Banks and companies around the world have long complained about the extraterritorial reach of US regulation — that they are forced to adopt rules made in Washington. Now Wall Street is playing the injured party.
Next month, US banks and brokers with European clients are scrambling to cope with losing a US “free pass” that protected them from the regulatory effects at home of following EU rules on how their research is paid for by clients.
The so-called Mifid II rules were brought in by the EU in 2018, delivering a fundamental shake-up in the way the broking business works. In the US, payment for research services — written reports but also matters such as industry conferences and access to company executives — is typically bundled with trading costs. Clients “pay” for research by steering trades and associated commissions through selected brokers.
That was the case in Europe, too, until 2018 before the Markets in Financial Instruments Directive split the two and forced investors to pay for research directly. The aim was to end what some feared were overly cosy relationships between banks and fund managers that obscured costs and the exact services end-clients paid for.
One of the key Wall Street problems with the split is longstanding US regulations requiring any party selling research to register as an investment adviser — involving a whole additional set of rules. Now, a five-year waiver from US regulators protecting banks from having to do this is about to run out. At best IA registration is a fiddly process. At worst, it will affect other investment banking operations.
This week Securities and Exchange Commission chair Gary Gensler told reporters the industry shouldn’t expect a reprieve. Few had expected one, but there is no single path for brokers to follow if they want to avoid the investment adviser registration.
“Scrambling is a good word. Firms are in very different stages of preparedness,” said Steve Stone, a partner with Morgan Lewis who is advising several clients on the effects of expiring waiver.
Gensler’s energetic agenda often makes him the baddie for Wall Street executives, but in this case the SEC can point to the fact it gave the industry notice a year ago. Its also not a mess of its own making, but caused by a change to EU rules. Nor are banks united on how to handle these issues: both Bank of America and Jefferies registered units as investment advisers when Mifid II came in, proving that it can be done without restricting investment banking activities.
For the brokers however, reorganising complex structures just to fit a foreign rule is frustrating when none of the activities for which they’re already overseen are changing. “Registering as IAs won’t give investors any extra protection — these are already highly regulated firms,” said one person involved in the industry discussion.
No two banks are set up exactly alike, either. Some have highly regarded trading desk analysts whose work doesn’t fit the traditional research model. Others worry that some client trades would fall foul of an US advisory bar on any proprietary trading. Advisers say some have European units through which they may be able to charge clients. Others, however, may have to cut some clients off.
Investors are also mixed. Advocates of unbundling sense an opportunity to split trading from research in the US, too — a cause they have championed since the 1970s — because it would make costs more transparent. It could also help midsized investors who will never be a top client for the likes of Goldman Sachs, but who would like to buy its research directly while trading with a smaller broker for whom they’d be a bigger fish. Others, having adjusted in 2018 for Mifid, simply want to know where to send their cheques after July 3.
In a twist keeping the issue fresh, last month the US House Financial Services Committee approved a bipartisan bill that would extend the waiver for six months and force the SEC to re-examine the issue, looking at the impact of Mifid on the US market. While it is unlikely to become law before the deadline, it could yet do so in the coming months.
US industry association Sifma had called repeatedly for the SEC to extend its waiver and pointed to European proposals that would allow some “rebundling” because of a belief that having fewer analysts selling research has hurt smaller companies. European investors slashed research budgets in the wake of Mifid — by 30 per cent, according to British sums, and more than half, on French estimates. Yet a 2022 SEC paper found the effect of Mifid on coverage was “inconclusive, unclear, or difficult to isolate”.
There is an obvious irony in Wall Street griping about extraterritoriality. But like European banks doing business in the US, there’s little choice.