One of the most consequential parts of the EU’s expansive Markets in Financial Instruments Directive, better known as MiFID II, was to unbundle costs for European money managers by forcing brokers to charge separately for their research instead of folding it into commissions on trading. The idea was to increase transparency and root out conflicts of interest. However the rules, introduced in 2018, also reduced the amount of equity research available. A partial rollback in 2021 allowed costs to be rebundled for coverage of stocks with a market cap below €1 billion ($1.1 billion). Now EU member states are arguing for a near-total u-turn. If adopted, their proposals would mean that brokers simply need to tell clients whether they are paying for research and trading jointly, and record the charges attributable to each.
2. Why is this an issue in the US?
The prospect of a rollback comes at a key moment. In the US, a waiver that has allowed brokerages to charge their European clients separately for trading and research is about to expire, forcing them to finally find a solution for serving MiFID-bound money managers. The SEC’s “no-action letter” is set to expire July 3 – with the underlying issue still far from resolved.
3. Why is the SEC ending the waiver?
In order to sell research on its own, US brokerages are required to register as “Investment Advisers” and face more stringent and restrictive rules. Most have not been keen on that option. The waiver was meant to buy industry members time to either register or find an alternative solution; it seems the regulator has decided that more than five years is long enough.
EU-based money managers, their investors and American institutions providing them with research and trading services. From the US point of view, this includes everyone from major broker-dealers like Goldman Sachs Group Inc. and Morgan Stanley to smaller specialized players. Only a few, like Bank of America, have registered as Investment Advisers after MiFID II, allowing them to take payments for research. As for the others, there are signs that large US brokerages are planning to get around the rules by offering research through their overseas affiliates.
5. Why not just register as an Investment Adviser?
That status brings more onerous regulations for the bank, including a fiduciary duty — an obligation to act in the best interest of the client. Certain activities would be restricted, such as principal trading with the brokerage’s own book. More generally, they may view the unbundling of the market — where research costs are no longer combined with trading costs — as potentially less profitable. Meanwhile, if more brokers did register as Investment Advisers, it could change the whole landscape for US research because firms could then take cash for research from domestic clients as well. That could mean a mass unbundling of the entire market.
6. What’s been the impact of the EU rules?
There’s a big debate about that. The rules were intended to foster competition and more independent research. The consensus is that the supply of research has shrunk instead. Frost Consulting estimates European managers’ research budgets have plunged about 70% since 2016. The French regulator’s 2020 review concluded that coverage of Paris-listed stocks worth at least €1 billion fell 15% on average. The question is whether this is good or bad. Some academic studies have suggested that the remaining analysts have become more effective, while one paper found unbundling has no impact on commissions or fund fees. Critics pushing for a reversal say the drop in coverage has hurt liquidity, especially among small-caps, and only helped big banks that can afford to sell comprehensive research cheaply.
7. Where’s this headed?
No one is sure. With the EU planning to tweak some of MiFID II, industry groups and even members of Congress have been lobbying the SEC for a fresh extension until those changes can be implemented. If the waiver does expire, US brokers have several options beyond registering as Investment Advisers. SEC Chair Gary Gensler is said to have informally told industry groups that selling research to Europeans via an EU affiliate is an acceptable solution, though there has been no official green light and it raises a litany of questions related to tax and regulation. It’s also not an option for brokers without a European affiliate. Other possibilities include money managers paying for US research with bundled commissions, and then reimbursing their European investors. Alternatively, American brokers could simply cut MiFID-bound clients off from US research.
• A QuickTake explainer from 2018 on MiFID II and the QuickTake on the market for investment research.
• Our news report from June 2023 on Gary Gensler confirming that the waiver will expire.
• A story on how the US industry started to allow even domestic clients to pay for research separately.
• A story on the extension of the US waiver in 2019. Wall Street Gets 3-Year Reprieve From SEC on MiFID Compliance
• A link to the pushback against ending the waiver from industry body SIFMA.
–With assistance from Justina Lee.
More stories like this are available on bloomberg.com
