ASIC RG 79 — ASIC Regulatory Guide – RG 79 Research report providers: Improving the quality of investment research

Page 1 REGULATORY GUIDE 79 Research report providers: Improving the quality of investment research December 2012 About this guide This guide is for Australian financial services (AFS) licensees who are research report providers. It is directed towards providers of research on investment products—known variously as research analysts, securities analysts or research houses—and the research reports they provide. It provides guidance on certain licensing and conduct obligations in Pt 7.7 of the Corporations Act 2001 (Corporations Act) as they apply to general advice prepared by research report providers for retail and wholesale clients. Page 2 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 2 About ASIC regulatory documents In administering legislation ASIC issues the following types of regulatory documents. Consultation papers: seek feedback from stakeholders on matters ASIC is considering, such as proposed relief or proposed regulatory guidance. Regulatory guides: give guidance to regulated entities by:  explaining when and how ASIC will exercise specific powers under legislation (primarily the Corporations Act)  explaining how ASIC interprets the law  describing the principles underlying ASIC’s approach  giving practical guidance (e.g. describing the steps of a process such as applying for a licence or giving practical examples of how regulated entities may decide to meet their obligations). Information sheets: provide concise guidance on a specific process or compliance issue or an overview of detailed guidance. Reports: describe ASIC compliance or relief activity or the results of a research project. Document history This version was issued in December 2012 and is based on legislation and regulations as at the date of issue. Previous versions:  Superseded Regulatory Guide 79 Managing conflicts of interest: An ASIC guide for research report providers, issued November 2004 and known in the ASIC Digest as [GD 200]. Rebadged as a regulatory guide 5 July 2007. Disclaimer This guide does not constitute legal advice. We encourage you to seek your own professional advice to find out how the Corporations Act and other applicable laws apply to you, as it is your responsibility to determine your obligations. Examples in this guide are purely for illustration; they are not exhaustive and are not intended to impose or imply particular rules or requirements. Page 3 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 3 Contents A Overview .................................................................................................4 The role of research .................................................................................4 Background to our guidance ....................................................................4 Relevant law ............................................................................................6 Updating our guidance.............................................................................7 Scope of this guide ..................................................................................7 B Research reports and research report providers ...............................9 What is a ‘research report’? .....................................................................9 What is a research report provider? ......................................................11 Distributing research prepared by another licensee ..............................11 C Research quality, methodology and transparency ............................14 The role of quality research ...................................................................14 Improving transparency and methodology ............................................15 Allocating appropriate resources ...........................................................21 Preparing the research report ................................................................23 Compliance reporting .............................................................................28 D Avoiding, controlling and disclosing conflicts of interest ..............29 Conflicts and the research industry .......................................................29 Business model and organisational structure ........................................32 Controls..................................................................................................36 Disclosure of conflicts of interest ...........................................................40 Additional disclosure issues...................................................................43 E Users of research ................................................................................44 FOFA reforms ........................................................................................44 Due diligence .........................................................................................45 Personal advice .....................................................................................46 Key terms .....................................................................................................47 Related information .....................................................................................50 Appendix: Sample compliance review ......................................................52 Page 4 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 4 A Overview Key points Research report providers are important gatekeepers, preparing investment research for retail and wholesale investors. The quality of this research has a significant impact on the quality of advice retail investors receive. This guide focuses on key phases of the research process to improve: • the quality, methodology and transparency of research report production and distribution (see Section C); • the management of conflicts by research report providers, including avoiding, controlling and disclosing these conflicts (see Section D); and • the ability of users of research to understand and compare the research services of different research report providers (see Section E). The role of research RG 79.1 The timely and accurate flow of information about issuers, securities and other financial products is vital to the fair, efficient and transparent operation of financial markets. Research report providers are fundamental in the transmission of this information, and the integrity of their research directly affects the integrity of our financial markets. Note: For the definition of ‘research report’ and ‘research report provider’, see Section B of this guide. RG 79.2 Research report providers also perform an important ‘gatekeeping’ function in the financial advice industry by: (a) identifying products to consider for inclusion on approved product lists; (b) assisting financial advisers to formulate financial advice for retail investors; and (c) providing research for use directly by retail investors in making investment decisions. Background to our guidance RG 79.3 In a number of recent corporate collapses in Australia, the investment products that failed were either highly