In principle, investors should not have to pay for access to the companies in which they invest. In practice, as previously reported in FTfm, fund managers are paying up to $20,000 an hour to intermediaries for access to company chief executives. Moreover, they are using clients’ money to pay for it: payments for corporate access now account for more than a quarter of dealing commissions, according to the Thomson Reuters Extel 2012 Survey.
The rise in importance of corporate access can largely be explained by three factors. The first is that spending someone else’s money is easier than spending your own.
In the Financial Services Authority’s letter to the fund management industry last November, which said that corporate access did not meet the definition of research or execution, the UK regulator stated that, “firms regularly spend millions of pounds of their customers’ money buying research and execution services from brokers. Only a few firms we visited exercised the same standards of control over these payments that they exercised over payments made from the firms’ own resources”.
This laxity reflects the fact that the FSA did not go far enough when introducing unbundling regulations seven years ago. The original vision of unbundling, contained in the 2003 FSA proposals in the wake of the Myners report, would have required fund managers to pay for research out of their own fees, rather than from clients’ commissions. Instead, the final rules, which became effective in 2006, required only that fund managers provide adequate disclosure of these costs to their clients under industry-led guidelines. This was a missed opportunity and, unfortunately, experience has shown that asking the financial services sector to regulate itself by no means ensures best practice is followed.
The second factor is that sell-side investment banks and corporate brokers are very good at ensuring they get paid handsomely for the services they provide. Those services constantly evolve to reflect both what clients are prepared to pay for and how far the sell side can seek out the grey areas in the regulations.
Corporate access, which at the time was far less significant an item, was not specified in the list of services that could not be paid for out of commissions under the new regime in 2006. No longer able to charge for soft commission items such as the provision of dealing screens, banks saw an opportunity to fill the gap through providing corporate access.
The third contributory factor has been the growing demand for corporate access, which is highly valued by fund managers. Traditional fund management commission pots continue to decline in size and the importance of hedge funds’ business to the investment banks has grown. Hedge funds, which may lack established links with the companies whose stock they invest in, have been prepared to pay well for that access. Recent US academic research, highlighted in FTfm last week, sheds light on why funds are prepared to pay. The study, “What are we meeting for? The consequences of private meetings with investors”, by David Solomon and Eugene Soltes, found that fund managers, and hedge fund managers in particular, who hold one-to-one meetings with executives make significantly higher returns as a result.
The Financial Conduct Authority, the FSA’s successor, is attempting to tackle the first two factors, although not through a renewed push towards full unbundling, which would probably be the most effective solution. In its November letter, the FSA addressed fund managers’ use of their clients’ money, which is expected to prompt them to stop paying for “concierge-style” corporate access with dealing commissions. The FCA has also promised further reviews of buyside firms, which will look at how commission payments have evolved once the significant proportion that goes to corporate access is removed. This should go some way to preventing the sell-side from pushing the envelope with inventive rebundling of access.
However, even if fund managers end up paying for corporate access with their own money, this leaves the problem that company managers’ inevitably limited time is being auctioned to the highest bidders, who are then profiting from that access at the expense of other investors.
Companies should be able to engage with their investors to develop long-term stable relationships, but one-to-one meetings carry the risk of inadvertent disclosures of non-public information. Banning meetings with individual investors feels too draconian, but banning payment for them combined with a rapid disclosure of their content over the internet would go a long way towards levelling the playing field for all investors.
Vince Heaney is an FT contributor
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