The US Securities and Exchange Commission decision to allow a no-action letter related to MiFID II to expire in July 2023 could put $100 million of research payments at risk and trigger further consolidation, according to a report from research analytics firm Substantive Research.
The survey, which canvassed 40 managers with a total of $6.5 trillion in assets, found that the majority were concerned that third-party and independent research providers would be most impacted while the large investment banks would gain additional market share.
The result of the MiFID II unbundling requirements in 2017 was that almost all European asset managers paid for investment research in cash. In response, the SEC issued a No-Action letter them to do the same for their US brokers.
However, this was not intended to be a permanent solution and in July, the SEC confirmed that it did “not intend to extend the temporary position beyond its current expiration date in July 2023”.
This means that European asset managers will no longer be allowed to pay for US broker research in cash, and instead must pay through trading commissions, as their US counterparts do.
Mike Carrodus, CEO of Substantive Research, said the ruling came out “without warning, and so quietly, may indicate that the SEC expects asset managers and brokers to be able to adapt to these changes without too much disruption.
But our latest industry survey makes it clear that this will create enormous problems for both asset managers in Europe and the many US brokers that provide them with investment research.”
The report highlighted respondents’ suggestions to improve the situation, but warned that they all involved significant structural challenges.
One option is for brokers to become registered investment advisors (RIAs). A number including Bank of America and Jefferies, have already done this, allowing them to take payments directly. However the survey shows that asset managers are split on whether this ultimately solves the challenges around paying for research.
European asset managers could also create research payment accounts (RPA) accounts, which is the only way they can generate research payments from trading commissions under MiFID II. However, the survey notes that these come with a complex administrative burden in order to comply with existing research unbundling rules, and there may be further regulatory clarification required for it to work.
For that reason, the report said 100% of survey respondents had a preference against implementing new structures internally in order to pay US brokers who don’t create new entities or become RIAs.
Last but not least, was a “RIA-lite” designation that would be less onerous for brokers. This would probably reduce the time frame needed to register, and would remove key obstacles that the brokers’ compliance departments have identified.
This solution was suggested in 2017 but the No-Action relief ensured that there was no need to proceed with it at the time.
“Many would also have sympathy with the opinion that the European Union and UK’s Financial Conduct Authority should be the ones to fix this, but with 27 countries needing to agree in the EU and the FCA focused on a number of other issues, a quick exemption to be allowed to bundle trades with research for US brokers would be very unlikely and probably unworkable, if it did happen,” said Carrodus.
He added, “While this was not a problem of their own making, by far the simplest solution is for the SEC to listen to feedback from the US brokers and global asset managers headquartered in the US, and extend the No-Action for at least another year. RIA and RPA solutions cannot be put in place by July next year, even if brokers and asset managers started working on them now.”