Watchdog gets tough on soft commissions

Fund managers will no longer be able to bundle the costs of research and other overheads into their fee to clients unless they have the customers' express permission to do so, under new rules put forward by the Financial Services Authority (FSA) yesterday.

The move is part of the Authority's initiative to make costs charged to investors far more transparent.

Critics have long argued that the practice of "bundling", which is a common practice in the investment industry, has led to some customers receiving a poor deal because it can be very difficult to pin down what the fees are spent on.

The FSA said in a consultation paper that bundling should only still be allowed when customers actively sign up for the option of paying all of their costs together.

Fund managers should also offer to charge them separately for a management fee, the cost of share dealing and other expenditure such as research, the FSA said.

The City watchdog is also cracking down on "softing", a process under which brokers agree to pay fund managers' costs in return for the promise of an agreed volume of business.

Gay Huey-Evans, the director of the FSA's markets and exchanges division, said: "These proposals are designed to do away with distortions in the market and make fund managers more answerable to their clients."

"Up to 40 per cent of total commission spend is used to acquire services additional to dealing so it is important that investors are clear on how their money is spent," Ms Huey-Evans added.

The FSA's suggestions come two years after Paul Myners, the former chairman of Gartmore, led a government-sponsored review of the investment industry, the result of which was a proposal that soft commissions should be phased out.

The Myners review stirred very strong emotions among fund managers, and the Authority's paper on the subject, which has been put out for consultation until the end of August, is likely to re-ignite the debate.

Barry Marshall, the head of dealing at Mr Myner's former company, said: "This is a paper which deserves to be read widely. A bundled service is not always bad but you have to question why they should exist."

Critics of the current system say bundling and softing make the market inefficient because they lead to practices such as selling shares at an unfavourable rate through a broker simply because he or she has offered good research on a company in an entirely different sector.

Mr Marshall pointed out this was as irrational as "going into a restaurant and asking only for a main course but being told you have to have the five-course banquet".

However, others argue that softing and bundling enable brokers to offer research, especially on smaller companies, which would not be cost efficient if it was offered as a separate service.

According to the FSA, more than £2.3bn was paid as commission by UK institutional fund managers to brokers in 2002.

It estimates that fund managers spent between £660m and £880m of the commission on services other than trading – with between £500m and £720m of that spent on investment research.