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Research costs reform seen squeezing fund firm profits

By Sinead Cruise

LONDON (Reuters) - Moves to revolutionise the way global fund managers pay banks for company research could slash the profitability of their equity funds business by up to 50 percent, research has showed.

Most fund firms pass on the cost of equity research, valued in the region of $5 billion a year, to their own clients, who pick up the bill as part of commissions paid to brokers for buying and selling stocks on behalf of the fund.

But as regulators step up efforts to police potential conflicts of interests between asset managers and investment banks, fund firms could soon be forced to pay for any research they require out of their own pocket.

Using data from publicly-listed international asset managers, Frost Consulting and financial software provider Quark estimate that operating margins for actively-managed equity funds (as opposed to those which passively track an index) would fall to 12.5 percent from 23.5 percent.

Active equities accounts for between 20 percent and 100 percent of an asset manager's business depending on the scope and scale of their company offering.

"The old model of having the research paid for in part by commissions is being eroded and if they were forced to cover the whole cost of the research they use, it would have very significant impact on profitability," Neil Scarth, principal at Frost Consultants, said on Monday.

"Asset managers are under pressure to provide greater transparency and accountability in terms of how they pay for the equity research they receive," Scarth added.

London-based trade body the Investment Management Association - whose members include Aberdeen Asset Management (LSE:ADN), F&C Asset Management (LSE:FCAM), Schroders (LSE:SDR), Jupiter Asset Management (LSE:JUP), Morgan Stanley Asset Management (NYS:MS) and Goldman Sachs Asset Management (NYS:GS) - is due to publish a report on how asset managers pay for equity research next month.

Watchdogs are weighing up a possible ban on the use of client commissions to pay for equity research. If large asset managers require the research to guide their investment strategies, they will be required to pay for it themselves.

Earlier this year, Britain's Financial Services Authority, now split into the Financial Conduct Authority and the Prudential Regulatory Authority, wrote to asset management firms to flag concerns about how they run their operations.

The key concerns included firms who were failing to control the amount of customer money spent on research and trading services or conduct regular reviews on whether services were eligible to be paid out of customer commissions.

(Editing by David Holmes)