Originally appeared in HFMCompliance, September 9th 2016
By Vicky Sanders, CEO RSRCHXchange
For a fund manager in the US, MiFID II and research unbundling has seemed distant for a while now. Both in the time to implementation, delayed a year to the beginning of 2018, and in physical distance, with the regulation emanating from the European Union. Global by nature, the financial research market is interconnected and governed by a sufficiently complex web of national regulatory frameworks. Because of this, regulation doesn’t often stay within the borders of the jurisdiction of the regulator creating the rules. Much of US regulation, whether recently Dodd-Frank or historically Elliott Spitzer’s Research Settlement, has been exported globally by the major US banks.
Recent meetings held by the US regulators have, however, brought MiFID II very much on-shore. MiFID II, which requires research to be unbundled from execution charges, introduces a contradiction for US broker-dealers. Under the 1934 Securities Exchange Act, US brokers are prevented from receiving direct payment for research unless registered as an investment advisor. Whereas, under MiFID II, banks and brokers must price and charge separately for their research services. Asset managers will be required to explicitly pay for research either from their own P&L or from a research payment account (RPA) funded by a direct fee to their clients or via a charge to clients collected at the point of execution. The SEC has acknowledged the major discrepancy between its own rules for broker-dealers accepting payments for research and the new European rules and it seems inevitable that something must budge.
There are options available to manage differences between jurisdictions, including, for example, a “no action” letter from the SEC. FINRA recently issued a filing suggesting that firms could use their international branches to facilitate sending research to EU clients and receiving payment in order to work around the conflict. The US could, as another alternative, adapt its own regulation to reflect the changes abroad. For the purpose of passporting to the EU, national regulators in places like Switzerland and Hong Kong are passing look-alike regulation to match the key components of MiFID II. And as we know, following the Brexit vote in the UK, passporting and therefore MiFID II become increasingly important with the phrase ‘regulatory equivalence’ on everyone’s lips.
From the perspective of a portfolio manager in the US, some see the new research rules fully implemented while others will remain relatively insulated for the time being. For an investment manager based in the US, receiving research only from US-based institutions, managing money for US clients, and trading US shares, there won’t be a tremendous amount of change other than some ripple effects. Many more will find themselves somehow wrapped up in the changes. Whether a satellite office of a EU-based fund manager or a US firm with an office abroad, many businesses have exposure to Europe and will begin to see the rules migrate across.
There are a few considerations for global businesses which make it difficult not to implement across their geographies. Global order routing processes, fairness to clients, and meeting the highest standard of global regulation are all factors pulling European rules across the Atlantic. Not to mention, more and more money is run in global funds and having different payment mechanisms for the same fund in different geographies quickly becomes unsustainable. Finally, if choosing to collect the charge alongside commission at the point of execution, then firms may actually be prohibited from charging different commission rates to different clients.
But this isn’t all bad news, bureaucracy and administration expense for asset managers; for many, having the freedom to pay for the content they actually want or need can be a liberating experience and one where they can improve their research inputs and better manage their costs. Where a marketplace for research develops in Europe, US portfolio managers may also find themselves with simpler access to a wide variety of research from banks who have been, to date, difficult to reach.
As we approach the fourth quarter, January 2018 is in sight and plans are beginning to emerge from asset managers and their banks and brokers. Committees are being formed to evaluate options and structures to adapt workflows to an unbundled world. National regulators in Europe, such as those in the UK, Germany and France, are releasing papers on research unbundling. US fund managers will look to their colleagues in Europe for guidance, but the wait-and-see time is quickly coming to an end. For US asset managers the need may be less pressing but it usually pays to be prepared as regulation is now a global phenomenon.
Vicky Sanders is Co-founder of RSRCHXchange, the online marketplace for institutional research