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Bridging the EU-US Gap on MiFID 2 Research: impact of the EU Commission FAQ and US SEC No Action Letters

  • United Kingdom
  • Financial services and markets regulation - MiFID


On the same day, the European Commission, via Frequently Asked Questions and the US SEC, via three No-Action Letters, issued clarification on an issue that has vexed EU investment managers and their US delegates since the MiFID 2 proposals on payment for investment research. Although the co-ordinated timing addresses an apparently unique EU/US combination of issues, the Commission FAQ are relevant to an EU manager’s delegation of functions to sub-advisors/managers in any third country.

The issue under MiFID 2 is that, from 3 January 2018, EU investment managers will have to pay brokers for investment research, using either (a) their own money or (b), where using their client’s money, via a mechanism which requires the managers to agree a budget and using a separate accounting mechanism to pay for that research. A regulatory challenge in the US for brokers having to account for research on an “unbundled” basis aggravates the operational challenge for EU managers seeking to put in place research payment accounts (“RPAs”) or change their business models to pay for research themselves.

Impact and effect

The effect of the FAQ is that a third country broker-dealer may receive combined payments for research and execution as a single commission when providing such services to a MiFID 2 portfolio manager or its third country sub-advisor. In other words, bundled payments are allowed albeit “based on current practice of national competent authorities” and subject to requirements on: (a) identification of payments for research; (b) budgeting and research need assessment; (c) audit and other control requirements; and (d) broker-dealer identification and allocation requirements.

The effect of the No-Action Letters is that (a) US broker-dealers may accept research payments from money managers in hard dollars or from advisory clients' research payment accounts; (b) US investment advisers may continue to aggregate orders for mutual funds and other clients; and (c) money managers may continue to rely on an existing safe harbor in US securities laws when paying US broker-dealers for research brokerage. As explained below, one of the SEC positions provides temporary relief only; it will sunset after 30 months.

The clarity on the issues both in the EU and the US is welcome. However, permitting the bundling of payments for research with payment for other services does not mean business-as-usual. Delegates, in particular, will have to note the requirements for the EU managers on budgeting and the separate identification of research payment amounts and the “auditability” of compliance with these requirements.

Moreover, the FAQ and No-Action Letters do not roll-back the “equivalent level of protection for clients under a delegation arrangement” concept advanced by the UK FCA in responding to questions on the reach of MiFID 2, despite the fact that the text of MiFID 2 and EU measures made under MiFID 2 have not altered MiFID 2 territorial scope. In this respect the Commission’s reference to “based on current practice of national competent authorities” appears to preserve Member State discretion on the question of delegation, despite the delegation provisions now being placed in an EU Regulation.

The FAQ document can be found here.

The press release on the SEC No-Action Letters can be found here.

The UK FCA’s announcement on the FAQ and No-Action Letters can be found here.

The Issue

Article 24 of the MiFID 2 Directive reinforces the restriction on the payment or receipt of non-monetary benefits. With respect to investment research, there are only two permissible methods of payment identified in Article 13(1) of the MiFID 2 Delegated Directive (EU) 2017/593: (a) direct payments by the MiFID II investment manager out of its own resources, or (b) payments from a separate RPA under the control of the manager. Article 13(1) imposes conditions for an RPA which include the requirement for the manager to agree a research charge with its clients. Article 13(9) also provides, amongst other things, that research which a broker or other firm provide to manager be subject to a separately identifiable charge.

The position was complicated by the fact that US broker-dealers may not receive research payments from money managers in “hard dollars” or from advisory clients’ research payment accounts, without putting themselves at risk of an SEC enforcement action based on providing research services unbundled from investment advice.

The position before the FAQ and No Action Letters

Article 31 of the Level 2 Organisational Regulation states that a MiFID investment firm’s outsourcing of critical or important operational functions [must] not result in the delegation by senior management of its responsibility” and must not “alter” the “relationship and obligations of the investment firm towards its clients under [MiFID 2].”

In the UK, the FCA interpreted this provision (in a letter to the Alternative Investment Managers Association dated 19 July 2017) to hold that, where a UK investment firm outsources part of the portfolio management service provided to their clients under MiFID 2, it “would need to take steps to secure an equivalent level of protection for its clients under a delegation arrangement.”

The FCA developed this, noting the European Commission’s FAQ on outsourcing under MiFID 1 and the reference to best execution. The FCA focussed specifically on US advisers conceding that a US investment adviser would not have to comply with the MiFID 2 Rules on payments for investment research where the adviser “cannot make separate payments to a US broker”. The FCA noted, however, that the EU investment firm “should secure the most comparable standards possible from the US [adviser]” and set out three requirements for US advisers to satisfy this “most comparable standards” test.