rated or the subject of very recent positive recommendations by research report providers just before the product failure. This has been a feature of collapses across investment classes including: (a) agribusiness schemes; (b) debenture issuers; (c) hedge funds investing in structured products; Page 5 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 5 (d) other managed or superannuation funds, with the most recent example being Trio Capital; and (e) property investment schemes. RG 79.4 Poor quality research or research that is not reliable, credible or current damages confidence in the research sector itself and in the financial services industry more broadly. Risks for the investment community are amplified where there is undue reliance on research reports and a lack of awareness of real and potential conflicts of interest which may adversely impact on the independence and therefore the reliability of those reports. RG 79.5 After the global financial crisis, concerns about the impact of conflicts of interest and the regulation of credit rating agencies and research report providers prompted the then Minister for Superannuation and Corporate Law, Nick Sherry, to announce a review of the regulation of credit rating agencies and research houses with a report to the Australian Government. RG 79.6 The report by the Treasury and ASIC, Review of credit rating agencies and research houses: A joint report (REP 143) was published in October 2008 and led to reforms to the regulation of credit rating agencies in Australia. RG 79.7 In November 2011, ASIC released Consultation Paper 171 Strengthening the regulation of research report providers (including research houses) (CP 171). In CP 171, we consulted on a range of measures to improve research quality, transparency and the appropriate management of conflicts of interest for research report providers. Note: For details of the consultation process, see CP 171 at www.asic.gov.au/cp and Report 318 Response to submissions on CP 171 Strengthening the regulation of research report providers (REP 318) at www.asic.gov.au/reports. Future of Financial Advice reforms and Trio Inquiry RG 79.8 The Future of Financial Advice (FOFA) reforms introduce a number of measures to improve the quality of personal advice to retail clients. These reforms include a statutory best interests duty for providers of personal financial advice and a ban on certain forms of conflicted remuneration in recognition of the fact that conflicts of interest can have a significant, negative impact on the quality of advice that retail investors receive. RG 79.9 The Parliamentary Joint Committee on Corporations and Financial Services Inquiry into the collapse of Trio Capital (Trio Inquiry) also considered the role of research in its inquiries. In its final report, the Trio Inquiry noted the ‘expectations gap’ that exists between what is expected of research by users and the limitations of the research on offer. RG 79.10 This guide and changes to other related ASIC guidance (e.g. Regulatory Guide 175 Licensing: Financial product advisers—Conduct and disclosure (RG 175)) aim to improve the quality of research and user’s understanding of the role research plays in the preparation of personal financial advice. Page 6 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 6 Relevant law RG 79.11 Under the Corporations Act 2001 (Corporations Act), Australian financial services (AFS) licensees who are research report providers for the purposes of this guide must comply with the general licensing obligations as set out in s912A. This includes: (a) the obligation to do all things necessary to ensure that their financial services are provided efficiently, honestly and fairly (s912A(1)(a)); (b) the obligation to comply with financial services laws and to take reasonable steps to ensure their representatives do likewise (s912A(1)(c) and (ca)); (c) the obligation to have adequate compliance arrangements (reg 7.6.03(g) and Pro Forma 209 Australian financial services licence conditions (PF 209)); (d) the obligation to have adequate resources, be competent, and ensure that representatives are adequately trained and supervised (s912A(1)); (e) where retail clients are involved—the obligation to give clients a Financial Services Guide (FSG); (f) where general advice is given—the obligation to warn clients that the advice does not take into account a client’s objectives, financial situation or needs (s949A); and (g) a range of prohibitions, including those for misleading or deceptive conduct in the provision of financial services, dishonest conduct, unconscionable conduct and insider trading. RG 79.12 Licensees are also obliged to have adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to the provision of financial services by the licensee, or a representative of the licensee, as part of the financial services business of the licensee or the representative (conflicts management obligation): s912A(1)(aa). RG 79.13 The conflicts management obligation and Regulatory Guide 181 Licensing: Managing conflicts of interest (RG 181) apply to all licensees, including research report providers. What an individual licensee needs to do to comply with the obligation varies according to the nature, scale and complexity of its financial services business. Note: We are revising RG 181 in light of the FOFA reforms. RG 79.14 The conflicts management obligation and the obligation to operate efficiently, honesty and fairly are interconnected. A licensee is unlikely to comply with the obligation to operate efficiently, honestly and fairly if it has inadequate conflicts management procedures. Conversely, having adequate conflicts management arrangements will help licensees to comply with their other obligations, including the obligation to operate efficiently, honestly and fairly. Page 7 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 7 Updating our guidance RG 79.15 Our review of practices among research report providers found some areas where our existing guidance and expectations should be revised or supplemented. RG 79.16 We are updating our guidance to help research report providers comply with their legal obligations including their management of conflicts of interest to improve the quality and reliability of investment research. A key focus of our updated guidance is on how conflicts of interest are managed, and where necessary, avoided, so as to ensure the resultant research has credibility and integrity and can reasonably be relied upon directly or indirectly by Australian investors. RG 79.17 We will conduct targeted surveillance of research report providers to ensure compliance with our guidance and, if necessary, we will revisit our regulation of this sector if we find evidence that standards are not improving. RG 79.18 In CP 171, we specifically consulted about whether research report providers should accept payment from product issuers to produce research about the issuer’s own products. We asked whether this conflict of interest can be effectively and robustly managed or should be avoided entirely. Our updated guidance does not require avoidance of this conflict at this