BlackRock is pleased to have the opportunity to respond to the FCA Discussion Paper on the use of dealing commission regime.

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1 31 October 2014 Wholesale Conduct Policy Team Financial Conduct Authority 25 The North Colonnade Canary Wharf London E14 5HS Submitted via to: RE: DP 14/03: Discussion on the use of dealing commission regime Dear Sirs, BlackRock is pleased to have the opportunity to respond to the FCA Discussion Paper on the use of dealing commission regime. BlackRock is a premier provider of asset management, risk management, and advisory services to institutional, intermediary, and individual clients worldwide. As of 30 September 2014, the assets BlackRock manages on behalf of its clients totalled 2.8 trillion across equity, fixed income, cash management, alternative investment and multi-investment and advisory strategies including the ishares exchange traded funds. BlackRock has a pan-european client base comprising public and private sector pension plans, insurance companies, third-party distributors and mutual funds, endowments, foundations, charities, corporations, official institutions, banks and individuals. BlackRock represents the interests of its clients by acting in every case as their agent. It is from this perspective that we engage on all matters of public policy. BlackRock supports policy changes and regulatory reform globally where it increases transparency, protects investors, facilitates responsible growth of capital markets and, based on thorough cost-benefit analysis, preserves consumer choice. General comments We support the need for transparent and robust management of the conflicts (whether between managers and their clients and between different clients of the same manager) that may arise in connection with the procurement of, and payment for, research. 1. Improving client outcomes through a two stage approach to managing change: robust conflict management using research budgets in conjunction with CSAs followed by analysis of more wide-ranging global change BlackRock welcomes further study and analysis of possible industry solutions that are able to deliver enhanced outcomes for our clients and end-investors. As a global asset manager, we underline the complexity of managing assets for European clients in non-eu jurisdictions with different rules on the use of dealing commissions, especially where bundled research and execution services are the prevalent model. As the provision of investment research bundled with dealing services reflects a global business model, we believe it is imperative that initiatives to enhance the rules on investment research are coordinated at a global level through the International Organization of Securities Commissions (IOSCO). Reform in the UK or the EU alone will not of itself drive change in other major markets unless there is strong global consensus and commitment to change. Driving change through IOSCO should avoid inconsistent treatment of clients from jurisdiction to jurisdiction and competitive distortions between regions, thereby maintaining Europe s global competitiveness. In the meantime, we believe that wide scale adoption of research budgets in conjunction with Commission Sharing Arrangements (CSAs) taking into account the valuable feedback from the FCA s 1

2 thematic supervisory review and following the best practice standards advocated by the Investment Management Association (IMA) will continue to deliver improved outcomes for end investors. We are concerned about a move to a fully unbundled world without further research on all markets which will be affected by the change to ensure that neither end investors nor issuers suffer unintended consequences of changes to the current regulatory regime. 2. Detailed market research is a precondition for a global regulatory debate The FCA Discussion Paper makes a number of statements regarding the potential impact of complete unbundling and the limited ability of CSAs to deliver significantly improved consumer outcomes. We do not agree with all of these statements as a number differ from our own experience of using research budgets and CSAs to manage conflicts and improve investor outcomes. We comment in more detail on specific statements in our response to Question 1 below and we strongly support the responses provided by the asset management industry associations and, in particular, the response submitted by the IMA. We echo the IMA s concern that a number of the statements made throughout DP 14/03 do not appear to be supported by adequate evidence or analysis. Any large scale reform of the research market should be preceded by a careful analysis of its possible impact and by reasoned conclusions that its benefits would outweigh its risks or costs. We recommend the FCA commission research to underpin further international developments. We believe that detailed quantitative analysis of potential market impacts and of the effect of CSAs on key consumer and market outcomes would be invaluable in pinpointing the key areas where further change is needed. This study should also include analysis of possible industry solutions that are able to deliver enhanced outcomes for our clients and end-investors. Previous research on dealing commission has predominantly focussed on the effect on equity markets. The MIFID reforms extend, however, to cover non-equity instruments and any research should also consider the effect of change particularly, on fixed income markets. Changes to develop the market for the provision of research should also aim to promote efficient and open markets and drive increased competition across providers of research. The market should operate so that managers of all sizes can obtain research at competitive rates and so avoiding barriers to entry. Market reform should also ensure that research on small and medium enterprises (SMEs) is not adversely affected so that there is continued high-quality research in a sector of the market which is seen as key for the future growth of the European economy. 3. The UK should move in tandem with developments in MiFID II We welcome the FCA s willingness to move in tandem with European developments. While the issue of paying for research through dealing commission raises serious investor protection and conflict of interest issues it all strongly impacts European market structures. Consistency in the regulation of European market structures is central to the MiFID II reforms in terms of addressing fragmented markets and deepening liquidity. These concerns apply just as much to the provision of research and we would urge the FCA to maintain its position of pursuing consistency with the final outcome of the current Level 2 process in MiFID II. We appreciate the opportunity to address and comment on the issues raised by this consultation and would welcome any further discussion on these important issues. Yours faithfully, Peter Walker Managing Director BlackRock Alpha Strategies Phone: peter.walker@blackrock.com Responses to FCA s specific questions Martin Parkes Director BlackRock Government Relations and Public Policy Phone: martin.parkes@blackrock.com 2

