In far-reaching analysis, US-based CFA Institute has assessed the impact of Mifid II on US research and what it means for the future and presented an agenda for authorities to adopt to deal with the many challenges posed by the European regulation.
In ‘The Future of Research in the US after Mifid II’, CFA Institute makes it clear that Mifid II has taken US regulations on the purchase of investment research to a place they ‘were not prepared to go’.
It also points out that the SEC had to issue three no-action letters in 2017 to help US investment firms avoid running afoul of EU regulations – once implemented in January 2018 – indicating the difficult job the commission had in reconciling the two systems: the US soft-dollar system and Mifid II.
The CFA report states: ‘Mifid II is also causing tectonic shifts in the competitive balance between asset managers, brokers and research providers. Sophisticated asset owners, for example, have long called for disclosure of research costs paid through client brokerage, but with little success.
‘Sensing the change in competitive balance from Mifid II, however, US asset owners are not only demanding disclosure of how their hired asset managers are using client brokerage, but in some cases also demanding they not be asked to pay for research at all.’
The report puts in context the June 26, 2019 letter to Jay Clayton, chair of the SEC, in which CFA Institute, together with the Healthy Markets Association and the Council of Institutional Investors, conveyed two recommendations to address issues raised by Mifid II for US-based broker-dealers and asset managers.
This coalition recommended that the SEC revise guidance under Section 28(e) of the Securities Exchange Act of 1934 as follows:
- Require investment managers and advisers who seek to rely on the Section 28(e) safe harbor to disclose amounts paid for research from client assets
- Require investment managers and advisers who seek to rely on the Section 28(e) safe harbor to adopt and implement procedures to ensure benefits of research go to the asset owners who pay for it.
To address the conflicts and changes Mifid II has created for US-based broker-dealers and asset managers, CFA Institute in this latest report recommends the following regulatory and industry responses:
- The SEC should interpret Section 202(a)(11) to permit broker-dealers to accept cash as payment for investment research without having to register as investment advisers
- The SEC should require asset managers to disclose to their asset-owner clients the cost of research purchased on their behalf through client brokerage arrangements
- Asset managers should adopt policies and procedures to ensure the research purchased from client brokerage arrangements, over time, benefits the asset owners whose trading commissions paid for it
- Asset managers should adopt and implement policies and procedures that move toward separating research procurement decisions from decisions about with whom and how to trade
- The SEC should consider investor outcomes rather than specific costs when interpreting whether an investment manager or adviser is achieving best execution for its clients
- The SEC should revise its interpretations of Section 28(e) and such other rules and guidance as is necessary and appropriate to put these recommended reforms into effect.
Jim Allen, head of Americas capital markets policy at CFA Institute, tells IR Magazine: ‘We think it is time the SEC revisits its interpretation on whether broker-dealers would have to register as investment advisers if they accepted cash in payment for their research. The more transparent the payments for research, the more asset owners will have an opportunity to ensure they are getting what they pay for.
‘Greater transparency around how much investment managers pay brokers and others for research is something asset owners have long wanted, and something CFA Institute has recommended since the release of its original Soft Dollar Standards.’
In 1998, as part of a coalition, CFA Institute helped to establish the Soft Dollar Standards, a project educating both members and the broader industry about the appropriate ethical use of this intangible asset. Their guiding principle was that any value an asset manager derives from trading investment assets on behalf of a client ultimately belongs to that client and use of that value must be to the benefit of that client.
‘The Soft Dollar Standards our organization created back in 1998 have withstood the test of time and remain relevant today,’ adds Allen. ‘Many regulatory changes have occurred in the intervening 21 years, including better regulatory definitions about what investment managers could buy with benefits generated from clients’ trades.
‘Implementation of these recommendations will take ethical standards in the industry a further step toward what our member volunteers recommended those many years ago.’