time. However, if an outcome of our surveillance activity is that this conflict is not being robustly and effectively managed, we will revisit the need for avoidance. RG 79.19 Research reports are not a proxy for due diligence on the part of wholesale investors such as the financial planning industry. We expect AFS licensees (including financial advisers) to conduct appropriate due diligence in choosing a research report provider. Our guidance is designed to assist and support licensees and advisers in that process: see Section E. Scope of this guide RG 79.20 This guide focuses on providers of research on investment products—known variously as research analysts, securities analysts or research houses—and the research they provide. RG 79.21 This guide was first published in 2004 under the title, Managing conflicts of interest: A guide for research report providers. In 2011, we reviewed practices in the research sector and this guide reflects our guidance as updated by that consultation process. RG 79.22 This guide does not summarise all legal obligations relating to research report providers. Rather, it focuses on certain licensing and conduct obligations in Pt 7.7 of the Corporations Act as they apply to general advice by research report providers to retail and wholesale clients. Page 8 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 8 RG 79.23 This guide supplements RG 181 on managing conflicts of interest, and should be read together with that regulatory guide. RG 181 focuses on broad principles and guidance for licensees generally in managing conflicts of interest, and sets out expectations that licensees should meet in order to comply with the conflicts management obligation: see RG 181.16. Building on RG 181, this guide covers various issues that research report providers should take into account in the design, implementation and maintenance of their conflicts management arrangements: see Section D. RG 79.24 This guide should also be read in conjunction with relevant sections of the Corporations Act and other related ASIC guidance, including RG 175, RG 181 and the following regulatory guides: (a) Regulatory Guide 104 Licensing: Meeting the general obligations (RG 104); (b) Regulatory Guide 105 Licensing: Organisational competence (RG 105); (c) Regulatory Guide 111 Content of expert reports (RG 111); (d) Regulatory Guide 112 Independence of experts (RG 112); and (e) Regulatory Guide 146 Licensing: Training of financial product advisers (RG 146). Page 9 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 9 B Research reports and research report providers Key points Research is ‘general advice’ that is prepared and distributed to inform the investment decisions of both retail and wholesale clients. Research produced by investment banks, stockbrokers and research houses for retail or wholesale clients is considered to be a ‘research report’ within the meaning of this guide. What is a ‘research report’? RG 79.25 For the purposes of this guide, a research report is general advice that: (a) is in writing; (b) includes an express or implicit opinion or recommendation about a named or readily identifiable investment product; and (c) is intended to be, or could reasonably be regarded as being intended to be, broadly distributed (whether directly or indirectly) to clients (whether wholesale or retail) in Australia. Note 1: Investment products include securities, warrants traded on a financial market, managed investment products, superannuation products and investment life insurance products. Reports about whether to buy, sell or hold these products prepared by research analysts, securities analysts or research houses are typical examples of ‘research reports’. Note 2: The expression ‘broadly distributed’ includes, but is not limited to, publication. RG 79.26 It does not include any of the following: (a) personal advice; (b) general advice that is provided only to an individual or small number of related clients (e.g. a family); (c) general advice that is provided only to related bodies corporate of the licensee; (d) general advice that is only about products issued by the licensee or its related bodies corporate; (e) a communication or piece of information that does not constitute general advice; (f) advice that is merely a restatement, summary or extract of another research report that has already been broadly distributed (whether in Australia or elsewhere and whether by the licensee or another person), provided it is clear that: (i) the advice is a restatement, summary or extract of another report; and (ii) readers are directed to who prepared the original research and, if available, how readers may obtain it (see RG 79.29–RG 79.34); and (g) advice that is not provided in Australia. Page 10 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 10 Table 1: Examples of a ‘research report’ for the purposes of this guide Type of investment research Explanation  General advice produced by a research report provider on a subscription basis or on a fee for service basis. This is a research report for the purposes of this guide.  General advice (often called ‘sell side’ research) prepared for advising on or dealing in financial products. All ‘sell side’ research is a research report for the purposes of RG 79, regardless of whether it is for retail or wholesale clients. × General advice given to related bodies corporate of the licensee. An example would be ‘buy side’ advice or analysis produced by an investment bank or fund manager for its own internal use. This is not a research report for the purposes of this guide. Such in-house advice which is not intended for broader distribution is not a research report. See RG 79.26(c). Where such advice is intended to be, or could reasonably be regarded as being intended to be, broadly distributed, it is advice to which this guide applies. See RG 79.25(c). × General advice about products issued by the licensee or its related bodies corporate (own products). General advice produced by a research report provider’s analysts about the provider’s own products or those of a related body corporate is not a research report for the purposes of this guide. See RG 79.26(d). For example, although a licensee’s analysts may produce such general advice for promotional purposes, it is not advice to which this guide applies. Because such general advice is not a research report, it should not hold itself out as such, as it does not have the requisite objectivity, rigor or independence that typically characterises a ‘research report’. Where a licensee wishes to broadly distribute research about its own products a clear conflict of interest arises. In such cases and consistent with industry practice, we expect licensees to avoid the conflict by obtaining research from an external source. See RG 79.135–RG 79.136RG 79.126. × General advice that is a restatement, summary or extract of another research report. Such a process may require permissions from the original provider. This is not a research report for the purposes of this guide. However, where such material is re-distributed, it should be clear that:  the advice is a restatement, summary or extract