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Anticipated impacts of MiFID II regulations on US and European asset managers

By Puja Sharma

August 18, 2022

  • Alternative Investment
  • Asset Management
  • Asset Managers
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asset management, managers, challenges

An asset management survey examines attitudes to impending structural market changes that put over $100m of annual research payments at risk.

Substantive Research,  a discovery and spend analytics provider for the buy-side, published the results of its latest asset management survey into the anticipated impact of the SEC allowing their MiFID II No-Action letter to expire in July 2023, which will be putting at risk over $100 million of annual research payments.

What are MiFID II regulations?

The MiFID II regulations that came into effect in Europe in January 2018 unbundled trading and research and pushed almost all European asset managers into paying for investment research in cash. At that time and in response, the SEC issued a No-Action letter that allowed European asset managers to pay US brokers in cash. The letter was not intended to be a permanent solution, and in July 2022, the SEC confirmed that the Division “does 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 fact that this has come 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 research surveyed 40 asset managers – 85% European and 15% Global/US, with a combined AUM of $6.5 trillion – on their attitudes to impending structural market changes and possible solutions for the multi-million dollar research market.

The overall finding is that European fund managers and US brokers that do business with each other will be severely disrupted, not only putting at risk over $100m of annual research payments but also decreasing competition in the research market, which has already been hit by MiFID II’s deflationary effects on research pricing.

What are some of the solutions?

  • Brokers could become Registered Investment Advisors (RIAs)

Six brokers to date have become RIAs, including BAML and Jefferies and which allows them to take research payments directly and in cash. The other brokers have decided against it mainly due to the added compliance burden and still have strong reservations. Even if they did decide to go ahead, it seems as if this solution would not allow them to supply the usual sales and trading content through the RIA, and they may have to create dual entities to provide the full research relationship to clients.

  • European asset managers could create “Research Payment Accounts” (RPA) accounts

The second solution to the expiry of the SEC No-Action letter would be for European asset managers to create RPAs, which is the only way they can generate research payments from trading commissions under MiFID II. However, these come with a complex administrative burden to comply with existing research unbundling rules, and there may be further regulatory clarification required for it to work.

For that reason, 100% of survey respondents had a preference against implementing new structures internally to pay US brokers who don’t create new entities or become RIAs.

  • A regulatory fix

Survey participants suggested that the SEC could introduce an “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.

  • The anticipated outcome of the SEC No-Action letter expiry

Asset managers are still consulting their legal departments and talking with their brokers, but 60% of those surveyed believe that the most likely outcome is that global US brokers will be paid entirely in Europe for research consumed in both regions and covering both markets. Therefore, any smaller US brokers that don’t have a European entity will be frozen out. These smaller brokers simply don’t have sufficient amounts of European revenues to justify fixing it all from their side and may be seen as necessary collateral damage from the European asset managers that cut them.

Key highlights

  • Views are split on whether brokers becoming Registered Investment Advisors (RIAs) solves research payment challenges, while Research Payment Accounts (RPAs) for the buy side are not considered a desirable option. Either way, they cannot be implemented in time.
  • 60% believe the most likely outcome is that global US brokers will be paid entirely in Europe for research consumed in both regions.
  • 68% believe that this change will mean market share further consolidates to the bulge bracket firms, decreasing competition in the research market, which has already been hit by MiFID II’s deflationary effects on research pricing.

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