The proposals are the first output of the FCA and HM Treasury review of potential capital markets reform to ensure the domestic regime is adapted to the structures of UK markets and maintains the highest regulatory standards. Along with the Treasury, the FCA has discussed market reform with market participants, and taken into consideration the responses that UK market participants submitted to the European Commission’s consultation in 2020 which led to the so-called “Quick fix” Directive amending MiFID II. However, the FCA's proposals differ from the changes in the EU. The FCA says it has focussed on amending UK MiFID requirements that are not achieving their objectives in an efficient way. Its proposals also reflect the different circumstances in the UK and the FCA's own analysis.

We look at the FCA’s proposals in more detail below.

Inducement rules – exemption for SME research

To reduce conflicts of interest, MiFID II introduced requirements to set separate charges for trade transactions and research buying (“unbundling”). Firms receiving research were required to either pay for research themselves from their own resources or agree a separate research charge with their clients.

While the FCA’s recent analysis on the impact of MiFID II did not find that the unbundling requirements significantly affected research analyst coverage for smaller UK public companies, it highlighted that the coverage level was already low. There were also some concerns raised by stakeholders about the coverage and quality of future research.

The FCA emphasises that it continues to support the aims of unbundling (such as investors paying lower charges and receiving better quality execution services). However, the FCA believes that allowing bundling in some parts of the equity market, e.g. in relation to SME research, is less likely to give rise to the harms that can be caused by bundling transactions and research. This is because of the lower levels of transactions in these segments and therefore lower incentives on offer. The FCA is also mindful of the broader context of supporting the recapitalisation of UK business following the impact of COVID-19 on the UK economy

By making changes that could improve research coverage for SMEs, the FCA expects there to be positive impacts on competition, such as an increase in asset manager interest and liquidity for SME firms. Therefore, the FCA proposes creating an exemption from the inducement rules for SME research below a market capitalisation of £200 million (assessed for the 36 calendar months preceding the provision of the research). Provided it is offered on a rebundled basis or for free, such research would constitute an acceptable minor non-monetary benefit and, therefore, not be capable of constituting an inducement under the FCA rules.

The EU's Quick fix Directive also introduces an exemption for SME research, but its market capitalisation threshold is a substantially higher EUR 1 billion (assessed over a 12 months period). The FCA states that its analysis indicates that the £200 million threshold better targets SME companies where investment research coverage is at its poorest.

Inducement rules – exemption for Fixed Income, Currencies and Commodities (FICC) research

The FCA proposes a similar exemption from the inducements rules to allow FICC research to be rebundled.

The FCA explains that its rationale is that FICC transactions are typically not paid for by an agency commission to the broker, but instead the broker earns its revenues from the spread (the gap between the bid and ask prices of an instrument). Therefore, the proposed exemption for FICC research does not create the same opacity risks between transaction fees and research costs that arise for equity research.

While the FCA recognises that rebundling of FICC research will not necessarily increase demand and supply, it believes that it will remove associated costs from applying the inducement rules, creating savings for producers and recipients of FICC research.

Inducement rules – exemption for independent research providers

The FCA notes that if independent research providers do not include execution when they provide research, their research does not raise the conflicts that can arise from investment firms providing research and offering execution services. Therefore, the FCA also proposes to include research provided by them in the list of minor non-monetary benefits. The exemption will only apply to independent research providers that are not engaged directly, or in the same group as a firm engaged in, execution and brokerage services.

Inducement rules – exemption for openly available research

The FCA proposes to include in the list of minor non-monetary benefits written material that is made openly available from a third party to any firms wishing to receive it or to the general public. In this context, “openly available” means that there are no conditions or barriers to accessing it, for example requiring a log-in, sign up or submission of user information by a firm or member of the public in order to access that material.

In introducing this exemption, the FCA states that investment managers can consume any such research without restriction. In addition, it might provide an incentive for entities such as trading venues in the UK to offer research on this basis.

Best execution reports

While dependent on HM Treasury amendments to the MiFID delegated regulation and on the outcome of consultations, the FCA proposes to remove completely two sets of reporting obligations on firms:

• the obligation on execution venues to publish a report on a variety of execution quality metrics to enable market participants to compare execution quality at different venues (RTS 27 reports); and
• the obligation on investment firms who execute orders to produce an annual report setting out the top five venues used for executing client orders and a summary of the execution outcomes achieved (RTS 28 reports).

This contrasts with the EU position which is suspending RTS 27 reports only for a period of two years.

The FCA explains that its policy work and discussions with market participants indicate that RTS 27 and RTS 28 have not achieved their policy goal of enhancing investor protection or improving information on execution quality and order routing. Its engagement with market participants found that the intended audiences (both retail and wholesale) for the reports, do not view them. The FCA considered whether there are improvements that could be made to the reports, or alternatives. However, it concluded that "there is no general approach based on aggregated data that will provide useful information for a sufficiently wide range of clients to make adequate use of them".

In a statement it made on 19 March 2021, the FCA said that it would not take action against firms that do not produce RTS 27 reports during 2021. In CP21/9, the FCA indicates that it expects to be able to take a final policy decision on whether to abolish these reports within that timeframe.

The FCA acknowledges broader issues regarding access to market data and states that it is currently considering the feedback received in response to its March 2020 call for input on accessing and using wholesale data, the deadline for which was extended to 7 January 2021. The FCA intends to publish a feedback statement on this later in the year to set out its findings and any next steps.

Next steps

Responses to this consultation can be submitted to the FCA until 23 June 2021. The FCA intends to publish a policy statement in the second half of 2021.

The FCA mentions that it will publish at least two further consultation papers this year. One, before the summer, will look at the consequences of LIBOR transition for the derivatives trading obligation. Another, after summer, will cover changes to markets requirements in the FCA Handbook and technical standards which can be effective without significant supporting legislative change.

This is only the beginning of UK capital markets reform. The FCA notes that additional amendments will have to be made by HM Treasury – in the context of MiFID, through changes to the UK MiFID delegated regulation. It says that the Treasury will propose changes to this delegated regulation “in due course”. The Treasury's forthcoming consultation will include proposed changes related to costs and charges disclosure for wholesale clients, electronic communications with clients, reporting to wholesale clients and changes to provisions linked to RTS 27 and 28.

This consultation highlights the compliance challenges that firms with a presence in the UK and the EU might face as the detail of UK and EU regulation diverge.