3 Q1: Do you have any comments on our analysis on the potential impact of unbundling payments for research from execution arrangements, based on MiFID II proposals? General comments The use of Commission Sharing Arrangements (CSAs) allows investment managers to source best execution and research services from different providers and therefore to allocate research commissions to any research provider they choose. They accommodate fixed or variable pricing for research, whichever is available and in the best interest of clients setting upfront budgets, robust governance and disclosure which all contribute to the enhancement of accountability and transparency. The reason a significant percentage of research is paid to broker-dealers is that their research is broader and more comprehensive in comparison with their independent competitors. Independent research providers do not always have the resources to provide the same breadth of research as the larger brokers dealers, where the research function also supports other businesses such as capital markets and wealth management. Nevertheless, we believe that both large broker dealers and smaller independent research houses are integral to the functioning of a successful and efficient market in research. We do not believe that external research should be treated as a benefit received and enjoyed by the portfolio manager. Rather, external research paid for out of dealing commission should be viewed as a benefit for the managed portfolio complementing the manager s own research and enriching the investment decision process. However, even if research is deemed to be a benefit enjoyed by the portfolio manager, we believe that research does not amount to a benefit likely to influence the behaviour of the recipient: it does not amount to an inducement for the portfolio manager. We believe that proper governance processes such as setting an up-front budget for research, the use of commission sharing arrangements and transparent client reporting are sufficient to counter concerns that research induces portfolio managers to trade (or to trade with certain brokers at the cost of poor execution quality), or to churn or (in commission-based markets) agree higher execution rates. Behaviours of this nature would result in higher costs being borne by the portfolio reducing portfolio performance and therefore manager s remuneration - than could be justified by any enhancement of performance that may be generated through the use of external research. Comments on specific statements We recommend that the following statements be reassessed in the light of the industry s comments, including those made by the IMA: 1. A transparent, priced market for research appears highly unlikely to emerge organically without structural change The pace of the progress towards greater transparency increased in response to the concerns expressed by the FCA in the Dear CEO Letter of 2012 has gained further momentum as a result of the more recent regulatory guidance. This process is ongoing and may reasonably be expected to deliver the level of transparency called for by the FCA, and to do so in a gradual and orderly fashion. Additional transparency will also be introduced by MIFID II in the form of disclosure of the total costs of a particular fund (including dealing commission) in a visible headline item such as the annual management charge. Importantly, this disclosure will allow investors to immediately compare the total costs borne by a fund, regardless of whether research was paid for with dealing commission or was initially paid with the manager s own money and then reflected in a corresponding increase of the annual management charge. 2. An unbundled research market should improve competition, reducing barriers to non-broker research providers and focusing on the price and quality of research offered. Unbundling would result in 3

