BATTERED BY A bear market and rapid technological change, the broking industry is struggling to reinvent itself. The advent of online broking and large-scale program trading has hit the traditional brokerage agency hard, while the Spitzer Global settlement is forcing banks to cease subsidising research from investment-banking revenue. Quite how standalone broking is supposed to make money is far from clear. Market regulators will find it difficult to remove the incentive to cross-subsidise research simply because investment-banking fees are so large. Reforms seem to have only scratched the surface - a model still needs to be found where research pays for itself. This may become a step closer if the British regulator gets its way. In what is already being labelled Big Bang II, the Financial Services Authority (FSA) is proposing a radical overhaul to 'unbundle' brokerage services to fund managers so that trading and research is paid for separately - costs other than trading, such as research, would have to be split and permission from clients sought. Soft dollar commissions - the practice where brokers provide services for their commission, such as free Bloomberg or Reuters, terminals would also be outlawed. The catalyst for these proposals was a review of institutional investment in 2001 led by Paul Myners, the former chief executive of fund manager Gartmore. He complained that costs incurred by fund managers were routinely passed on to their clients, saying the practice reduced the economic incentive to cut expenses. Under the new regime, fund holders should benefit from lower dealing costs and the incentive for fund managers to reduce spending on research. While this industry jargon can be confusing, its implications are stark to many in the investment community. Whereas research costs have been implicit in commission rates and are routinely passed on to clients, they would now show up on the fund managers' profit and loss - costs will rise and profits fall. Conversely, fund holders should benefit from better performance through lower dealing and research charges. As you would expect, most fund managers oppose the changes. What is wrong with the old system? Well, when times are good, few questions are asked on management fees, but if your fund has just had its third down year, beating an index is not much consolation, especially if you now have to delay your retirement. Much of the political sympathy lies with the pension holders rather than fund managers as shortfalls in endowment mortgages and pension black holes fill the headlines. The implications are potentially far reaching. The demand for research will inevitably fall as fund managers must now bear its full cost. Fund trustees are unlikely to agree to an increase in management fees in today's climate. With a smaller pie to go round and a new direct-pay delivery mechanism, a shake-up in research providers looks inevitable. We will now get a system where research provision will be market-demand led, rather than the previous system, which encouraged mass production and consumption. There are concerns that research quality could suffer, yet there could be new opportunities for more nimble boutique providers due to their less onerous regulatory hurdles. While investment banks could still cross-subsidise their research, the new environment would surely make costs and pricing much less opaque. There are many other issues too numerous to include in this space. The practicality of the reforms is a grey area. What happens, for instance, if one fund manager's trustee agrees to pay for research and another does not? You then have the problem of the free rider. Also, could fund managers pick and mix research, or would they need to take the whole offering? As it stands, it seems clear that the industry remains in a state of flux. Unbundling may seem a radical solution to the issue of diminishing commission rates but should provide a powerful economic incentive for fund managers to cut expenses. The consumer should be able to see the true amount of fees behind a fund's performance. If the regulations do go through, expect the FSA to seek a global agreement, so Hong Kong - as a major financial capital - will not be insulated from these changes. It may be that even fund managers will finally find that the old adage now applies to them too - that there is no such thing as a free lunch! This time it might even be too late for a good old-fashioned bull market to keep the regulators at bay. Jake van der Kamp is on holiday