The Commission FAQ

(1) In response to the question whether a MiFID 2 Portfolio Manager or its Third Country Sub-Advisor may combine: (i) a payment for research; and (ii) a payment for execution services into a single commission to a third country broker-dealer, the Commission states that, “based on the current practice of national competent authorises”, a third country broker-dealer may receive combined payments for research and execution as a single commission when providing such services to a MiFID 2 Portfolio Manager or its Third Country Sub-Advisor. It may do so as long as they:

a. can identify the payment attributable to research.

b. base the research budget on a reasonable assessment of the need for research.

c. subject the research budget to appropriate controls, which include maintaining a clear audit trail of payments made to research providers.

d. are able at all times and based on their own internal allocation/budgeting process, to identify vis-à-vis their own clients the amount spent on research with a particular third country broker-dealer.

(2) In response to question whether third country broker-dealers are required to identify a separate charge for research in cases where a MiFID 2 Portfolio Manager or its Third Country Sub-Advisor pays for these services out of (a) a RPA or (b) directly out of their own resources the Commission:

a. confirm that a MiFID 2 Portfolio Manager and Third Country Sub-Advisor must ensure that they identify a separate charge for research supplied by third country broker-dealers.

b. state, however, that in the absence of a separate research invoice, the MiFID 2 Portfolio Manager of its Third Country Sub-Advisor may decide, among other things, to consult with third parties, including the third country broker-dealer, with a view to determining the charge attributable to the research provided.

c. confirm that the supply of and charges for those benefits or services must not be influenced or conditioned by levels of payment for execution services.

The SEC No-Action Letters

In a press release issued October 26, 2017, the SEC announced the publication of three related no-action letters (the “SEC Letters”) and expressed its belief that compliance with the letters provides a path for market participants to comply with the research requirements of MiFID I2 in a manner consistent with the U.S. federal securities laws.

Specifically, and subject to various terms and conditions, the SEC Letters take the position that:

(1) U.S. broker-dealers, on a temporary basis, may receive research payments from money managers subject to MiFID 2 in hard dollars or from advisory clients’ research payment accounts, without putting themselves at risk of an SEC enforcement action based on providing research services unbundled from investment advice. The temporary period runs for 30 months from MiFID 2’s implementation date. During this time period, SEC staff hope to better understand the evolution of business practices post-MiFID 2 implementation. The staff will monitor and assess the impact of MiFID 2’s requirements on the research marketplace and affected participants in order to ascertain whether more tailored or different action is necessary.

(2) U.S. money managers may continue to aggregate orders for mutual funds and other clients, in reliance on the position taken by SEC staff in 1995 in a letter issued to SMC Capital, while accommodating the differing arrangements regarding the payment for research that will be required by MiFID 2.

In SMC Capital, the SEC staff stated that the mere aggregation of orders for advisor clients, including collective investment vehicles in which the adviser, its principals or employees have an interest, would not violate Section 17(d) of the Investment Company Act, Rule 17d-1 thereunder or Section 206 of the Advisers Act if the adviser implements procedures designed to prevent any account from being systematically disadvantaged by the aggregation of orders. The SMC Capital no action letter is available here.

The staff also noted that advisers must adopt policies and procedures reasonably designed to ensure that (1) each client in an aggregated order pays the average price for the security and the same cost of execution (measured by rate), (2) the payment for research in connection with the aggregated order will be consistent with each applicable jurisdiction’s regulatory requirements and disclosures to the client, and (3) subsequent allocation of such trade will conform to the adviser’s allocation statement and/or the adviser’s allocation procedures; and

(3) Money managers may continue to rely on an existing safe harbour under U.S. securities laws when paying broker-dealers for research and brokerage, without risking SEC enforcement action against the money manager; the money manager must pay for the research through the use of an RPA that meets the requirements of MiFID 2 and additionally:

a. The money manager must makes payments to the executing broker-dealer out of client assets for research alongside payments to that executing broker-dealer for execution,

b. The research payments must be for research services that are eligible for the safe harbor under Section 28(e) of the Securities Exchange Act of 1934,

c. The executing broker-dealer must be effecting the securities transaction for purposes of Section 28(e), and

d. The executing broker-dealer must be legally obligated by contract with the money manager to pay for research through the use of an RPA in connection with a client commission arrangement (CCA).

The FCA Statement

In welcoming the FAQ and No-Action Letters, the FCA noted that the announcements will ensure that firms can continue to access US research from 3 January 2018, while also maintaining the investor protection safeguards of the MiFID 2 regime.

In supervising the MiFID 2 inducements and research provisions, and cross-border practices by firms in this area, the FCA indicated that it will focus on ensuring investors’ interests are advanced. Arrangements which comply with MiFID 2 and other jurisdictions’ rules, while enabling EU firms’ continued access to research produced by US and other non-EU jurisdictions are likely to be the best way of serving investors.

The FCA also noted, somewhat cryptically, that arrangements in which a UK asset manager pays the EU entity of a broker for global research content, or research is circulated within a buy-side group, can also be an acceptable way of achieving this, provided that they do not influence the firm’s order routing decisions, execution costs and ability to act in its clients’ best interests. Work may be necessary to work-out exactly what is meant here.

Further information and advice

We have advised and assisted over 45 EU and US firms buy-side and sell-side firms on the impact of MiFID 2 on their business. For further information on the issues in this briefing, please contact your usual Eversheds-Sutherland contact or any of the people below:

For more information contact

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