of another report; and  readers are directed to who prepared the original research and, if available, how readers may obtain it. See RG 79.26(f). ×Client directed (‘bespoke’ research) prepared for a particular client and not for broader distribution. Such client directed research is not a ‘research report’ to which this guide applies. See RG 79.25(c). ×Economic research or credit research prepared by a licensee’s research analysts. Such advice does not include an express or implicit opinion or recommendation about a named or readily identifiable investment product and therefore is not a research report to which this guide applies. See RG 79.25(b). Page 11 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 11 What is a research report provider? RG 79.27 For the purposes of this guide, and subject to RG 79.25–RG 79.26, a research report provider is a licensee that provides research reports to other persons (clients). This includes situations where the licensee causes or authorises another person (e.g. an authorised representative of the licensee) to provide research reports to other persons (clients). RG 79.28 This guidance is designed to apply flexibly to different types of research report provider to improve the quality, transparency, integrity and comparability of research for the end users of the research, regardless of whether they are retail or wholesale clients. Distributing research prepared by another licensee RG 79.29 For users of research to have confidence in the integrity of the research and decide how much reliance they should place on it, it is important that they can see: (a) the identity of the licensee who prepared the research; (b) the complete research report (not an extract or summary), unless the advice is an extract or summary that has already been widely distributed in accordance with RG 79.26(f); and (c) any conflicts of interest disclosures that apply to that research report. RG 79.30 We do not consider that research report providers can effectively meet their obligations to manage and disclose their conflicts of interest where research is ‘white labelled’ (i.e. prepared by one entity and rebranded and distributed by another), without attribution to the research report provider who originally prepared it. Distributing research in this way makes it difficult for users to assess the value of the research and the impact of any conflicts of interest on the quality and integrity of the research. Licensees preparing research reports can meet their obligations where a research report is co-branded with the licensee distributing the report. RG 79.31 If a research report prepared by one licensee (A) is provided to other persons (clients) by another licensee (B) then, for the purposes of this guide, Licensee A is the research report provider, and not Licensee B (regardless of whether Licensee B also puts its own name on the research report). However, this is only the case where: (a) Licensee A causes or authorises Licensee B to provide the advice contained in the research report to other persons; and (b) Licensee B makes no material changes to the advice contained in the research report. Page 12 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 12 RG 79.32 As Licensee A is the research report provider, we expect that: (a) Licensee A’s licence covers preparation of the research report; (b) it is clear to a reader that Licensee A prepared the research report where the report is co-branded; and (c) Licensee A’s conflicts of interests disclosures are attached to the research report: see RG 79.35–RG 79.36. RG 79.33 Where Licensee B makes material changes to the research prepared by Licensee A, Licensee B assumes the obligations of the research report provider as set out in this guide. Any recommendations in the report must be those of Licensee B based on its own assessment of the product in compliance with the quality, conflicts, transparency and disclosure requirements of this guide. RG 79.34 The general advice contained in research reports forms part of the advice chain by which retail and wholesale clients make investment decisions. Each licensee should consider its compliance obligations in the preparation and distribution of research reports. This includes whether the licensee preparing the advice permits other licensees to pass on its research to retail clients and in what circumstances. Our expectations of users of research reports such as financial advisory firms that rely on research in the preparation of approved product lists or personal advice for retail clients are set out in Section E of this guide and in RG 175. Access to conflicts of interests disclosures RG 79.35 Sometimes the advice contained in a research report (or a summary or extract of the advice) is broadly distributed to a wide range of end-users (e.g. through the media or a public announcement). Research report providers should take reasonable steps to ensure that end-users have access to the relevant conflicts of interests disclosures. The most appropriate way to make this information available will depend on all of the facts and circumstances. Note: For example, research report providers should take reasonable steps to ensure that: (a) research reports are disseminated together with conflicts of interest disclosures (or made available by reference); and (b) where the advice contained in a research report (or a summary or extract of the advice) has been (or is likely to be) broadly distributed to a wide range of end- users (e.g. through the media or a public announcement), the relevant conflicts of interest disclosures are made available by reference (e.g. on a website). RG 79.36 In summary, the licensee that prepares the report is the research report provider for the purposes of this guide. If the research is on-distributed by another licensee and no material change is made to the report, the original licensee who prepared the report remains the licensee responsible for compliance with this guide and their conflicts of interests disclosures as relevant to the specific report should follow the report. Disclosures should be relevant to the activity of the respective licensee (e.g. the licensee that prepared the research as distinct from the licensee that distributes the research). Page 13 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 13 Table 2: Examples of a licensee distributing research prepared by another licensee Example Explanation Licensee A prepares research. Licensee B distributes the research. Licensee A is attributed as the preparer of the research and their conflicts of interests disclosures are attached to the report. Licensee A is the research report provider for the purposes of this guide. The research distributed by Licensee B must be complete and unchanged and include Licensee A’s conflicts of interests disclosures as they relate to that research report. Licensee B can be contractually obliged by Licensee A to attribute and ensure there is no alteration to the report and include conflicts of interests disclosures. The research may be co-branded by Licensees A and B. Licensee A produces institutional research and distributes that research to brokerage