Big Wall Street banks are struggling to respond to rules governing investment research after the main US watchdog brushed aside pleas for a second extension to a temporary waiver.
After July 3 US broker-dealers are set to lose the protection of a five-year “no action” letter from the Securities and Exchange Commission that covered them against having to register as investment advisers.
Those affected include Goldman Sachs, Morgan Stanley, JPMorgan and Citigroup.
The waiver stemmed from the EU’s 2018 Markets in Financial Instruments Directive, which required investors to pay separately for investment research and trading services.
European rules only mandate investors based in those jurisdictions to “unbundle” the payments, not US investors. However, US regulations consider brokers to be investment advisers if they charge specific fees for research rather than bundling it as a service with sales and trading.
US banks have been accepting payments from Mifid-compliant clients, but have been protected by the SEC’s letter from registering as investment advisers.
Without that protection they face a choice of registering, moving research teams in to already registered affiliates, or potentially cutting clients bound by Mifid regulations off from research produced in the US.
“Banks are talking to each other and to their clients. It’s already causing disruption,” said one person involved in the behind-the-scenes discussions.
All four banks declined to comment.
Last month SEC chair Gary Gensler and senior staff met bank representatives as well as industry associations to discuss the issue. But the regulator ultimately refused to alter its long-held stance, according to three people with knowledge of the meeting.
The SEC declined to comment.
Banks have resisted Investment Adviser status because it would restrict them from some activities including principal trading, and could hinder their ability to offer bespoke research, according to people with experience of the rules. The costs and complications of reorganising to register would depend on each bank’s individual arrangements, but were not insurmountable, they added.
Several brokers including Bank of America and investment bank Jefferies registered research units as IAs as part of their initial response to Mifid in 2018. Both offer full-service investment banking and their services did not change after the switch. Bank of America and Jefferies declined to comment.
In July last year the SEC said that it did not intend to extend the no-action letter, emphasising that it was always only intended as a temporary stop-gap while the industry ironed out any issues in complying with the Investment Adviser regime.
Indeed, in 2020 the regulator asked banks to discuss with it their problems with moving beyond the waiver to a long-term solution.
In a February appeal to the SEC to ease its stance, industry association Sifma pointed to European debates on rolling back some Mifid provisions and asked for at least an extension while these were being settled.
“It is counterproductive for US institutions to be compelled to curtail research coverage of public companies or potentially change operations solely to comply with a foreign regulatory requirement that appears likely to substantially change,” it wrote.
The European rollbacks follow arguments that requiring payments has cut the availability of research, particularly research covering smaller companies.
Last month the UK government launched a review of investment research, including the effects of Mifid’s unbundling, while the EU is planning to drop the requirement to pay for research covering companies with annual sales under €10bn.
However, several US investor advocates have thrown their support behind the SEC in the hope that forcing brokers to register as IAs could open the door for a broader US move to unbundle research and trading costs.
“In Europe, investment research became transparently priced, investors were suddenly freed . . . and research and trading costs plummeted without any measurable decrease in access or quality. Worse than being just left behind and in the dark, many US investors have been instead left with the tab,” three big groups, including the CFA Institute, wrote in a letter to the SEC last month.
Critics of bundled research have long argued that it forces fund managers to pay for services they do not want. The most prized part of research is typically a broker’s ability to offer access to company executives, but bundled services pushes bank clients to use its trading services rather than simply paying for the research service.
These critics lauded Mifid II for forcing bankers and their clients into frank conversations around the value of research.
“If you’re a low turnover shop, you don’t have a big commission wallet. Putting a little bit with a lot of [brokers] gets you research — but you don’t get much service from being a little bit relevant to a lot of people,” said the trading head of one midsized fund manager.