Research houses paid to rate financial products by the issuers of those products will have to separate their research from their consulting activities under proposals by the Australian Securities and Investments Commission.
The move comes after research houses gave their approval to a string of failed investment schemes and funds. In June a parliamentary inquiry commenced into the collapse of Trio Capital, with particular reference to the role of the research houses after they produced positive reports on superannuation funds associated with Trio.
Some research houses are paid tens of thousands of dollars by fund managers and investment-scheme promoters to rate their investment products. They can also receive other payments from fund managers and investment-scheme promoters, such as conference fees and payments for using researchers' ratings in advertising.
Rather than hard-headed, independent assessments of the merits of investments, research reports can often amount to little more than marketing material.
While much progress has been made on reforming the financial planning industry, the research industry has been allowed to carry on pretty much as usual with its "pay-for-ratings" revenue model.
The consultation paper put out by the Australian Securities and Investments Commission proposes that: "Physical and organisational information barriers" be put in place by researchers to separate research from their investment, consulting and funds management services. That sounds suspiciously like the "Chinese walls" that are supposed to separate the broking and deal-making arms of investment banks.
The regulator also proposes research houses lodge a compliance report every two years. The report would show how they manage conflicts of interest, how they disclose such conflicts to users of the research and how they manage research quality and transparency.
However, the biggest conflict of interest - payments from those being rated - will almost certainly not be banned. The regulator is as much about facilitating an innovative financial services sector as it is about protecting consumers.
In all likelihood, when it issues its updated regulatory guidance in May next year, it will be about managing and disclosing conflicts of interest, not eliminating them.
One of the few tangible improvements likely to come from the regulator is that researchers will have to state on the front page of every report who commissioned it and who paid for it. Fund managers shop around for a research house that will give their products the best ratings and very few negative reports are issued by researchers with pay-for-ratings revenue models.
The regulator proposes that researchers publish all their reports, including those that are negative.
A couple of the researchers, including Morningstar, Mercer and van Eyk, are relatively free of conflicts of interest because they do not get paid by those they rate. But it's unlikely major researchers such as these and the specialist superannuation researchers SuperRatings and Chant West are at the centre of the regulator's concerns.
There are many small researchers specialising in rating products in particular markets, such as agribusiness, property and superannuation, for whom some changes to their businesses would likely have to be made to comply with the updated regulatory guidance.
Frequently Asked Questions about this Article…
What are ASIC's proposals for research houses that are paid to rate investment products?
ASIC proposes research houses separate their research from consulting and funds-management activities with physical and organisational information barriers (like "Chinese walls"), lodge a compliance report every two years, state who commissioned and paid for each report on the front page, and publish all reports including negative ones.
Why is ASIC scrutinising paid ratings and research-house conflicts of interest?
The scrutiny follows cases where research houses gave positive reports to products that later failed — notably the parliamentary inquiry into the collapse of Trio Capital — raising concerns that some research amounted more to marketing than independent assessment.
How do research houses get paid and why can that be a conflict of interest for investors?
Some research houses receive tens of thousands of dollars from fund managers and promoters, plus conference fees and payments for use of ratings in advertising; that "pay-for-ratings" revenue model can encourage favourable reports and discourage negative findings.
Will ASIC ban payments from product issuers to the firms that rate them?
According to the consultation, ASIC is unlikely to ban payments. The regulator appears focused on managing and disclosing conflicts of interest rather than eliminating paid arrangements.
What practical changes will help everyday investors read research reports more safely?
Under the proposals, reports would clearly state on the front page who commissioned and paid for them, researchers would publish all reports (including negative ones), and biannual compliance reports would explain how conflicts are managed — all measures aimed at improving transparency for investors.
Which research houses are considered relatively free of conflicts of interest?
The article notes Morningstar, Mercer and van Eyk as relatively free of conflicts because they do not get paid by the firms they rate, while specialist superannuation researchers such as SuperRatings and Chant West are among those the regulator is particularly concerned about.
What should investors watch out for when relying on research house ratings?
Look for who commissioned and paid for the report, be cautious of marketing-style language, check whether negative reports are published, and consider the research house's business model — whether it earns fees from the products it rates.
How might small specialist researchers be affected by ASIC's updated guidance?
Small researchers focused on niche markets like agribusiness, property and superannuation may need to change parts of their business models or operations to comply with new disclosure, separation and compliance-reporting requirements.
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