houses (Licensees B, C and D). Licensee A does not authorise further distribution of its branded research. Licensee A is the research report provider for the purposes of this guide and there is no further distribution of the research. Personal advice prepared by Licensees B, C or D in reliance on Licensee A’s general advice is the responsibility of Licensees B, C or D. Licensee A gives permission to Licensees B, C and D to distribute its research to retail clients directly (e.g. on a website or via a client portal). Licensee A is the research report provider for the purposes of this guide and its conflicts of interests disclosures must be attached to the research as further distributed. Licensee A may decide to co-brand the research with Licensees B, C or D or review the research before distribution to retail clients. Research is sourced from Licensees A, B and C by a dealer group (Licensee D). Licensee D has permission from Licensees A, B and C to redistribute their research. Licensee D does not make any material change to the research beyond amalgamating and distributing it to its advisers who may also pass it on (un- modified) to their retail clients. For the purposes of this guide, Licensees A, B and C are the research report providers as they are the authors of the research. The research distributed by Licensee D must include clear statements that the general advice was prepared by Licensees A, B and C and their conflicts of interests disclosures should be attached to each report. Licensee D makes material changes to the research prepared by A, B and C and distributes the research under its own brand. Licensee D is the research report provider and should make its own assessment of the product and comply with the quality, transparency and conflicts management obligations in RG 79 for any research it produces. Page 14 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 14 C Research quality, methodology and transparency Key points Delivering a quality research report requires: • clearly articulating the research approach, its scope and any strengths and limitations that apply; • maintaining and following a robust methodology; and • allocating appropriate human and other resources. The role of quality research RG 79.37 Research is relied upon by both retail clients and wholesale clients (e.g. licensees and institutional investors). Across the spectrum of research report providers, there are differences in business models, products researched and client groups. Regardless of the business model adopted by a provider, the quality of the resultant research is important to the integrity of our financial markets and to the quality of financial advice provided to Australian investors. RG 79.38 The constituent parts of a high-quality research service are the human and other resources applied to the research task, quality internal processes (including robust conflicts management processes) and good disclosure. RG 79.39 Research is promoted as an expert service to assist intermediaries and clients in making decisions about investment products. It is important that research does (and is seen to) demonstrate the professional expertise and judgement of the research report provider. Users of research should be able to see and assess the expertise that different research report providers bring to the task of preparing research. Note: See Regulatory Guide 112 Independence of experts (RG 112) on principles for the preparation of expert opinions in an analogous context. These principles relate to independence, conflicts management and the conduct of the expert in preparing the report. RG 79.40 Ensuring that research is of a reliable and robust quality will reduce the risk that licensees breach: (a) their general AFS licence obligations (s912A(1)); and (b) the prohibition on misleading or deceptive conduct. RG 79.41 In the context of expert or professional opinions, cases decided under the false, misleading or deceptive conduct provisions in the Australian Securities and Investments Act 2001 (ASIC Act) and the (then) Trade Practices Act 1974 (Trade Practices Act) have held that a statement of opinion by a person in their professional capacity involves an implied Page 15 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 15 assertion that the opinion has a reasonable basis, is the result of the exercise of due care and skill, and is able to be relied upon: An opinion given in circumstances that suggest that the opinion was based on the exercise of certain expertise … carries with it the implication that it is based on rational grounds and accordingly will breach the prohibition if it has no reasonable basis. This is especially true where the person giving the opinion holds themselves out as having special skill in relation to the … subject of the opinion. Note: See s52 of the (then) Trade Practices Act, MGIGA (1992) Ltd v Kenny & Good Pty Ltd (1996) 70 FCR 236, RAIA Insurance Brokers Ltd v FAI General Insurance Co Ltd (1993) 41 FCR 164, Chiarabaglio v Westpac Banking Corporation (1989) ATPR 40–971 and Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200. Improving transparency and methodology RG 79.42 To improve the quality and reliability of investment research in Australia, it is important that users (and prospective users) of research, be they retail or wholesale clients, have clear, comparable and meaningful information about: (a) the different research report providers in the market; (b) the strengths and limitations of different research approaches; and (c) a clear understanding of how research recommendations or ratings are produced and what they mean. RG 79.43 Factual and relevant information about the research service gives important context to the research, improves users’ ability to understand the research and decide whether to use and rely on it, and to what extent. RG 79.44 Our guidance gives providers flexibility in how they communicate this information to users and prospective users of their research services. Some disclosures are appropriate for the broader market while others are specific to the research report. Consistent with international regulators, our objective with this guidance is to create ‘an environment where the research produced by analysts for clients is objective, clear, fair and not misleading’. Note: See IOSCO Statement of principles for addressing sell-side securities analyst conflicts of interest: A statement of the Technical Committee of the International Organisation of Securities Commissions, 25 September 2003, p. 2, at www.iosco.org. RG 79.45 We expect AFS licensees that prepare research reports to give the following information about their research products and services: (a) scope and expertise of the research service; (b) process by which products are selected for coverage and filters applied; (c) research methodology applied; (d) spread of ratings; and (e) conflicts management policy. Page 16 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 16 RG 79.46 We expect AFS licensees preparing research reports to give this information in a relevant and meaningful way so that users can understand and compare research services. Giving