Society responds on re-bundling research fees

In this IR Society response, which draws on the findings from our 2023 member poll on investment research, we emphasise the importance of research for valuations and the London markets, noting the impact of MiFID II unbundling on the quality of coverage and the industry perspectives provided. We are therefore generally supportive of the FCA's proposals for increased payment optionality as this could lead to increased/improved quality of coverage for small- and mid-caps, provided the associated ‘guardrails’ are proportionate and aligned with the equivalent US and proposed EU regimes.

The Investor Relations Society

Suite 717, 70 Gracechurch Street

London, EC3V 0HR

Wholesale Markets Sector Team

Financial Conduct Authority

12 Endeavour Square, London, E20 1JN

By email: cp24-7@fca.org.uk

5^th June 2024

Dear Sirs,

Re: CP 24/7 Payment Optionality for Investment Research

Introduction

Thank you for giving us the opportunity to comment on this consultation on Payment Optionality for Investment Research, available here: CP24/7: Payment Optionality for Investment (fca.org.uk). This response is made on behalf of the UK’s Investor Relations Society (‘the IR Society’).

The IR Society represents Members working for publicly listed companies and investor relations focused service providers, to assist them in the development of effective two-way communication with the markets. It has approaching 800 Members, drawn mainly from the UK, including the majority of the UK FTSE 100 and many of the FTSE 250 constituents and some from companies listed overseas.

The IR Society’s mission is to promote best practice in investor relations; to support the professional development of its Members; to represent their views to regulatory bodies, the investment community and Government; and to act as a forum for issuers and the investment community.

As such, our response has been primarily constructed through the lens of a corporate issuer, which is typically the subject of the investment research, as opposed to being a direct consumer. We do see the quality of investment research as being a critical factor for the proper working of equity markets and the proper valuation of issuers, and as a result of MiFID II unbundling, there have been a number of disadvantages felt by a great number of companies, including the reduction of research coverage, quality of coverage and the industry perspectives provided. This has had particular impact on the smaller and mid-cap companies where coverage is smaller, and where many struggle to achieve a consensus from 3 research houses.

We have not answered the specific questions which are less relevant to our members, but we set out below our general comments on how investment research influences valuations and market liquidity, some of the consequences of MiFID II for the IR profession, and some caveated support for the current proposals.

We have also provided some empirical views from our membership when asked last year about the importance of investment research. This was drawn from a 2023 Member survey, which included a request for views on the quality of investment research, the findings from which we submitted to the independent Review of UK Investment Research. The survey also asked for views on certain aspects of the FCA’s 2023 listings review, and we attach a summary of the findings from that Member survey.

General Comments

The Society is supportive of measures that would increase the competitiveness of the London markets and, as our poll has indicated, the availability of diverse and quality investment research is an important factor for this. In this regard, we draw on the findings from our 2023 ‘Listing Rule Reform’ IRO snap poll around the most significant factors in deciding where to list, in which:

liquidity was cited by 83% of respondents;
depth of markets was cited by 80% of respondents;
comparable peers was cited by 78% of respondents;
valuations was cited by 66% of respondents; and
investor / analyst expertise was cited by 61% of respondents.

Whilst not considered the most important factors, this survey demonstrates that valuations and quality of analysts are considered by our IRO members as significant factors in deciding where to list. [This is consistent with the EY/UK Finance paper: UK Capital Markets - Building on Strong Foundations (May 2023) which identified factors such as liquidity, access to sophisticated investors with a deep understanding of the company’s sector, valuation and research coverage, and the presence of comparable companies in the market as among the key factors that determine where a company chooses to list.]

Looking more specifically at investment research, the Society’s view is that investment research is an important part of an efficient market, which was borne out by the findings of our 2023 Investment Research snap poll. Answers to the questions posed on the quality of research :

our member IROs consider there is a link between research coverage and valuations, with nearly three-quarters (74%) of respondents believing there is a specific link between equity research and valuations for listed companies or those seeking to list. This underscores the crucial role played by research in shaping market perceptions and determining the fair value of companies, and also suggests that potentially improving the quality of research on companies could positively impact valuations; and
whilst our IRO members are generally satisfied with the number of analysts covering their company, they had concerns regarding the perceived varying quality of research. Indeed, most noted that they would prefer fewer analysts but higher quality. A particular issue was that some analysts were not updating models sufficiently frequently. This was attributed to analysts covering an increasing number of stocks and having less time for each one. Analyst estimates should be informed and up-to-date, so that the market has a reasonable expectation of financial results. If analysts fail to update their forecasts, this can lead to inaccurate consensus estimates that may give rise to a need to correct the misapprehension, which is a cumbersome and potentially damaging process.

We also note that another consequence of the MiFID II restrictions has been the apparent ‘juniorisation’ of the sell side, which has resulted in a reduction in non-company-specific research and, in turn, increasing levels of direct corporate access. This has made an initial investor meeting with the Investor Relations Officer even more important as this is an opportunity for the IRO to explain the investment proposition, market/sector positioning etc and thus allow subsequent C-suite engagement with the buy side to be more constructive. We believe this increase in direct engagement with the buy side is beneficial to both issuers and investors, and will be unaffected by these current proposals.

Comments on the proposals in CP24/7

As we set out above, the Society views investment research as an important part of an efficient market, and we are therefore supportive of measures that will increase the amount, breadth and quality of research. In principle, we therefore support increased payment optionality as this could lead to increased/improved quality of coverage for small- and mid-caps, and there may also be more tangible benefits for smaller active fund managers.

However, in order to encourage the use of any such additional payment options, any proposed ‘guardrails’ should be proportionate, and also not be more prescriptive or less flexible than those in other jurisdictions (for example, the equivalent US and proposed EU regimes). Otherwise the additional optionality will not be utilised and the potential benefits will not be achieved. In particular, alignment with overseas regimes is important in helping the UK remain competitive on a global basis, and such alignment is therefore important for fulfilling the FCA’s secondary competitiveness objective.

We hope you find these comments useful. Please do not hesitate to make contact if you have any questions.

Your faithfully,

Liz Cole

Head of Policy and Communications

Investor Relations Society

(Email: enquires@irsociety.org.uk, Tel: + 44 (0) 20 3978 1980)

Laura Hayter

Chief Executive Officer of the Investor Relations Society

(Email: enquires@irsociety.org.uk, Tel: + 44 (0) 20 3978 1980)

Ross Hawley

Chair of the Investor Relations Society’s Policy Committee

(Email: enquires@irsociety.org.uk, Tel: + 44 (0) 20 3978 1980)

Published 5 June, 2024