4 more independent research providers, resulting in better and cheaper research. Unbundling would increase the potential supply of research considerably: from a limited number of brokers with internal research capacity to hundreds of third parties. We are concerned that the contrary may actually be true and that the asset management industry is more likely to react to unbundling by concentrating its research spent on a smaller number of research providers. The abandonment of the current model of ex-post valuation and payment for research in favour of a model where an upfront commitment to a specific provider at a fixed price is required is more likely to encourage greater reliance on the research capabilities of a smaller number of brokers. Additionally, investment managers may increasingly favour larger brokers (within which an investment manager would presumably retain the ability to shift focus as its research needs change over time) over more specialised independent research providers. The economics of the production (for the sell side) and procurement (for the buy side) of research on small and mid-cap stocks would likely result in a dramatic reduction of available research on these companies. The Edison report (Edison, The Future of Equity Research, and January 2014) suggests that stock exchanges and issuers may move to fill this gap, and draws a parallel with the rating agencies being the primary sources of information in the bond market. Needless to say, both such research models would present conflicts. 3. We are aware that, in the short term, all investment managers may incur higher costs [ ]. Although this may in turn cause some competitive distortions both within the UK and for UK firms competing internationally, we do not expect distortions to be significant. For example, it has been argued smaller investment managers would be disproportionately affected because they would be less able to absorb the costs or else less successful at passing them on to clients. However, in the medium to long term the situation would not be different to the status quo in this respect. Smaller firms would not incur larger ongoing costs than they currently do, nor would they be in a worse relative position vis-à-vis larger firms. It would be helpful to see more analysis in support of this statement, which appears to have as its underlying assumption that most (if not all) managers would be able to withstand those initial higher costs. We remain concerned about the potential competitive distortions that the unbundled research model may introduce. The cost benefit and competition analysis in section 5 of DP14/03 dismisses this and other concerns voiced by the industry on the basis that the EEA will operate under the model described in ESMA s draft advice to the European Commission. We would encourage the FCA to refresh its cost benefit analysis should the European debate on the market for research produce a different outcome. In any event, we would encourage the FCA to provide stronger analytical support for some of the conclusions reached. Q2: Do you have any analysis that would help inform our view of possible benefits or costs of extending requirements in MiFID II to cover all research goods and services? If ESMA remains of the view that research amounts to an inducement, then while recognising the difficulty of defining minor in this context - we would urge the FCA to assist ESMA in identifying a more accurate and quantitative measure than the current 'proxies' of generic and widely available. The references in the ESMA Consultation Paper to 'generic' and 'widely accessible' research as a minor, nonmonetary benefit may not always equate to the deployment of less valuable resources by the provider of research. On the other hand, given brokers' need to produce research for other purposes (such as capital markets mandates, their own trading strategies and wealth management divisions, primary dealership obligations) an argument could be made that limited incremental resources would have to be deployed to tailor such research to individual (or a subset of their) clients. 'Generic' and 'widely accessible' are themselves concepts which are difficult to define and risk introducing disparate interpretations by the National Competent Authorities, and defeating the fundamental objective of 4

5 promoting uniform investor protection standards in Europe. In addition, if generic and widely available were to be interpreted as equating to little or no value to the portfolio manager (and therefore to the managed portfolio), then it would seem that that would frustrate the Level 1 intention to allow the receipt of minor nonmonetary benefit that are capable of enhancing the quality of the service provided to our clients. We believe that the correct measure of "minor" should be one that would not negate that quality enhancing feature of permissible non-monetary benefits. A quantitative measure of "minor" would likely be best expressed as a proportion of total costs or of assets under management. Finally, we recommend that the list of permissible non-monetary benefits should not be an exhaustive list. Given that any such benefits would need to exhibit the feature of being capable of enhancing the quality of the services provided to clients, limiting the flexibility of the Level 2 measures to evolve with the times may ultimately frustrate that objective. 5