meaningful information about product coverage and filters, methodology and ratings spreads in particular, is critical for users of research to conduct a proper assessment of the research service and any limitations that apply to it. RG 79.47 Providers can make this information available in a number of ways and as appropriate to their business model or client group. For example, summary information may be publicly available on a website or in a separate document such as a Financial Services Guide (FSG) as appropriate to the provider’s business model. More detailed information may be made available to clients, subscribers and end users through direct communications or in the research report. We expect providers to direct users to this information in each research report. Where research is on-distributed to other licensees, we expect the research report to direct end users to these disclosures. RG 79.48 We will monitor compliance with our guidance in the course of future surveillance activities. Where these disclosures are not achieving the policy objective of improving the transparency and comparability of investment research, we will consider the need to impose licence conditions on AFS licensees providing research reports. Scope and expertise of research service RG 79.49 Research report providers should clearly communicate the nature and scope of their research service. This includes clearly communicating the extent to which they are promoting themselves as experts and the basis for this (e.g. providers should give summary information about the expertise, qualifications and experience they and their staff possess). RG 79.50 We expect research report providers to give sufficient information for a client or prospective client to understand the scope of the service and the expertise the provider brings to the research task. We do not expect these disclosures to include commercially sensitive aspects of the business. Coverage and filters RG 79.51 Many research report providers filter the financial products they cover in order to form smaller portfolios of products for more detailed research. The selection process may often be qualitative and users of the research should be made aware of this process and any selection biases that may affect research report providers’ coverage decisions. RG 79.52 Regardless of the research report provider’s approach, it should be clear to users (and prospective users) how a provider makes coverage decisions, what criteria they apply and any important limitations. For example, for equities Page 17 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 17 research, a provider may choose to cover equities on the basis of a certain sector of the economy or market capitalisation. For managed funds research, a provider may cover funds within an index or on the basis of some other criteria. RG 79.53 Coverage decisions can be relatively stable or dynamic depending on the business model adopted by the research report provider. We expect each provider to determine its approach to communicating product coverage. The purpose of such information is to give users a meaningful guide as to the approach adopted by that provider and any limitations in that approach. RG 79.54 If a research report provider begins or ceases to cover a financial product, or class of financial products, this information should be made available to clients or subscribers and, where practicable, providers should give reasons. For example, a provider may: (a) expand coverage to new sectors of the economy; (b) limit coverage to a narrower class of products than previously covered or within a class of products; (c) change the categories to which funds are allocated for rating which may have a significant impact on ratings spreads; or (d) publish research on a managed fund which is subsequently frozen and therefore cease coverage of the fund (see RG 79.100–RG 79.106). RG 79.55 Research report providers should publish on their website or with the research report, as appropriate, either: (a) a list of all financial products they currently cover; or (b) a description of the classes of products they cover and the scope (or percentage, as appropriate) of that coverage. RG 79.56 This description should include all products that are below the research report provider’s investment grade (or similar) rating. This information will give users a more holistic view of the available products, and align the risk profile of the products in the broader investment universe to which that product belongs. RG 79.57 Many research houses classify managed funds into specific peer groups to simplify the comparison of funds. These groups are defined by selecting funds which are similar in terms of asset class, asset size, investment objectives, risk, and investment style. The research report provider should explain the rationale for that selection and any limitations that apply. RG 79.58 Coverage policy is an important issue for users of research to understand to make sense of individual product ratings. A research report provider may give summary information about its coverage policy by type of product and indicate the extent of coverage within that category. We expect this information to be updated regularly for users of the research. Page 18 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 18 Example 1 A research report provider conducts a fact find and segments the market against certain criteria. The excluded products may have been filtered out on the basis of quality or certain qualitative and quantitative criteria and the rated products considered the ‘best of breed’ and therefore warranting further analysis. This process should be clear as the ratings spread is likely to mean more positive product ratings are likely to result and this information is important for readers of the resultant research. See RG 79.65–RG 79.69 on the spread of ratings. Methodology RG 79.59 We recognise that research report providers employ different methodologies. We do not seek to prescribe the way research report providers approach investment research, nor do we expect all providers to adhere to the same methodology. However, regardless of these differences, we expect research report providers to maintain and follow a robust methodology in their research and to be transparent in the methodology adopted and how it is applied. RG 79.60 To help users of research to assess different research models, research report providers should publish (in summary form) their methodology for assessing or rating products. We expect that this will include an explanation of their rating system, including the definitions, criteria and assumptions used. We do not expect providers to publish confidential, proprietary information. However, the information should be sufficient for a reader to understand the key elements of the methodology applied and any important limitations that may apply to it. RG 79.61 Regardless of where the information is published (e.g. on the provider’s website or in the FSG), research reports should direct readers to this information in the report. Example 2 Some research report providers employ a quantitative