Research market in dire straits as SEC’s ‘no-action’ letter on MiFID II lapses in June – survey

Rick Steves

“Of all the regulatory news that has hit the research market in the last few months, this is the one change that will fundamentally impact what fund managers can access and pay for in future.”

Markets are unprepared for the imminent structural changes impacting the investment research industry from summer 2023, caused by the lapsing of the SEC’s ‘no-action’ letter on MiFID II, a research study found.

Substantive Research published the results of a survey of 40 Asset Managers with a combined AUM of $6.5 trillion, gauging their reaction to SEC’s ‘no-action’ letter on MiFID II.

What’s the big deal with the lapse of SEC’s ‘no-action’ letter on MiFID II?

When MiFID II came into effect in 2018, Europe unbundled trading and research, forcing almost all asset managers to pay for research in cash only.

The regime in the US is the direct opposite of this approach, as the SEC requires research to be paid in commissions alongside a trade and doesn’t allow for research to be paid in cash.

To solve the disconnect, shortly before MiFID II was implemented, the SEC issued a ‘no action’ letter, which acted as a ‘carve out’ that allowed European asset managers to pay US brokers in cash.

However, in July 2022, the SEC stunned the markets by giving notice that it would allow the ‘no action’ letter to lapse in July 2023, believing that there were sufficient viable solutions, and sufficient time for asset managers to prepare for the rule change.

In July 2023, the SEC will allow its ‘no-action’ letter on MiFID II to lapse which will cause major disruption for the transatlantic investment research market, putting over $100 million of annual research payments at risk.

There are potential solutions to the disconnect, but they are all fraught with significant challenges and Substantive Research’s survey shows that there is no consensus amongst Asset Managers on how to solve the problem. With six months to go until the deadline, time is running out.

Mike Carrodus, CEO of Substantive Research, said: “Of all the regulatory news that has hit the research market in the last few months, this is the one change that will fundamentally impact what fund managers can access and pay for in future. Almost six months on from the SEC’s surprise announcement that its ‘no action’ letter will lapse, and with six months to go before the deadline, our research shows that there is still no viable way forward for asset managers and time is running out.”

What solutions are there and what asset managers think

The first possible solution is that brokers become registered investment advisors (RIAs), with a handful having already done so. This would allow them to take payments in cash from asset managers, but creates significant operational and compliance burdens and risks, and many brokers have expressed deep reservations about taking this route.

The report found that asset managers are increasingly doubtful that brokers will solve research payment challenges by becoming Registered Investment Advisors (RIAs) – 73% now do not expect US brokers to register as RIAs (vs. 33% in Aug 2022).

The second solution would be for European asset managers to create structures where they generate commissions from trading, but then reimburse the funds in order to keep research costs away from clients, (buy-side firms say that end investors are now used to not paying for their asset managers’ research costs, and would not allow a reversal back into these charges.)

On the likelihood of European asset managers solving the issue by creating structures to generate commissions from trading, the number of firms that will ‘definitely not adapt their processes’ rose to 43% from 36% last year.

The third solution would be for European asset managers to pay US brokers entirely in Europe for research consumed in both regions and covering both markets. But that would mean that any smaller US brokers that don’t have European entities would be frozen out, as they simply don’t have sufficient amounts of European revenues to justify fixing it all from their side. But from the perspective of European asset managers, losing access to these niche US brokers may be seen as necessary collateral damage in the quest to keep processes simple and straightforward.

On US brokers being paid via their European business units as a solution to the problem, 60% of respondents thought this the most likely outcome (unchanged from last year), but the number saying this would not work grew from 11% to 23%.

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