Latest Substantive Research survey shows the markets are unprepared for iminent structural changes impacting the investment research industry from summer 2023

  • Asset managers are increasingly doubtful that brokers will solve research payment challenges by becoming Registered Investment Advisors (RIAs) – 73% now do not expect US brokers to register as RIAs (vs. 33% in Aug 2022).
  • On the likelihood of European asset managers solving the issue by creating structures to generate commissions from trading, the number of firms that will ‘definitely not adapt their processes’ rose to 43% from 36% last year.
  • On US brokers being paid via their European business units as a solution to the problem, 60% of respondents thought this the most likely outcome (unchanged from last year), but the number saying this would not work grew from 11% to 23%. 

London, 06 February 2023: Substantive Research, the research discovery and research spend analytics provider for the buy-side, today publishes the results of its updated survey on the anticipated impact of the SEC allowing its MiFID II ‘no-action’ letter to expire.  

With just six months to go until the letter lapses, there is still major confusion amongst the asset management community and a lack of consensus about a satisfactory way forward, leaving over $100m of annual research payments at risk.

Background to the issue

When MiFID II came into effect in 2018, Europe unbundled trading and research, forcing almost all asset managers to pay for research in cash only.  The regime in the US is the direct opposite of this approach, as the SEC requires research to be paid in commissions alongside a trade and doesn’t allow for research to be paid in cash.  To solve the disconnect, shortly before MiFID II was implemented, the SEC issued a ‘no action’ letter, which acted as a ‘carve out’ that allowed European asset managers to pay US brokers in cash.  However, in July 2022, the SEC stunned the markets by giving notice that it would allow the ‘no action’ letter to lapse in July 2023, believing that there were sufficient viable solutions, and sufficient time for asset managers to prepare for the rule change.

Substantive Research’s survey shows that all the potential solutions have fundamental problems that guarantee significant disruption.

Substantive Research’s previous survey – August 2022

In August 2022, shortly after the SEC’s announcement, Substantive Research conducted a survey of the buy-side, to gauge the opinions of the largest asset managers, to learn what resolutions they thought were most likely to solve the problems that the lapsing of the ‘no action’ letter would cause.

Its original findings were alarming, with buy-side consensus that this development could severely disrupt the way European fund managers and US brokers do business with each other, putting at risk over $100m of annual research payments and decreasing competition in the research market. 

Mike Carrodus, CEO of Substantive Research, said:  “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.”

Likely solutions – latest survey findings, January 2023

1. The first possible solution is that brokers become registered investment advisors (RIAs), with a handful having already done so. This would allow them to take payments in cash from asset managers, but creates significant operational and compliance burdens and risks, and many brokers have expressed deep reservations about taking this route. 

  • In the August 2022 survey respondents were unclear as to whether brokers would take this route, with 29% of respondents of the view that they would, 32% of the view they wouldn’t, and the remaining respondents unsure. 
  • The updated 2023 survey shows that asset managers are now much less hopeful that brokers will solve the impasse this way. 73% now do not expect US brokers to register as RIAs, with 7% saying they will and 20% unsure.

2. The second solution would be for European asset managers to create structures where they generate commissions from trading, but then reimburse the funds in order to keep research costs away from clients, (buy-side firms say that end investors are now used to not paying for their asset managers’ research costs, and would not allow a reversal back into these charges.) 

  • In August 2022, 64% of respondents said they would rather not, with 36% saying they definitely will not use this option. They had just completely revamped their research valuation and payment processes due to MiFID II, and expressed very little interest in complicating things even further now.   
  • The updated survey shows an increase to 43% of firms that “definitely will not adapt their processes”, and accordingly a smaller number, 47%, who “would rather not”. However, 10% of respondents are now “prepared to create new structures if required” which is a new development since last summer’s poll. 

3. The third solution would be for European asset managers to pay US brokers entirely in Europe for research consumed in both regions and covering both markets. But that would mean that any smaller US brokers that don’t have European entities would be frozen out, as they simply don’t have sufficient amounts of European revenues to justify fixing it all from their side. But from the perspective of European asset managers, losing access to these niche US brokers may be seen as necessary collateral damage in the quest to keep processes simple and straightforward.  

  • In August ‘22, 60% of respondents expected this to be the solution that the market aligned with, and this is exactly the response received in the updated survey, unchanged at 60%. The number that “didn’t know” decreased from 29% to 17%
  • But the buy-side is now split as indicated above – with the number saying this solution would not work increasing from 11% to 23%. 
  • These are the firms who will have to create entirely new research funding and payment structures. They’ve decided to take the solution into their own hands – and will have to work quickly to have everything in place by July this year. New commission sharing processes will be set up to be able to pay alongside a trade, but then the funds will be reimbursed afterwards to ensure end investors are still protected from these costs.

Mike Carrodus, CEO of Substantive Research added: “None of the potential ‘fixes’ for the MiFID II research disconnect are risk free and all involve added complexity and cost.  So for both the SEC and the industry itself, 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.” 

Substantive Research surveyed 40 asset managers – 85% European and 15% Global/US, with combined AUM of $6.5 trillion – on their attitudes to impending structural market changes and possible solutions for the multi-million-dollar research market.

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