methodology, where ratings are generated based on past performance of the funds. This includes factors such as historical returns, volatility, performance ratios, age of fund and size of fund. Where the primary input is data from historical financial reports, for example, it is essential that users understand the extent to which those data inputs are reviewed (e.g. audited) or subject to any further review or analysis by the research report provider. Publishing ratings on the basis of such data may be misleading where users do not have sufficient information to evaluate the methodology employed. Reviewing and rating products RG 79.62 There are different ratings schemes (i.e. definitions or classifications) across the spectrum of research report providers. In some sectors, classifications and definitions (e.g. ‘buy, sell and hold’, ‘recommended, neutral, not recommended’) are relatively well understood. In other sectors, a lack of Page 19 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 19 consistency in definitions of ranking classification has affected the ability of users to make an accurate judgement of the quality of research. For example, when rating fund managers, there is no single or agreed method for classification of the type of fund manager within the investment universe. RG 79.63 This can lead to confusion among users about: (a) whether a product rating should be seen as an absolute conviction about the quality of a product, or a relative one against its peer group; and (b) whether the user can compare different research report providers’ classification of products. RG 79.64 We expect research report providers to provide a clear indication of the type and classification of products that they research and evaluate. Spread of ratings RG 79.65 Information about how the ratings methodology is selected and applied in practice—that is, beyond any general statement of principle—is important for readers relying on the research. RG 79.66 Providing information about the spread of ratings is an important accountability and transparency measure for both research report providers and users of their services. We expect research report providers to give information about the spread of their ratings (i.e. how many products or what percentage received each type of rating during the relevant period). This will give users of the reports another tool to gauge the quality and reliability of a particular research report provider. RG 79.67 These disclosures should be sufficient to assist users (and prospective users) to assess the methodology applied without including commercially sensitive aspects of the business. RG 79.68 Some research report providers already provide this information to their subscribers on their websites or with their research to their clients. For example, some providers are subject to international obligations to disclose their analysts’ spread of ‘buy, sell and hold’ recommendations over a given period. Providers should consider how they can meaningfully communicate their ratings spread in the context of the coverage decisions they make and the filters they use to select products for research. RG 79.69 Ratings spreads can also be affected by issuers withdrawing from the research process (where research is commissioned). Where this occurs, we expect providers to disclose how many issuers withdrew from the ratings process in a relevant period (such as the past year). Providers should give sufficient information for users to form a meaningful view of how these factors may affect the ratings spread and therefore a more holistic view of the research service. Page 20 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 20 Example 3 Some research report providers provide higher ratings or more positive recommendations more frequently than others. This is an important piece of information for users of these services. Conflicts management policy RG 79.70 Robust processes for managing conflicts of interest are important legal requirements and essential to producing good quality research. Users of research reports should have enough information to form a realistic view about the potential impact of any conflicts of interest on the quality and objectivity of the research service. If research report providers rely on a general disclosure obligation about how they manage conflicts of interest, this disclosure should include a statement on how such conflicts are managed where research is concerned. Testing the quality and integrity of research RG 79.71 Back-testing is a process by which a research report provider may compare the past performance of researched or rated products against relevant benchmarks. In our view, back-testing can be usefully employed as part of a research report provider’s review processes to test the rigor of a ratings methodology or the integrity of conflicts management processes. RG 79.72 While we do not require such processes under this guidance, we consider self assessment processes that review research methodologies, assumptions or ratings spreads, for example, to be best practice both for the research report provider and for wholesale clients such as financial advisers that rely on the research. We note that some research report providers already conduct such reviews in compliance with international obligations. RG 79.73 We consider that best practice review processes would include an annual review with the results being made available to the users of research reports by the same method that the research is generally distributed. We recommend that wholesale clients such as financial advisers consider whether such processes are in place, as part of their due diligence when purchasing research. We may revisit this issue in the context of any future compliance activity. Example 4 A research report provider conducts back-testing of past ratings to examine correlations between the ratings and the actual performance of products for a period, appropriate to a typical investment horizon of the product type (e.g. one year for equities, or three to five years for managed funds) after the research is published. Page 21 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 21 Example 5 Reviewing ratings spreads, such as the proportion of ‘buy’ recommendations a banking group’s corporate clients receive over a 12-month period compared to those of non-corporate clients, may provide a good indicator as to whether the research is of good quality and that conflicts are being effectively managed. Allocating appropriate resources RG 79.74 AFS licensees have general obligations under s912A(1) of the Corporations Act to: (a) do all things necessary to ensure that the financial services covered by their licence are provided efficiently, honestly and fairly; (b) comply with the conditions on their licence; (c) take reasonable steps to ensure that their representatives comply with the financial services laws; (d) have adequate financial, technological and human resources to provide the financial services covered by their licence and to carry out supervisory arrangements; (e) maintain the competence to provide the financial services covered by their