With the U.S. Securities and Exchange Commission (SEC’s)’s MiFID II ‘no action’ letter lapsing in July 2023, UK-based Substantive Research has found that all potential solutions to the issue “have fundamental problems.”
Substantive Research’s study, conducted in January 2023, follows up on an August 2022 survey collecting buy-side opinions on potential solutions before the ‘no action’ letter becomes out-of-date.
Currently, the US requires research to be paid in commissions alongside a trade while Europe is almost exclusively cash-only. To allow for European asset managers to do business with US brokers, the SEC published its ‘no action’ letter.
Initial findings warned that US broker and European fund manager relationships could be severely disrupted post July.
One potential solution, post-lapse, is for US brokers to become registered investment advisors (RIAs), something that would allow them to take cash payments. However many were hesitant to do so, due to operational and compliance risks.
While the 2022 survey saw the majority unsure of whether brokers would follow this route, with only 29 per cent believing that they would and 32 per cent that they wouldn’t, in 2023 almost three quarters (73 per cent) are confident that brokers will not become RIAs.
A second solution is for European asset managers to generate commissions from trading and reimburse subsequent funds. Many respondents claimed that this structure would not be well received by end-investors, who generally do not pay for research costs.
In August 2022, 64 per cent preferred not to adopt this regime and a further 36 per cent said they would “definitely not use this option.” The figures for these are now 47 and 43 per cent respectively, however 10 per cent state that they are now “prepared to create new structures if required.”
The third and final solution considered by the study is for European asset managers to pay US brokers exclusively in Europe for research covering both regions and markets. The immediate problem with this approach is the exclusion of US brokers without European entities, with smaller firms unable to maintain a European presence.
However, in both 2022 and 2023 the majority of respondents (60 per cent) expected market alignment with this strategy. Between the two surveys, those who believed that the solution would not work rose from 11 to 23 per cent, and those who “didn’t know” fell from 29 to 17 per cent.
Mike Carrodus, CEO of Substantive Research, says: “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.
“None of the potential ‘fixes’ for the MiFID II research disconnect are risk free and all involve added complexity and cost. There needs to be a significant rethink, or an entire universe of research will become inaccessible for a market who needs additional insights more than ever.”
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