U.S. firms in uncharted waters over looming EU requirement to unbundle research

Thomson Reuters Regulatory Intelligence - U.S. broker-dealers are facing daunting challenges ahead of a European Union requirement (here) that compels asset managers to strip out payment for research, by either pushing the costs directly on to clients or paying for it themselves.

A Polish border guard stands beside a European Union flag during a ceremony at the Czech-Polish border checkpoint in Hradek nad Nisou December 21, 2007.

The rules, which take effect in January, will affect U.S. firms and how they distribute research to their European clients. With the Securities and Exchange Commission still on the fence over whether it will grant firms exemptions or relief from conflicts with U.S. rules posed by the European regulation, many are scrambling to put contingency plans in place.

“This is a very complicated process that would entail a lot of changes,” Gerard Citera, managing director and associate general counsel at JPMorgan Securities, told a New York conference last week sponsored by the Securities Industry and Financial Markets Association (SIFMA).

The European Union’s Markets in Financial Directive II, or MiFID II, takes effect on January 3, 2018. It will provide a legal framework governing the rules applicable to investment firms, regulated markets, service providers, and third-country firms providing investment services in the EU.

One of the most controversial aspects of MiFID II for asset managers has been the requirements on research unbundling. Investment firms providing both execution and research services will have to price and supply these separately. Traditionally, research costs have been included in commission charges for equity trading, and bundled into the cost of the doing business in other markets, such as fixed income, foreign exchange and commodities.

While the MiFID II rules on unbundling research are primarily targeted at EU asset managers and firms, U.S. banks that distribute research to their European clients also fall under the rules and are struggling to prepare for the January deadline. Their primary hope is that the SEC will grant them an exemption or so-called no-action relief from U.S. rules that conflict with EU’s requirements, but it is unclear whether the agency will act in time.

“We are definitely cognizant of industry concerns,” Vanessa Meeks, senior counsel in the SEC’s division of investment management, told the SIFMA conference. ”It’s not really clear at this point if relief will be possible . . . I guess it’s too early to tell.”


The unbundling of research from execution charges poses a challenge for U.S. broker-dealers due to existing rules that prohibit such a separation. Under the 1934 Securities Exchange Act, U.S. brokers are prevented from receiving direct payment for research unless they are registered as an investment adviser, which is one option that U.S. firms are contemplating. But for broker-dealers to register as investment advisers a whole new set of responsibilities and oversight take effect that many are reluctant to engage with.

For example, the level of care provided to broker-dealer clients – many of whom are institutional clients – differs from the services provided by investment advisers to their retail customers. Less care is needed for institutional clients, say industry experts.

In addition, if broker-dealers registered as IAs, they would become subject to enforcement exams by the Financial Industry Regulatory Authority, another requirement they would want to avoid.

For asset managers, MiFID II will require them to explicitly pay for research either from their own P&L or from a research payment account (RPA) funded by a direct fee to their clients or via a charge to clients collected at the point of execution. The SEC has acknowledged the major discrepancy between its own rules for broker-dealers accepting payments for research and the new European rules.


One possibility to meet the new rules is for U.S. firms to use their international branches to send research to EU clients and receive payment to work around the issue. However, there are challenges with such an option when the research is global in nature, such as economic research, or specific to the U.S.

Steve Haggerty, deputy director of global research at Bank of America Merrill Lynch, told the conference that in their analysis research on U.S. companies and markets is by far the largest source of information consumed by non-U.S. clients.

“Ring-fencing” the research department from the firm with changes in corporate structure, including a possible spinoff of such departments, is also being considered. But industry experts say there are challenges with that strategy as well.

One problem is the relationship research functions have with existing sales and trading operations at broker-dealers. That relationship is more than just providing research, and often includes having analysts meet clients or on conference calls to discuss strategy. It is unclear how spinning off the research arm of a major firm would affect the use of analysts by sales and trading groups.

Moreover, in deciding how much to charge for research, there are important differences between markets. In the fixed-income world, the cost of research is bundled into the spread on products sold to clients, instead of commissions that are used in equities. Untangling the research costs from such spread pricing will be more difficult.

“On the fixed-income side the discussion is much more difficult,” said Pamela Torres, general counsel of the global investment research division at Goldman Sachs.

“What am I paying for and what am I receiving?” she asked, in describing part of the challenge.

All of the complexities and uncertainties involved have many hoping that the SEC will adopt its own view and offer guidance ahead of the January deadline.

(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. He is a former financial industry compliance consultant and executive, and earlier served as a financial journalist with Reuters. Email Henry at