licence; and (f) ensure that their representatives are adequately trained and competent to provide those financial services. Note: See Regulatory Guide 104 Licensing: Meeting the general obligations (RG 104) and Regulatory Guide 105 Licensing: Organisational competence (RG 105). RG 79.75 As the complexity of some financial products increases, it is essential that research analysts have the requisite skills and experience supported by an appropriate level of supervision and adequate sign-off processes to produce high-quality research. RG 79.76 Human resources are a key input to research report providers’ processes and output. Research report providers should allocate sufficient resources to support the effective performance of their research staff. RG 79.77 In some cases, research is heavily relied upon in the distribution of complex products to retail clients who are unlikely to properly understand the product their adviser recommends they invest in. Where this is the case, the expertise of the research analyst and the quality measures adopted by the research report provider are particularly important in ensuring retail investors (and their advisers) are making properly informed decisions. RG 79.78 Research report providers often cover a substantial number of financial products of varying complexity. Careful consideration needs to be given to balancing the commercial imperative to provide broad product coverage with the need to maintain the quality of research output and the allocation of adequate staff time to each research report. Page 22 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 22 Staff competence and expertise RG 79.79 To analyse financial products well, research report providers need to allocate appropriate resources to each research task. This includes allocating sufficient numbers of staff with suitable qualifications for the research task and setting appropriate timelines for the completion of tasks. RG 79.80 In light of continuing product innovation and developments in financial markets, research report providers should continue to train and supervise the work of their research analysts, particularly junior staff. This can be done by setting up mentoring and supervisory arrangements and ongoing training and development initiatives. RG 79.81 The requirements set out in Regulatory Guide 146 Licensing: Training of financial product advisers (RG 146) are a minimum, general standard for advisers. This standard establishes a basic level of competency, a platform upon which we expect AFS licensees to build to create the appropriate level of competency required for analysts to perform credible research. Rotating research analysts RG 79.82 Rotation of research analysts can be a useful way to reduce the risk that a research analyst becomes too familiar or close to the products and the product issuers under review, which may give rise to conflicts of interests. RG 79.83 If a research report provider decides not to rotate analysts in its practice, careful consideration should be given to how it will manage any possible conflicts of interest that may arise. For example, a research report provider might be too small for analyst rotation or believe that the benefits of analysts developing specialist knowledge and expertise in particular industries exceed the risks involved. Each provider should consider whether it is reasonable in the circumstances to rotate analysts. This issue should be the subject of internal compliance controls and monitoring. Research sign-off process RG 79.84 It is essential that an appropriate sign-off process is incorporated into a research report provider’s work process. All research should be subject to proper evaluation (e.g. via a peer review process) and a proper approval process (e.g. involving a committee of senior research staff: see RG 79.142). RG 79.85 Research reports should be based on reasonable grounds. It is important that the content of each research report reflects the view of the research report provider, and it may be misleading for a research report provider to publish a report containing views it does not agree with. An appropriate sign-off process would reduce the incidence of this risk: see RG 79.89–RG 79.91. Page 23 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 23 Preparing the research report RG 79.86 Quality measures operate in tandem with measures to manage conflicts of interest. They are mutually reinforcing and should be read together. Table 3: Quality and transparency measures for the research report Quality measures Description Reasons for opinions or recommendations Report should have clear, unambiguous reasons for its recommendations. Reports based on ‘reasonable grounds’ Research reports should be based on ‘reasonable grounds’, with each research report reflecting the views of the research staff who wrote or approved it. Reports for ‘proper purpose’ Offers or threats of favourable or unfavourable research must not be used to solicit benefits or other business, and research must not be used to unfairly or artificially increase trading volumes or to otherwise generate revenue for the provider’s ancillary businesses, for example. Past performance warning Where research ratings are based on past performance the past performance warning should be given. Who commissioned or paid for the research Where this occurs, it should be clearly and prominently disclosed in the research report. Publishing all (including adverse research) Many providers publish all research regardless of the rating while others only publish research where certain rating criteria are met. Publishing all research (broadly or limited to subscribers only) demonstrates research coverage and reduces the perception that conflicts of interest may interfere with the research process and outcome. Research should be dated and users should have information to assess the currency of research Providers should maintain the currency of research based on the parameters in this guide. Information about the currency of research must be made available to users. Research ratings should be available Research, both positive and negative, should be available with access to historical research to counter any perception that conflicts of interest may influence the ratings process. Reasons for opinions or recommendations RG 79.87 The research report (or accompanying disclosures) should state the reasons for the opinions and recommendations. This will help clients form a view about the research report and whether to rely on it. We expect all research report providers to take reasonable steps to ensure that their recommendations, and the basis for these recommendations, are clear, unambiguous and transparent. Note: This is particularly so for the main recommendation or opinion given in the report (if any). For example, research report providers should ensure that research reports explain terminology, rating systems and valuation methods used in the report. Page 24 REGULATORY GUIDE 79: Research report providers: Improving the quality of investment research © Australian Securities and Investments Commission December 2012 Page 24 RG 79.88 Research report provi