FSA Backs Off on Post-Trade Analytics in Final Soft Dollar Rules
On second thought, maybe software used to analyze execution quality should be softable. In its final soft dollar rules, the U.K. Financial Services Authority backed off from an earlier position that software used to analyze execution quality is not a softable good or service. Under the rules
On second thought, maybe software used to analyze execution quality should be softable.
In its final soft dollar rules, the U.K. Financial Services Authority backed off from an earlier position that software used to analyze execution quality is not a softable good or service. Under the rules, published July 22, post-trade analysis of an adviser’s own trades (as opposed to a post-trade analysis of the market generally), is softable.
The SEC is expected to follow the FSA’s lead in defining the scope of softable research and execution. However, it is not yet clear whether the SEC will issue an interpretative statement or proposed rulemaking on the definitions.
In any event, the Investment Adviser Association should be pleased. The group had asked the FSA to reconsider its proposed position on post-trade analytics, pointing out that an adviser’s analysis of its experiences with prior trades may play an important role in its best ex decisions going forward. "Practices that aid best execution analysis and competition among brokers based on execution quality should be encouraged, rather than stifled," said the group in a May 31 comment letter.
The FSA apparently agreed. "We do recognize that information about how well a broker conducted a particular transaction or series of transactions for an investment manager could fall within the execution parameter," said the regulator. However, the FSA continued to take the position that general post-trade analytics are not softable products and services: "Our view is that many of the new analytical IT products being developed (which are commonly called ‘post-trade analytics’) are not ‘execution.’" As a result, under the final rules, products that provide information about the quality of markets generally, such as liquidity, market impact, and comparisons of the trading of different brokers against different benchmarks, are not softable. Of course, added the FSA, if the analytical software meets the criteria for a softable research service, it could be classified as such.
Data feeds. The FSA also clarified its position on data feeds: while raw data feeds continue to be excluded from the definition of research services, if the data has been cooked a bit, the information may become softable. "Data that has been manipulated into some form of output may be research, as long as the tests set down in our rules are met," said the FSA (namely, the manipulated data must provide new insight and represent original thought, etc.). In addition, added the regulator, "to the extent that a raw data feed meets our criteria for an ‘execution service,’ it could be classified as such, but investment managers must be able to justify the decision to do so."
Seminars and trade publications. The FSA reiterated its view that attendance at investment-related seminars and subscriptions to specialized trade journals are not softable research.
Adviser-broker negotiations. Under the FSA’s approach, brokers and advisers are expected to sit down ahead of time and discuss projected commission rates. The FSA indicated that it expects these discussions to be "recorded in a way that could, if required, be retrieved and compared to the actual rates or amounts paid for execution."
Disclosures. Under the final rules, advisers must explain to clients "generally" why the firm might find it necessary or desirable to use client commissions to purchase soft dollar products. The FSA, in assessing the adequacy of an adviser’s soft dollar disclosures to clients, will "have regard" to the extent to which the adviser has adopted disclosure standards developed by the U.K. Investment Management Association. In its adopting release, the FSA said that it expects the IMA disclosure code to "become the standard means of disclosure of commission spend for U.K. institutional and retail funds." However, the FSA acknowledged that the IMA code may not be the most appropriate means of disclosure for private clients.
The IAA had asked the FSA what disclosure requirements apply when, for example, a U.S. adviser delegates investment management authority to a U.K. firm for the U.S. firm’s customers. In the adopting release, the FSA explained that the identity of the U.K. firm’s customers to whom disclosure is required will depend on the commercial arrangements in place. Applicable rules do not require firms to "look-through" to underlying customers, noted the FSA, adding that "this is a matter for the firms to decide."
Also of note: U.S. clients of U.K. managers will receive the new disclosures. Moreover, U.K. managers’ use of U.S. clients’ commissions will be subject to the new soft dollar limitations.
Effective date. The FSA’s new soft dollar rules become effective January 1, 2006 and provide a six-month transition period. No later than July 1, 2006, all U.K. managers must have provided their clients with disclosure about their soft dollar policies and confirm that their practices comport with the new rules.