How do research houses manage conflicts of interest?

Research Review is compiled by PortfolioConstruction Forum in association with Money Management, to help practitioners assess the robustness and disclosure of each fund research house compared with one another, and given the transparency they expect of those they rate. 

This month, PortfolioConstruction Forum asked the research houses:  As a result of RG79 section D, ‘Avoiding, controlling and disclosing conflicts of interest’, what has your firm changed, or what will it change, in terms of both its business process and activities, and what has been added or changed in terms of the disclosures provided?

Lonsec

In terms of the potential conflicts of interest that arise specifically from different research house business models, the updated RG79 acknowledges that conflicts may exist due to both indirect payments from product providers – cross subsidisation from activities such as funds management, data collection, advertising and conference participation – and direct payments from product providers to participate in the research process.

In ASIC’s words, indirect payments may “not be as readily apparent to a user of the research”. 

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As a result of ASIC’s decision that indirect payments be subject to the same disclosure requirements as direct payments from product issuers, disclosure practices across the sector are expected to be lifted. 

Lonsec Research operates a business model based on direct payments and subscription revenue and believes that the conflicts that are associated with direct payments are more transparently managed and audited for compliance, than indirect payments.  

We have well established and robust compliance, operational and commercial practices in place. As an AFSL holder, we have an obligation under the law to have in place adequate arrangements for the management of conflicts of interests.  

While we continually strive to enhance existing processes, we will not be making any material changes to our current conflicts management processes.

We are very confident in the vigour of our conflicts management processes. We believe the conflict of receiving payments from product issuers has, and can continue to be, managed effectively and robustly. 

In terms of disclosure, we will not be making any material changes to disclosures around conflicts management.

We have a well established practice of disclosing key elements in each research report, including the fact that we receive a fee for assessing the product issuer described in the research report, using comprehensive and objective criteria.  

Mercer

Mercer does not comment on these sorts of matters other than to say we always comply with the regulatory environment in all areas and localities of operation. 

We have strict global policies in place with respect to the avoidance, controlling and disclosure of conflicts of interest. 

Morningstar

One of the foremost conflicts which RG79 addresses is the issue of direct payments between product providers and research firms for the production and publication of ratings/research reports.

Although RG79 does not explicitly require avoidance of the conflicts of interest associated with issuer-pays research, ASIC states that it will maintain surveillance of this area.  

Morningstar continues to believe that the subscriber-pays model is the most effective way of addressing the actual and potential conflicts of interest associated with this issue.

Morningstar selects products for assessment on the basis of analyst judgement rather than a financial transaction. 

Morningstar enables product providers to license the right to republish our ratings and research in promotional materials.

Any licensing agreement takes place after the ratings and research have been completed and published to our clients and the wider marketplace, and the product provider therefore cannot influence the outcomes. Licensing negotiations are not undertaken by research personnel.  

We also have an associated business, Ibbotson Associates Australia, which provides investment management and consulting services.

While the two companies have the same ultimate parent, they have separate profit and loss accountabilities, separate reporting lines, and physical and electronic separation of staff and resources.

Morningstar avoids any potential conflict by not undertaking or publishing analyst research on Ibbotson’s investment products. 

We will be enhancing the disclosures associated with our managed funds research to ensure that users are fully-aware that product providers may elect to license the right to reproduce our intellectual property after publication, and that we do not undertake analyst research on our associated investment management and consulting business. 

Zenith

Overall, the enhancements to RG79 will result in minor changes to Zenith’s business processes and activities.

We already have sophisticated procedures and policies in place regarding our obligations to managing potential conflicts of interest under the previous version of RG79 (released November 2004). 

Currently, our systems and processes are broadly compliant with the updated guidance from an operational perspective. Most of the changes we make will be in refining and tailoring our disclosure practices on these operations to be in-line with those in the updated guidance. 

A key change as a result of the upgrades to RG79 is the creation of an internal Zenith compliance committee solely dedicated to the monitoring of our obligations under RG79.

Previously the supervisory obligations embodied by RG79 were the responsibility of our Compliance Officer, along with wider compliance duties under our AFSL.

Given the additional obligations of the enhanced guidance, we believe having a formal panel dedicated to monitoring and enforcing policies and procedures relevant to RG79 will be a progressive step.  

Regarding changes to our disclosure requirements, the most significant changes will be to the following areas. 

Spread of ratings: while already complying with this measure in our Annual Sector Reports, our systems are being upgraded to allow ratings spreads to be available on individual ratings reports and on our website.

This will allow real time disclosure on the number and proportion of ratings issued. 

Increased ratings transparency: we are upgrading our systems to allow users to more easily access historical ratings for each product reviewed.

Previously, while all users were informed when we ceased coverage of any product (and the reasons why), the ability for users to access this information on past ratings, was not as user friendly as it could be. 

Going forward, users will be able to directly identify when coverage of a product has ceased, the reasons why and whether product issuers have ever withdrawn from the ratings process. 

Approval before distribution: our ratings process has always required that each report and rating must be reviewed by a combination of peers and experienced supervisors before release to clients.

While we have always kept written records of this system internally, we will be making this more transparent in each report by publishing the name of the supervisory individual who authorises its release rather than just the name of the analyst who authored the report. 

Upgraded policy disclosure: in line with RG79 requirements, upgraded disclosure documentation will be available from our website regarding the following additional key areas not mentioned above (Scope and expertise of research services; Process for selecting funds for coverage and filters applied; and Zenith’s conflicts management policy). 

Van Eyk

van Eyk Research has reviewed RG79 and, in our opinion, have already implemented measures to ensure compliance with most aspects of the guide in our existing business model and remuneration structure. 

Conflicts are already avoided, wherever possible, by the following means: 

• Business Model: van Eyk does not operate a pay-for-ratings business model. That is, we do not accept any payment from fund managers for our ratings – investment research is available by subscription only to the main users of the research – financial planners. This ensures there is no financial incentive within the ratings process for van Eyk to produce favourable reports on any fund manager. 
• van Eyk does not publish investment research, opinions or ratings in the sectors where we provide services to investors, namely for multi-manager or fund-of-fund products or individually managed accounts.  
• Members of the research staff do not review any fund manager if they hold an interest in the securities of the fund manager or units in its managed investment schemes.  
• van Eyk has established a remuneration structure aimed at minimising conflicts. Research staff members are paid a salary. There are no key performance indicators for the research team that are directly tied to revenue generated by the research unit or any other business unit. 

Potential conflicts between non-research services to clients (such as asset consulting) and the research service are controlled by strict and formal segregation of business units, including physical separation of business areas and strict separation of computer directories. 

However, there are some minor actions we will be undertaking in order to comply with all aspects of RG79 by the implementation date. These include: 

• Further expanding on the nature and scope of our research service and research methodology; and 
• Reviewing our Conflicts of Interest Policies. 
• In terms of additional disclosures conflicts, we are looking to action the following points: 
• Reviewing the disclosures around our relationships (research and non-research) and standardising the wording of these disclosures.