The FCA found that wholesale data markets can be improved, but has ruled out a significant intervention.

The FCA has published the findings of its wholesale data market study (MS23/1.5), which examined competition in the markets for credit ratings data, benchmarks, and market data vendor services. It follows the publication of an Update Report in August 2023, which outlined the FCA’s provisional findings regarding potential competition concerns and communicated the FCA’s provisional decision not to make a Market Investigation Reference (MIR) to the Competition and Markets Authority (CMA). The FCA found that wholesale data markets can be improved, but has ruled out a significant intervention because of potential unintended consequences, such as the impact on the availability and quality of data in a market relied upon by investors worldwide.

Background

The FCA launched the wholesale data market study on 2 March 2023, following user concerns about how well wholesale data markets were working and in recognition of the fact that wholesale data is critical for financial market activities, including identifying investment opportunities, executing trades, making investment decisions, evaluating financial positions, and meeting regulatory obligations. The FCA’s market study covers competition in three separate but interconnected markets:

• Benchmarks across various asset classes
• Credit ratings data provided by credit rating agencies (CRAs) and their affiliates
• Market data vendor (MDV) services, which involve the redistribution of various types of wholesale data

It is the first use by the FCA of its powers to conduct a market study under the Enterprise Act 2002, rather than using its general information gathering and investigatory powers under FSMA 2000. A key advantage to the FCA of using the Enterprise Act power is the statutory power to gather information from non-regulated firms, which its FSMA powers do not allow. The Enterprise Act power is therefore more appropriate to the markets under consideration, given the significant number of non-regulated firms active in those markets.

The market study forms part of the FCA’s wider work on wholesale data, which includes the trade data review, whose findings and next steps were published alongside the launch of the market study. The FCA believes that effective use of wholesale data is key to economic growth and maintaining the UK’s competitive edge in global markets.

While this market study focused on UK users of wholesale data, the FCA recognises the international and connected nature of the markets under study and the wider global importance of effective competition in this space.

Overarching Findings and Outcomes on Market Dynamics

While the FCA notes that it did not find evidence that users cannot access the wholesale data they need, it identified the following four common themes across all three markets:

• The markets are highly concentrated, with a few key providers holding significant market share and maintaining high profitability.
• Most key providers are highly profitable and have maintained profitability.
• These key providers offer essential data, often without effective alternatives, leading to limited competition and potentially higher prices for users.
• Barriers exist for challenger firms, raising difficulties for them to enter or expand in these markets and resulting in limited challenger competition for key providers.

Credit Ratings Data

The FCA’s key findings in relation to credit ratings data are as follows:

• Credit ratings and data feeds are essential for many users, with a few large firms dominating the market. Given the vital role of credit ratings, the FCA concludes that no credible alternatives are available.
• Users do not appear to view the ratings of different CRAs as substitutable alternatives, but as complementary information. Users often need data from multiple CRAs, which limits their ability to switch providers. Instead, they may purchase data feeds from a new CRA in addition to their current data feed to meet their coverage needs, for example, the need to obtain a credit rating for multiple securities in the same asset category rather than for a single security. The FCA concludes that multi-sourcing has a significant impact on competition for data feeds, but the drivers are located both on the demand and supply sides.
• MDVs are a valuable distribution channel for CRA data, but not a source of independent competitive pressure for CRA data affiliates. Similarly, most users do not see free data as an effective alternative and cited issues such as machine readability and interoperability, the need for real-time data, query limitations, and data quality and reliability.
• Smaller, challenger CRAs face barriers to entry due to limited market coverage, less historical data, and weaker brand reputation, leading to weakened competition. The FCA finds that this mainly results from issuers valuing consistency in the rating process and lacking the incentives to switch credit rating providers. In addition, challenger CRAs are often perceived by the market as giving less accurate or overly optimistic credit ratings compared to the largest CRAs and lack the stability and reliability enjoyed by the largest CRAs.
• Evidence suggests that certain CRAs have a dominant position in the credit rating market. The FCA’s view is that CRAs and their data affiliates have market power, with users having limited bargaining power to negotiate with suppliers to decrease prices. In addition, the FCA expresses concerns in relation to the complexity and sometimes opaqueness of the data feed licensing agreements. While users are generally satisfied with the data quality, there are concerns about the methodologies and past inaccuracies of CRAs when predicting the risk of default.

Benchmarks

The FCA’s key findings in relation to benchmarks are as follows:

• Benchmarks are widely used in financial markets, with strong network effects often leading to one industry standard. Benchmarks are a crucial tool for valuation purposes, the absence of which would lead market participants to collect the information themselves each time they need to use it. Benchmarks also reduce pricing opaqueness and information asymmetry, leading to increased liquidity in the market.
• In markets where network effects are strong, competition tends to be “for the market” rather than “in the market”. Even though competition “for the market” might still exist, the FCA identifies that market-driven displacement of an industry-standard benchmark is unlikely due to the switching costs and the limited potential for a critical number of users to switch from one benchmark to another at the same time.
• Benchmark users are often incentivised to preserve the network effects because the wide availability of financial products linked to a benchmark helps users to build investment strategies, hedge risk, and make comparisons.
• Benchmark providers have significant brand power with end investors, meaning that asset managers are inclined to use established benchmarks in investment portfolios. Investors’ brand awareness is not a problem on its own, but can lead to poor investor outcomes if their decisions are based on the perceived reputation and quality of benchmark administrators, rather than the actual value of their product.
• Although less impactful than network effects and brand awareness, the FCA emphasises that the competition dynamics in the market for benchmarks are impacted by barriers to switching, vertical integration, and barriers to entry. The FCA’s view is that benchmark administrators have market power, with users lacking the ability to credibly threaten to switch providers or to negotiate in response to a price increase or degradation of service.
• Besides brand awareness and network effects, potential entrants face barriers to entry due to startup costs associated with product development, obtaining input data, and regulatory compliance. The introduction of new indices involves a significant amount of research, technology infrastructure, and distribution networks, while input data and licensing costs have been rising in recent years.
• Evidence suggests that, although established benchmark providers have significant market power, suppliers still invest in the quality and innovation of their products. While users are generally satisfied with the quality of the benchmarks, there are concerns about the accuracy of calculations, data delivery or reporting times, and liability clauses, which are prevalent among benchmark administrators and exclude liability for errors, effectively transferring the risk responsibility to the user.
• Users raised concerns about the ability to compare prices and switch providers. The FCA expresses the view that market power enables benchmark administrators to adopt potentially harmful commercial practices, including adopting complex fee structures, increasing fees, imposing complex and opaque licensing arrangements, and bundling benchmarks.

Market Data Vendors

The FCA’s key findings in relation to MDVs are as follows:

• MDVs are crucial in distributing wholesale data, with a few large firms dominating the market. Data is predominantly licensed rather than purchased. Licensing arrangements often involve both downstream MDVs and upstream data generators, with users facing complexity and coordination costs, a diverse set of contractual obligations, additional complexities due to the intermediary role of MDVs, and the need for actively managing multiple licenses in order to access greater flexibility and data customisation.
• While users have some choice and ability to switch, they face barriers and concerns over pricing practices. The majority of users believe the market offers credible alternatives to their existing providers, but did recognise that network effects play a role in their choice of MDV, especially if MDVs offer highly specialised and differentiated products, creating a unique value proposition for diverse user needs.
• Potential entrants face barriers to entry due to costs associated with the establishment of technological infrastructure as well as the acquisition and licensing of data from generators, but both small and large MDVs stated that technological advancements reduce these costs. Competition dynamics have also been influenced by the recent vertical integration in the wholesale data value chain and consolidation through M&A activity in the sector.
• While the MDV market is concentrated, it has potential for dynamic competition. Despite the consolidation, the FCA finds evidence of entry and innovation (with disruptive new entrants in the fields of crypto and ESG data), partial switching between providers, and multi-sourcing of data. Users were satisfied with the quality of data they receive, but raised concerns over costs. The FCA expresses the view that market power enables MDVs to adopt potentially harmful commercial practices, including increasing fees, bundling data products, imposing complex licensing terms, and onerous exit terms.
• Although MDV activity generally falls outside the FCA’s regulatory perimeter, the Reasonable Commercial Basis (RCB) framework under MiFID does apply to the licensing practices of firms and activities which the FCA does regulate, such as trading venues. The FCA received representations from data users during the course of the market study, which mentioned the need to strengthen the RCB framework to help deliver better outcomes and suggested that MDVs should also be subject to the RCB requirements.

Next Steps

The report concludes that, while users can access necessary data, certain competition issues in the UK wholesale data markets arise due to market power, complex licensing arrangements, and pricing practices. The FCA aims to encourage more effective competition to improve market outcomes, focusing on transparency, fairness, and reasonableness without directly regulating prices or mandating product unbundling. The report sets the stage for future regulatory actions and reforms to address the identified issues and promote a more competitive market environment. However, the FCA decided not to make a MIR to the CMA at this time, preferring to take a holistic approach that uses its own existing regulatory powers. This is an interesting outcome, given that the FCA found that the statutory test to make a MIR was otherwise met. This likely reflects the advantages the FCA has as a specialist sectoral regulator, with both its powers under FSMA and concurrent powers under the Enterprise Act and the Competition Act 1998 to enforce competition law. Interestingly, the FCA notes that to the extent it needs to regulate conduct currently outside the scope of its remit, it can apply to HM Treasury to extend the regulatory perimeter, which may be quicker than the time it would take for the CMA to conclude a market investigation.

The FCA plans to address the issues identified in the study through its broader work to review the regulatory framework, including via the Wholesale Markets Review and Primary Markets Effectiveness reforms, and other tools, avoiding direct regulation of prices, but considering improvements in transparency and fairness. In relation to other initiatives, the FCA is continuing with its plans to develop a consolidated tape for bonds, with an expected start date of 2025, and will use the findings from this market study to inform that work. The FCA states that it will publish an update this year on proposals for a consolidated tape for equities.

The FCA also raises the possibility of proposing changes to the Reasonable Commercial Basis (RCB) framework in MiFID II / MiFIR to address feedback during this review that the RCB framework is not delivering on its objectives. The FCA states that changes to this framework may be a way of addressing points raised by users of MDV services in relation to licensing practices. Alongside this, the FCA will continue to review whether any competition issues are underpinned by anti-competitive conduct or agreements and whether action under the Competition Act 1998 would be appropriate, currently ruling out a more interventionist approach on pricing, for which the FCA notes that the quality of data has not been raised as a concern.

The FCA’s view remains that it is well-placed to develop an appropriate and proportionate approach to addressing issues identified in the market study and through the ongoing work outlined above, the FCA may identify further specific areas for action.

Stakeholders are invited to share their views on the conclusion of the market study by 12 April 2024.