiency. Richard Saunders, chief executive of IMA, says: "On
average they [fund managers] say spreads could increase by 15%." He
adds that this "implies increased costs of up to 20bp".
Another concern is that investment firms, especially international ones,
might move to jurisdictions where costs are lower. An IMA survey in 2002
found that around "£900 billion of assets are managed in the UK on
behalf of overseas institutional clients," says Saunders.
The IMA argues that, in any case, there is little benefit to be gained from
banning soft commissions and bundling. Saunders says: "The potential
benefit is tiny." He adds that the typical all-in cost of managing
money is 129 basis points a year. Out of this 129bp, softing and bundling
account for around 3bp. "So we are talking about 2% to 3% of total
fund management costs, or one 40th of 1% on fund performance," says
Saunders.
The LRT fund's Angell argues that transparency and choice are more
important. "I'm happy to pay a higher fee to investment managers
for unbundled research so I can see what I'm paying for," he says.
"Three basis points is not the point. The non-competitive testing of
brokers is probably costing 10 basis points in market impact." That
is, the lack of competition for brokers means that fund managers are not
necessarily getting the best execution price.
Although the FSA proposes transparency of client costs it does not go as
far as to make unbundling a requirement. IMA and NAPF have also attempted
to increase the transparency of transaction costs. In a joint effort, the
two associations introduced a disclosure code last year, although it did
not come into full effect until July this year. In addition, UK investment
house Gartmore agreed unbundling arrangements with Merrill Lynch and
Goldman Sachs in April.