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.