While U.S. mutual fund managers are running for cover amid allegations of market manipulations that favor big institutional traders over the little guy, Britain's money-management industry is embroiled in its own controversy. Regulators there are proposing to break up what they regard as too-cozy ties between brokers and money managers. But brokers and many asset managers warn that the proposed reforms will bankrupt smaller fund-management firms and breed a culture of substandard research. What both sides agree on is that it's the biggest fight to hit the City since the Big Bang reforms of 1986, when the industry was deregulated. Britain's National Association of Pension Funds (NAPF), which backs the change, says it could lead to "a wholesale restructuring of the British investment market."
At issue are two long-standing business practices: "bundling" and "softing." Neither is illegal, but both, critics say, raise questions about whose interests are being served. Bundling happens when brokers lump together trading charges with extra perks, such as in-house research or access to analysts, into a single commission. Softing occurs when a fund manager agrees to steer a set volume of trades through a broker in return for credits that can be used to purchase services such as independent research or Bloomberg terminals. In both cases, fund managers pass on these costs to clients. That makes it difficult for investors to figure out exactly what they're paying for, or if it's money well spent. "Many pension funds are made to pay for unwanted, sometimes unknown, services," says Christine Farnish, chief executive of NAPF. "Those who pay for something should know what they are buying."
The Financial Services Authority wants to abolish soft commissions and force money managers to pay for any perks they get from brokers out of their own management fees instead of shareholders' assets. While fund managers might then be tempted to jack up their fees in response, they would face massive resistance from institutional investors. The reforms, supporters say, will improve transparency, reduce conflicts of interest, and boost accountability. "A consensus is emerging that softing and bundling do not operate in the best interest of clients," says FSA Chairman John Tiner.
Fund managers and brokers, however, have successfully lobbied to delay implementation of the new rules -- at least until the FSA clarifies its intentions early next year. The industry argument: If fund managers are forced to pay for currently "free" services such as research, operating costs will rise. The result will be an increase in trading spreads -- the difference between the price brokers pay for a stock and what investors pay -- to make up for lost commission revenue. What's more, the industry warns, the reforms could be fatal to independent research, which is still in its infancy in Britain and depends on business generated by soft commissions. "There are enormous potential implications, with limited, if any, benefits," says Richard Saunders, CEO of the Investment Management Assn., whose members manage more than $3 trillion in assets.
Securities companies say they can address any abuses by monitoring themselves. But advocates of the new rules counter that the industry has a poor record of self-policing. Still, many fear the government will give in to industry pressure and kill the proposed prohibition of bundling. "If the FSA abolished soft commissions and not bundling, it will be a disaster," says Brian O'Keefe, managing director of London-based investment-consulting firm Templeton Blake. If softing only is killed, independent research outfits will have no means of getting paid unless fund managers write checks, which they are reluctant to do. Meanwhile, investment banks will continue to subsidize their own research through bundled trades.
As supporters see it, by tackling conflicts of interest the FSA's proposed new rules would give the City new credibility. Expecting the industry to support the changes, though, is like asking turkeys to vote for Christmas. zz
By Kerry Capell in London