August 17, 2022

Substantive Research publishes buy-side reaction to SEC MiFID II No-Action Letter Expiry

Latest asset management survey examines attitudes to impending structural market changes that put over $100m of annual research payments at risk

  • Views are split on whether brokers becoming Registered Investment Advisors (RIAs) solves research payment challenges, while Research Payment Accounts (RPAs) for the buy side are not considered a desirable option. Either way, they cannot be implemented in time.
  • 60% believe the most likely outcome is that global US brokers will be paid entirely in Europe for research consumed in both regions.
  • 68% believe that this change will mean market share further consolidates to the bulge bracket firms, decreasing competition in the research market, which has already been hit by MiFID II’s deflationary effects on research pricing.

London 17 August 2022: Substantive Research, the research discovery and research spend analytics provider for the buy-side, today published the results of its latest asset management survey into the anticipated impact of the SEC allowing their MiFID II No-Action letter to expire in July 2023, putting at risk over $100m of annual research payments.

The MiFID II regulations that came into effect in Europe in January 2018 unbundled trading and research and pushed almost all European asset managers into paying for investment research in cash. At that time and in response, the SEC issued a No-Action letter that allowed 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 instead must pay through trading commissions, as their US counterparts do.

Mike Carrodus, CEO of Substantive Research, said: “The fact that this has come out without warning, and so quietly, may indicate that the SEC expects asset managers and brokers to be able to adapt to these changes without too much disruption. But our latest industry survey makes it clear that this will create enormous problems for both asset managers in Europe and the many US brokers that provide them with investment research.” 

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.

The overall finding is that European fund managers and US brokers that do business with each other will be severely disrupted, not only putting at risk over $100m of annual research payments but also decreasing competition in the research market, which has already been hit by MiFID II’s deflationary effects on research pricing. 

Three possible solutions have been suggested by industry participants, but all of these involve significant structural challenges. Even if any of them are viable options they are unlikely to be achievable before July 2023.

– Brokers could become Registered Investment Advisors (RIAs)

Six brokers to date have become RIAs, including BAML and Jefferies and which allows them to take research payments directly and in cash. The other brokers have decided against it mainly due to the added compliance burden and still have strong reservations. Even if they did decide to go ahead, it seems as if this solution would not allow them to supply the usual sales and trading content through the RIA, and they may have to create dual entities to provide the full research relationship to clients. Finally, there is a worry that if an asset manager took research from one of these RIAs they wouldn’t be allowed to trade with that broker, which would make it completely unworkable.

Our survey shows that there is no clear consensus amongst survey respondents as to whether large US brokers who haven’t yet registered as investment advisors will now do so:

– 29% of respondents think brokers will register as RIAs
– 32% of respondents think brokers won’t register as RIAs
– The remaining respondents are unsure 

– European Asset Managers could create “Research Payment Accounts” (RPA) accounts

The second solution to the expiry of the SEC No-Action letter would be for European asset managers to create RPAs, which is the only way they can generate research payments from trading commissions under MiFID II. However, these come with a complex administrative burden in order to comply with existing research unbundling rules, and there may be further regulatory clarification required for it to work. 

For that reason, 100% of survey respondents had a preference against implementing new structures internally in order to pay US brokers who don’t create new entities or become RIAs.

– A Regulatory Fix

Survey participants suggested that the SEC could introduce an “RIA-lite” designation that would be less onerous for brokers. This would probably reduce the time frame needed to register, and would remove key obstacles that the brokers’ compliance departments have identified. This solution was suggested in 2017 but the No-Action relief ensured that there was no need to proceed with it at the time. 

Mike Carrodus commented: “Many would also have sympathy with the opinion that the EU and FCA should be the ones to fix this, but with 27 countries needing to agree in the EU and the FCA focused on a number of other issues, a quick exemption to be allowed to bundle trades with research for US brokers would be very unlikely and probably unworkable, if it did happen.”

Carrodus added: “While this was not a problem of their own making, by far the simplest solution is for the SEC to listen to feedback from the US brokers and global asset managers headquartered in the US, and extend the No-Action for at least another year. RIA and RPA solutions cannot be put in place by July next year, even if brokers and asset managers started working on them now.” 

The anticipated outcome of the SEC No-Action letter expiry:

– Asset managers are still consulting their legal departments and talking with their brokers but 60% of those surveyed believe that the most likely outcome is that global US brokers will be paid entirely in Europe for research consumed in both regions and covering both markets. Therefore, any smaller US brokers that don’t have a European entity will be frozen out. These smaller brokers simply don’t have sufficient amounts of European revenues to justify fixing it all from their side, and may be seen as necessary collateral damage from the European asset managers that cut them.


– Accordingly,
68% of survey participants believe that this change will mean market share further consolidates to the bulge bracket firms, further entrenching a trend of market concentration to the big brokers, as covered in our April 2022 survey.

Carrodus concluded: “The reason this is a big problem is because even if the buy or the sell side decide they will be the ones to fix it, there isn’t time to implement solutions and the current rules mean they probably can’t fix it completely anyway. Without acknowledgement from the regulators that this is not something easily solvable, the likely outcome is that we will see more revenue hits for medium and smaller US brokers, and less diversity, choice and competition in the research industry. European fund managers will need to source research from an even more concentrated set of bulge bracket names than before.” 

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