The European buy-side expects to be severely disrupted by the US Securities and Exchange Commission’s (SEC) recent decision to allow its research no-action letter to expire in 2023, a Substantive Research survey has found.
Originally published in response to research unbundling requirements under Mifid II in 2018, the letter was designed to temporarily reduce pressure on EU buy-side firms by allowing them to pay US brokers in cash for research. Its expiry means firms will now have to pay through trading commissions like their US counterparts.
In the survey conducted by Substantive Research, 40 asset managers – 85% of which were European – found that the SEC’s decision would likely put $100 million worth of annual research payments at risk and decrease competition in the already suffering research markets by channelling business away from smaller firms and into already larger bulge bracket names.
Substantive Research chief executive, Mike Carrodus, implied the quiet approach the SEC had taken to this decision suggested that the regulator expected participants to be able to adapt to the changes easily.
Several solutions have been put forward by participants including brokers becoming Registered Investment Advisors (RIAs) – a route already opted for by Jefferies and Bank of America Merrill Lynch – allowing them to take payments directly and in cash. A third of buy-side respondents expected brokers will not do this in Substantive’s survey.
Alternative solutions include EU asset managers creating Research Payment Accounts (RPAs) – the only way they can generate research payments from trading commissions under Mifid II – or the SEC introducing a “RIA- lite” regulatory fix. All respondents had a preference against the RIA option due to a complex administrative burden and potential for further regulatory clarification down the line.
Carrodus added that even if implemented immediately, these solutions would not be available by July next year when the letter expires. Instead, he suggested the SEC should consider extending the letter for a further period to allow firms to come to terms with the changes.
“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,” said Carrodus.
“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.”