Europe’s revised Markets in Financial Instruments Directive (MiFID II), effective January 3, 2018, makes a number of important regulatory changes concerning the delivery of financial services and products. A number of these changes have an extraterritorial element that can have a significant impact on US firms. A particularly contentious area has been how European Union (EU) investment firms should interact when they seek out brokerage and research services from broker-dealers in non-EU countries like the United States.
Recently the European Commission issued FAQs on the issue to provide further clarification to the market. At the same time as the European Commission issued its FAQs, on October 26, 2017, the Securities and Exchange Commission (SEC) published three no-action relief letters that are intended to provide a path for market participants to comply with the MiFID II research requirements in a manner that it consistent with U.S. federal securities laws.
Under U.S. law, a U.S. broker dealer may enter into a client commission arrangement (CCA) with a money manager to receive one bundled payment from a money manager to pay for both permissible brokerage and research services. Pursuant to the CCA, upon receipt of the payment, the U.S. broker dealer then deducts the brokerage execution costs from the bundled payment and credits the portion applicable to research to a CCA account that is administered by the broker dealer or alternatively, transmits it to a third party that administers the CCA account. If the broker dealer received a separate payment for research divorced from any brokerage services, the broker dealer normally would be required to register as an investment adviser under the U.S. federal Investment Adviser Act.
Under MiFID II rules, these type of bundled payments will be prohibited, thus leaving the U.S. broker dealer who may have clients covered under MiFID II the choice to either register as investment advisers under the U.S. Investment Adviser Act to received unbundled research payments from their MiFID II-covered clients, even though U.S. law allows them to receive such bundled payments, or terminate their client relationships with their MiFID II clients to avoid violating MiFID II.
Under the series of letters issued October 26, the SEC will not undertake enforcement actions against broker dealers receiving separate payments where clients and assets are under MiFID II jurisdiction subject to certain conditions, including allowing broker dealers to receive payments for research alongside payments for brokerage commissions, and the broker dealer must transmit those payments for research into Research Payment Accounts established in accordance with MiFID II rules. This reverses the time of “unbundling” – currently under a CCA, the bundled payment is made to the broker dealer, who then unbundles it into a brokerage commission and a research payment into a CCA account maintained by the broker dealer or a third party. The exemption from the Investment Adviser Act registration that otherwise would apply to separate payments is effective for only 30 months from the implementation of MiFID II.
In the press release announcing the issuance of these no-action letters, the SEC stated that during this 30 month period, SEC staff will “monitor and assess the impact of MiFID II’s research provisions” in order to determine whether it will take further action. It invites the public to share their comments on the impact of MiFID II’s research provisions on U.S. broker dealers and investors, as well as the quantity and quality of research that is provided.
Additional general information on MiFID can be found in our online “MiFID II Academy.”