MiFID II officially entered the global financial services sector about a year ago. But while most are acutely aware of its impact on financial markets domiciled in the European Union, few understand its implications overseas.
Today, the US remains a market of focus.
Saved by Temporary Lifelines
Shortly before MiFID II came into force, US broker-dealers supporting EU investment managers were thought to be severely exposed to regulatory disruption.
The main reason: In receiving separate compensation for research services rendered, broker-dealers would be considered investment advisors under US law. That meant facing more stringent regulatory requirements, including restrictions on certain types of trading with clients they “advised”.
Broker-dealers previously skirted the requirements via an exemption in the law that allowed for research payments to be bundled with client commissions paid for executing trades. Unfortunately, the standalone research payments mandated by MiFID II all but plugged that loophole.
With no timely solution at hand, the US Securities and Exchange Commission (SEC) had to move swiftly to temper MiFID II’s impact or risk a sector-wide fallout. Such pressing circumstances led the SEC to introduce non-permanent no-action reliefs after holding consultations with the EU.
Out-and-out brokers and dealers cheered the news.
They now had a new kind of exemption, albeit a temporary one, that granted them the legal right to render research services to EU investment managers, and to receive payments separately without being penalised.
Investment advisors, too, caught a break with their own version, which permitted them to continue aggregating orders to buy or sell securities, all while receiving varying payments for research from EU clients. This was done on condition they charge clients the same average price for the security and execution costs.
A third no-action relief also helped US money managers operate within the safe harbour, as long as they paid executing broker-dealers for research with client assets through a MiFID II-approved research payment account.
Time to Ask the Hard Questions
The trio of no-action reliefs brought about a welcome respite to the US financial services sector. And to some degree, even enabled market players to act more in accordance with the spirit of MiFID II.
For the SEC, the exemptions bestowed the luxury of time to engage with other regulators, including those in Europe.
“As the staff evaluates possible recommendations, it is invaluable to hear from a diverse group of market participants,” commented SEC Chairman Jay Clayton in a press release. “In particular, it is important to have data and other information about how MiFID II’s research provisions are affecting broker-dealers, investors and small, medium, and large issuers, including whether research availability has been adversely affected.”
Still, that begs the question: How long is too long for a temporary fix?
Alluding to duration, former SEC Commissioner Kara M. Stein has warned that “while a time-limited approach may allow staff to study the impact of MiFID II, taking over 900 days is simply unreasonable.”
This inaction, she adds, may be costly to investors and advantage some market participants over others.
The industry now stands at the crossroads. Market participants can either capitalise on this new regime of provisions to gauge MiFID II’s impact and plan an appropriate response or use the temporary measures as a mere excuse to prolong inaction.
Don’t Discount Market Pressures
Those who go the distance to enact change will actually discover that it’s in their best interest, especially in winning favour from investors.
US asset managers, for example, might eventually be pressured to pay separately for research as clients demand equal treatment and cost transparency, similar to their European counterparts.
According to Smartkarma’s Head of US Business Development Warren Yeh, some have been known to go so far as to absorb the cost of research with a good deal of bravado to prove their incredible level of client accommodation.
Just last year, Vanguard Group pledged to pay for stock research it purchased from banks. A move of this measure from one of the world’s leading money managers would inadvertently place pressure on rivals to follow suit, or risk alienating themselves from clients.
Viewed in this context, free market forces can indeed be a force for change more powerful than any regulatory mandate can ever be.
David(s) vs. Goliath(s)
There is a darker side, however, to such free-market competition: Research providers – the supply side – are now caught in a tussle for market share.
Of late, more independent research upstarts have come into the fray because of increased demand generated by MiFID II.
Big banks have responded by engaging in a price war of attrition. If market participants recall, not long ago JP Morgan made headlines for offering access to basic equity research for as low as US$10,000 per year.
Insight Provider Douglas Kim, who publishes on Smartkarma, views this race to the bottom as a way to further weed out smaller independent research firms and platform operators over the next one to two years.
But price isn’t everything.
“In the end, as in every service industry, it all comes down to focusing on the customer and delivering a great value proposition,” said Kim.
“Whether it be timely, in-depth thematic research, a great long-short call, or helping the client to better understand a new technological concept, independent research providers need to provide great ideas and differentiated research on a consistent basis so that investment managers would find reasons to continue purchasing their research services,” he adds.
Tick Tock, Tick Tock
MiFID II’s strong influence in the US financial services sector is undeniable, and its long-term impact is still very much uncertain.
However, as Wall Street ponders the many ways forward to step out of the shadows of no-action reliefs, one thing remains clear: resistance to change only impedes market competitiveness.
Time is running out.
The original version of this article was published in November 2018 on TabbFORUM.