Securities Finance Industry News | SEC decision to let MiFID II no-action letter expire could cause problems

According to Mike Carrodus, CEO of Substantive Research, the US Securities Exchange Commission’s (SEC) decision to allow its second no-action letter relating to the Markets in Financial Instruments Directive (MiFID II) to expire “will create huge problems for asset managers in Europe”.

Carrodus’ comments come in response to Substantive Research’s asset management survey which examines attitudes to impending structural market changes, including the SEC’s decision to expire the MiFID II no-action letter in July 2023.

Carrodus added that the introduction of an expiry date could throw global research markets and relations between European and global asset managers and US brokers into chaos, with adverse effects on competition on the investment research market.

The MiFID II regulations that came into effect in Europe in January 2018 separated trading and research and pushed almost all European asset managers to pay for investment research in cash.

At that time, and in response, the SEC issued a no-action letter allowing 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 will instead have to pay through trading fees, as their US counterparts do.

As part of its survey seeking opinions on the expiration date of the no-action letter, Substantive Research interviewed 40 asset managers – 85% were European while the remaining 15% were based outside of Europe. Europe.

The general conclusion was that European fund managers and US brokers who do business with each other will be severely disrupted, with added concern about less competition in the research market, which has already been hit by deflationary effects. of MiFID II on research. pricing.

60% of asset managers predict that the most likely outcome will be that global US brokers will be fully paid in Europe for research consumed in both regions. Therefore, all small US brokers that do not have a European entity will be excluded.

However, Substantive Research claims: “These smaller brokerages simply don’t have enough European revenue to justify fixing everything on their end, and can be seen as necessary collateral damage from the European asset managers who have them. cut.”

As a result, 68% of survey participants believe that this change will mean that market share will further consolidate in favor of companies in the bulge bracket, further entrenching a trend towards market concentration for large brokers.

Two other possible solutions that have been suggested by industry participants include broker-dealers becoming Registered Investment Advisers (RIAs), or a broader regulatory solution – the SEC’s introduction of a “RIA-lite” designation. which would be less costly for brokers.

Substantive Research says this would likely reduce the time it takes to register and remove key barriers identified by broker compliance departments. This solution was suggested in 2017, however, the relief without action ensured that it was not necessary to pursue it at the time.

Respondents’ opinions were split on whether brokers becoming Registered Investment Advisers (RIAs) would solve research payment issues, while research payment accounts (RPAs) for the buy side are not. not considered a desirable option. Either way, neither can be implemented in time, according to Substantive Research.

Commenting further on the research findings, Carrodus comments: “Many would also agree with the view that the EU and the UK’s Financial Conduct Authority (FCA) should be the only ones to solve this problem, but with With 27 countries to agree in the EU, and the FCA focused on a number of other issues, a quick exemption to be allowed to aggregate trades with the search for US brokers would be highly unlikely and likely impossible, if it happened.

He adds, “While not a problem on their part, by far the easiest solution is for the SEC to listen to feedback from US brokers and US-headquartered global asset managers, and extends the non-action for at least another year. RIA and RPA solutions cannot be implemented by July next year, although brokers and asset managers have started working on them now.

“Without the recognition from regulators that this is not something easily solvable, the likely outcome is that we will see more revenue for midsize and smaller US brokers, and less diversity, choice and competition in European fund managers will need to source research from an even more concentrated set of bulge range names than before.

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