Investment research and financial analysts

The Commission is taking stock of the European legislative measures on investment research and issues guidelines to be followed in this field. It deals for the most part with conflicts of interest, but also with other topics connected with analyst registration, independent research, issuer relations with analysts and investor education.

ACT

Communication from the Commission to the Council and the European Parliament of 12 December 2006 entitled "Investment research and financial analysts" [COM(2006) 789 final - not published in the Official Journal].

SUMMARY

Investment research provides financial information to ensure appropriate pricing, help issuers to raise capital and ensure deep and liquid secondary markets for financial instruments.

Financial analysts carry out this type of research by synthesising raw information to make it accessible. This work helps investors make decisions and facilitates research, investment advice and marketing communication by intermediaries.

Analysts are of great assistance for the financial markets. They do, however, face a variety of conflicts of interest. The interests of a firm or of clients may, for example, conflict with the interests of those to whom the research is directed. The Commission is therefore considering measures to improve the value and integrity of investment research.

This communication echoes the work done by the Forum Group on Financial Analysts and the International Organisation of Securities' Commissioners Technical Committee (OICV-IOSCO). Work of the Forum Group and the OICV-IOSCO

The focus of the Forum Group's report is the prevention, management, monitoring and disclosure of conflicts of interest relating to investment research. It gives recommendations to analysts involved in securities offerings or other finance work. It also advises companies on best practice, dissemination of investment research to the retail market, remuneration of analysts and securities dealing by analysts.

The OICV-IOSCO is focused on analysts working in integrated investment banks or broker-dealers, although the effects of conflicts of interest also affect other individuals. The report seeks to implement consistent rules relating to:

• identification, avoidance, management, disclosure and elimination of conflicts of interest;
• the integrity of analysts and their research;
• education of investors concerning the conflicts of interest faced by analysts.

Market Abuse Directive and Markets in Financial Instruments Directive (MiFID)

Successive Directives on market abuses require information which advises an investment strategy to be fair and disclose the existence of conflicts of interest. The Commission has set up a disclosure regime for conflicts of interest that could influence investment data.

As soon as a firm provides investment services, it must be authorised by the MiFID and comply with its requirements. The MiFID requires firms to:

• take steps to identify conflicts of interest;
• disclose their conflicts of interest policy;
• define and implement measures designed to serve their clients' interests;
• indicate where the steps taken are not sufficient to ensure the client's interests;
• inform their clients of the nature and origin of conflicts of interest.

Conflicts of interest - investment research

A recommendation described as "investment research" or something similar, or presented as objective and independent, is deemed to qualify as investment research. Generally directed at the client, such a recommendation may not constitute advice, as it must correspond to the needs of a specific client or be based on the specific situation of the client. Investment firms must effectively separate activities that serve clients and those that serve business interests. Thus, a firm that gives recommendations not constituting research must indicate that these are not given in accordance with standards designed to promote objectivity.

To guarantee their objectivity, investment firms must prevent persons involved from having certain dealings, particularly if they have knowledge of the timing or content of research before the public.

Firms disseminating information produced by third parties are not bound by these measures, provided that they have not altered this information and that they have verified the application of MiFID requirements.

Four outstanding issues

Work done by the Forum Group and the OICV-IOSCO has left four issues outstanding. The first relates to the possibility of mandatory registration by analysts of their qualifications. However, problems of analyst subjectivity do not derive from their lack of competence, but rather from the failure of firms to manage conflicts of interest affecting their research.

The second issue relates to the research services of independent firms and investment banks. Although the former are financed by their clients and the latter more indirectly, there are not necessarily quality differences between the two. For the research they carry out to be treated fairly, the MiFID permits investment firms to accept inducements, as long as these improve the quality of services and are disclosed to the client. This authorisation is valid for 'bundled' or 'softed' services provided by brokerage houses to portfolio managers.

The third issue relates to implementation of a best practice code to cover issuer relations with analysts. The rules set out by the Market Abuse Directive and the MiFID prohibit issuers from having undue editorial influence over research. They also prohibit them from disclosing price-sensitive information to analysts ahead of its release to the rest of the marketplace. For the Commission, the development of a best practice code will make relations between issuers and analysts more professional.

The final point relates to investor education. The Commission considers that it is the Member States, trade associations and investment firms that must take action in this area. The Commission itself undertakes to inform and educate consumers, notably through a conference that aims to bring together best practice in consumer education and to find out how to improve their financial literacy.

See also

• Further information can be found on the European Commission's DG Internal Market and Services website

Last updated: 14.01.2008