Tick Tock: The SEC Should Extend MiFID II No-Action Relief Now

  • The Securities and Exchange Commission (SEC) no-action relief relating to MiFID II will expire on July 3rd, fewer than 40 days away.
  • Absent this relief, firms are unable to address conflicts of law problem that arises between the current European Markets in Financial Instruments Directive II (MiFID II) requirement for investment advisers to make separate, unbundled payments for research and the application of the Investment Advisers Act of 1940 (Advisers Act) to any U.S. broker or dealer that accepts such separate, unbundled payments for research. That is why the SEC issued no-action relief in 2017 and extended it in 2019.
  • Coalition Greenwich just completed a survey that highlights the problems sell and buyside firms will face and the likely loss of research that will occur upon the expiration of the no-action relief.
  • European Union (EU) policymakers have signaled their intention to implement regulatory changes rolling back the MiFID II unbundling requirement, with the U.K. also rethinking its unbundling requirement and following developments in the EU.
  • The House Financial Services Committee (HFSC) overwhelmingly voted for H.R. 2622, which would direct the SEC to extend the MiFID II no-action relief for six months and study the potential impact of the expiration of the relief. The bipartisan support for directing the SEC to extend the no-action relief is the correct path forward.
  • Given these dynamics, it is imperative for the SEC to extend the no-action relief at least until the European changes are finalized and implemented.

MiFID II is a massive piece of market structure legislation which was implemented in Europe in 2018.  Investment managers subject to MiFID II (which includes both EU- and UK-based investment managers and U.S.-based investment managers that manage certain EU and UK accounts) were immediately required to separate, or unbundle, payments for research, as broadly defined under MiFID II, from payments for trade execution.

Given the global nature of the U.S. capital markets, the rule impacts U.S. broker-dealers, resulting in U.S. broker-dealers that provide research services to MiFID II investment managers receiving separate payments for those research services. This, however, is problematic because the receipt of payments for such research services subject broker-dealers’ research activities to the Advisers Act, which has requirements that are fundamentally incompatible with how research and sales and trading services are typically provided to investment managers by broker-dealers and would layer on an entirely different regulatory regime than broker-dealers’ current comprehensive regulatory framework overseen by the SEC and the Financial Industry Regulatory Authority (FINRA).

SIFMA has previously raised strong concerns over the requirement that U.S. broker-dealers accepting MiFID-required unbundled payments for research services would be subject to regulation as investment advisers under the Advisers Act.

In October 2017, the SEC responded to these concerns with the issuance of a no-action letter that it subsequently extended in November 2019. The no-action relief under that extension will expire on July 3, 2023—fewer than 40 days away.  In order to continue to accept unbundled payments for research after the relief expires, U.S. broker-dealers will be faced with tough choices that are not workable for some, such as registration of certain parts of their businesses as an investment adviser. A new survey by Coalition Greenwich and commissioned by SIFMA shows that these potential paths pose problems, and there will be negative impacts to the research markets upon the expiration of the no-action relief.

The survey indicates that a large majority of sell-side respondent firms believe that registering as an investment adviser is not a viable solution to the conflicts-of-law problem they face under the Advisers Act in connection with the MiFID II unbundling requirement. Moreover, it points to the confusion such firms face upon the expiration of the no-action relief, given the lack of a workable path forward.  In particular, in connection with the expiration of the no-action relief:

  • A significant majority of sell-side respondents (71%) are not planning to register as investment advisers and still are unsure of whether they will need to terminate or restrict access to research upon expiration of the no-action relief.
  • A significant majority of sell-side respondents (93%) are concerned that they will be put at a competitive disadvantage relative to their non-U.S. peers upon the expiration of the no-action relief. They also are concerned about how prepared they might be for the impact of the expiration.
  • The approach of using a European affiliate for research activities does not help sell-side firms without a European presence. These U.S. firms may lose MiFID II-manager clients upon the expiration of the no-action relief unless they are registered investment advisers or establish a European affiliate. However, both options require significant investments and organizational transformation, and the data suggests neither option is likely to be pursued.
  • While a majority of buy-side respondents indicate that they are prepared for the NAL expiration, the data suggests that some of them may need to make further adjustments to continue to access the same research after the expiration of the NAL.
  • In addition, buy-side respondents as a whole are concerned about losing access to U.S. broker research as a result of the expiration. Half of these respondents are concerned about losing access to published research and meetings with research analysts from U.S. broker-dealers. Of this group, 80% are concerned about losing access to research on U.S. small-cap companies and 100% on large caps, with 40% being concerned about losing access to research on fixed-income securities.
  • Finally, all sell-side respondents, along with a significant majority of the buy-side respondents (75%), believe the best approach is for the SEC to extend the NAL.

The survey shows that the least disruptive option at this point is an extension of the MiFID II relief, given the significant risk that impacted buy-side managers will lose access to important research services and the negative impact on the competitiveness of U.S. markets and research providers.  On this latter point, while all U.S. broker-dealers providing research would be negatively impacted if the relief is not extended, regional and smaller broker-dealers who lack European operations would be the most harmed.

An extension is especially appropriate now given that the EU and the U.K. are re-evaluating the MiFID II unbundling requirements, with the EU considering rolling back those requirements further or even making them optional.  At a minimum, an extension until the legislative/regulatory processes in the EU and U.K. play out would help participants plan for potential changes to the MiFID II unbundling requirements without also having at the same time to deal with potentially disruptive changes to their research businesses as a result of the Advisers Act requirements.  Such an approach would also have the benefit of allowing U.S. and European regulators to more fully coordinate regarding this critical area of the marketplace.

There is no reason to ask U.S. firms to tie themselves in knots to comply with a European law when the EU is actively considering changes to it.  As signaled by the HFSC vote, the SEC should extend the no-action relief before the clock runs out.

Joe Corcoran is Managing Director and Associate General Counsel in SIFMA’s Capital Markets Group.