By Daniel Carpenter, Head of Regulation at Meritsoft (a Cognizant company)
Over a year has passed since the introduction of MiFID II, and the situation for research brokers has changed beyond all recognition – and not just for those operating in Europe. The massive increase in the cost of research, partially driven by the substantial additional administration burden requiring individually itemised costs, has weighed heavily on research houses with asset managers focusing their budgets in the midst of an industry shakeup. While US broker-dealers servicing European clients were recently provided some relief in the form of no-action letters issued by the SEC, these letters are set to expire in just over a years’ time.
All of the above and the extended adoption of CSA’s (Commission Sharing Agreements) have triggered widespread speculation about what the landscape of research payments will look like. Will the letters be allowed to lapse? Will ‘unbundling’ find its way over to the US? The next 12 months looks increasingly uncertain for research houses, but should it?
For those unfamiliar with the regulatory climate in Europe, these changes will see research houses tasked with itemising the cost of investment research and then “unbundling” this from the costs of transactions billing. These are the costs which would previously have been combined with the other fees paid by the asset manager. Under MIFID II, research houses have two choices; they can bill the client for a separate research fee, or absorb the costs of research in their P&L. Either way, research houses need to have the right solutions and infrastructure in place to itemise these costs, communicate them with recipients and reconcile consumption. The rest is up to them.
The new rules have transformed how markets operate in Europe and the SEC has clearly taken note. At a recent industry conference, two representatives from the SEC highlighted their concern stating that ‘unbundling’ would benefit larger houses, while damaging mid-sized and smaller brokers. Despite this, the same representatives acknowledged that the regulatory body is looking at different answers to the questions posed in the no-action letter. It looks increasingly likely that the solution will, at its heart, most likely involve asset managers paying for their European-facing research separately from other services.
The SEC has confirmed that regardless of which approach, or approaches, it finds workable they are likely to issue guidance or “market-based” no-action relief to provide the industry with clarity about acceptable solutions for compensating US brokers for their investment research. However, US research and brokerage houses cannot afford to sit and wait for the SEC to provide specific steps. It is safe to assume, regardless of the policy outcome, that asset managers will want a much more granular level of insight into their research activity, with audited research interactions which can then be invoiced, as well as tracked and aligned with CSA’s. With this in mind, research business lines need to see the writing on the wall and begin making the necessary preparations for a landscape that will bear some resemblance to Europe’s.
Looking at the bigger picture, the no-action letters are just the tip of the iceberg. Its almost two years since Sharon Bowen, former CFTC Commissioner, strongly endorsed the adoption of a MIFID II-style set of regulations in the US, and while there’s been no solid action yet, the momentum amongst US policy makers is building for an equivalent set of rules. The debate around the no-action letters provides banks and research houses with an opportunity to fully integrate the best systems for itemising research costs, not just for European-facing clients, but also for all US-facing clients who would surely be affected by a US version of MiFID II.