SEC No Action Letters and European Commission FAQ

October 30, 2017

A joint approach to paying for research? SEC and European Commission release simultaneous statements on the MiFID II research rules.

Last week saw coordinated action from both the U.S. Securities and Exchange Commission (“SEC”) and the European Commission (“EC”) to address the incompatibility of MiFID II’s inducements and paying for research rules with existing U.S. federal securities laws. This has been welcomed as a positive move averting possible chaos within the asset management and brokerage sectors from January 2018. But do these measures solve the whole problem?

Below are key points from the twin statements from the SEC and EC, plus the accompanying press release from the UK’s Financial Conduct Authority (“FCA”).

The MiFID II Reforms: What was the Problem?

Under its expanded inducements regime, MiFID II prohibits investment managers from accepting “free” research from broker-dealer firms. Research services are permitted only if directly paid for by the manager, or via a Research Payment Account (“RPA”) controlled by it. The RPA can be funded either by a direct charge to the client, or through a research commission collected alongside (but separately identified from) an execution commission. Under current SEC rules, broker-dealers are prohibited from receiving hard dollars for research – effectively, the exact reverse of the MiFID II position. These rules (if implemented unchecked) would present major problems both for U.S. advisers organized on a global basis, and for EU investment managers receiving research from U.S. broker-dealers.

Last Week’s Statements: Who Said What

Securities and Exchange Commission

The SEC has released three “no-action” letters which, in combination, are designed to provide relief to U.S. investment managers and broker-dealers such that they (and their clients) can meet MiFID II requirements while remaining on the right side of U.S. federal securities laws, without requiring wholesale changes to their business models.

  1. U.S. Broker-Dealers: For a temporary period of 30 months beginning January 3, 2018, U.S. broker-dealers will be permitted to accept research payments from investment managers who are subject to MiFID II requirements (whether paying from P&L or via RPAs) without triggering the requirement to be a registered Investment Adviser;
  2. U.S. Money Managers:
    • Money managers and advisers may continue to aggregate orders on behalf of multiple clients, even where some clients are paying differing amounts for research due to MiFID II obligations. However, they must continue to implement procedures to prevent any account from being systematically disadvantaged.
    • Money managers can pay executing broker-dealers for research services via an RPA and still rely on the existing safe harbor under Section 28(e) of the Exchange Act (provided that the other applicable conditions of Section 28(e) are met).

European Commission
The EC has issued its guidance in the form of an FAQ which aims to guide EU investment firms on how to interact with non-EU broker-dealers for research and execution services:

  1. Single Commissions: EU investment managers, and their third country delegates, can combine payments to non-EU broker-dealers in a single commission, as long as the payment attributable to research can be identified.
  2. Non-EU Broker-Dealers: Broker-dealers are not obliged to identify a separate charge for research services to firms paying for research under MiFID II rules, irrespective of whether payments are made out of an RPA or directly by the investment manager – in other words, the obligation to determine the charge attributable to research falls on the EU manager or their non-EU delegate, not the non-EU broker (although the investment manager may want to consult with them before making that determination).

What is the Impact on EU and U.S. Managers?

EU managers are permitted to access research and execution services from non-EU brokers, but will have to make their own assessment of how much of a single commission payment is attributable to research. The EC appears to have worded this requirement vaguely, perhaps in the hope that a common industry approach will emerge.

Managers registered under both the SEC and EU regimes can pay hard dollars for research services from their U.S. research providers, whether or not these payments are made via an RPA. However, the situation is still problematic for global managers who wish to pay for research using soft dollars in the U.S., whilst paying hard dollars in the EU – in such cases, these groups will either have to erect intra-group information barriers to prevent sharing of research, or the EU firm will have to make a separate payment to its U.S. affiliate.

U.S. managers will find that their position has not substantially changed. EU counterparties trading with U.S. managers not directly subject to MiFID II are not obliged to separate out charges for research and execution services, although some are expected to do so for commercial reasons.

What are the Remaining Uncertainties?

The FCA’s Chief Executive also issued a statement broadly welcoming the joint SEC/EC initiative. However, in a loosely worded section, he appeared to endorse the concept of research circulated in a buy-side group. At face value, this would appear to allow the research purchased by a U.S. firm with soft dollars to freely circulate this with its UK/EU affiliate. However, this would appear to sharply contradict previous ESMA guidance.

Looking Further Ahead

The SEC appears to view the no-action relief as being more than just a temporary measure. The 30-month interlude is designed to give SEC staff sufficient time to better understand the evolution of business practices after implementation of the MiFID II research provisions. This implies some sympathy with the underlying intentions of the reforms, albeit tempered by a desire to watch and wait from the sidelines.

From an EU perspective, the EC’s announcement signals a partial retreat from a regime that could have severely disadvantaged European managers.


Next Steps

ACA is actively involved in discussions with its clients and affected firms. Should you wish to discuss the matter in greater detail please contact Martin Lovick, James Andrews, Adam Palmer or your regular ACA consultant with any questions.