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With under 10 weeks until the January 3, 2018 effective date, the U.S. Securities and Exchange Commission (“SEC”) has issued three no-action relief letters providing some clarity and guidance for US-based firms impacted by certain provisions of the European Markets in Financial Instruments Directive II (MiFID II). While the no-action letters are an important first step and help reduce some uncertainty, some of the relief is temporary. Questions remain on how to implement the SEC guidance, and the no-action relief does not address other MiFID II provisions that impact US firms.
Each no-action letter provides unique relief for different market participants as follows:
- Registered broker-dealers and foreign broker-dealers relying on Rule 15a-6 may, on a temporary basis, accept hard dollars and/or payments from research payment accounts (“RPA’s”) from money managers without being required to register as investment advisers under the Advisers Act
- Money managers who manage client accounts that must unbundle research and execution costs may continue to aggregate orders for mutual funds and other clients as long as certain conditions are met, and
- Money managers who manage client accounts that must unbundle research and execution costs may continue to rely on the existing safe harbor in Section 28(e) when paying broker/dealers for research and brokerage under specific circumstances.
Relief from the Investment Advisers Act of 1940 for broker-dealers receiving payments for research from investment managers subject to MiFID II (the “SIFMA Letter”)
The SIFMA no-action letter addresses the conditions where US broker/dealers may receive payments for research services that are unbundled from execution costs under the requirements of MiFID II. The relief granted by the Division of Investment Management allows US broker/dealers to accept hard dollar payments for research services without having to register as an investment adviser until July 3, 2020 (30 months from the MiFID II implementation date of January 3, 2018) if a money manager subject to MiFID II pays for the research from its own account, from an RPA funded with its clients’ money, or a combination of the two.
Industry participants sought relief due to the conflict between the unbundling requirements of MiFID II and US securities laws and because of the significant reliance by global investment managers on US broker-dealers for research services. Several banks, broker-dealers and asset managers in the US had been heavily lobbying the SEC for relief so firms could pass on research costs separately from trading and execution charges as required by MiFID II without requiring the US firms to become registered investment advisers.
Being a registered investment adviser carries with it additional fiduciary responsibilities and regulatory requirements that broker/dealers want to avoid. There were also concerns around US broker/dealers being at a competitive disadvantage from research firms outside the US if the US firms were subject to an additional layer of regulation under the Advisers Act, which could impede their ability to provide liquidity or act as a counterparty in transactions.
The 30 month window for the temporary relief was provided to give some clarity to the market while also providing the SEC additional time to assess the impact of MiFID II’s unbundling provisions and to solicit input from the industry before issuing more permanent guidance or rules.
In a release coordinated with the SEC’s issuance of the SIFMA No-Action Letter, the European Commission issued an FAQ acknowledging the need for EU managers to be able to continue to access research and execution services from broker/dealers outside the EU and to take into account different methods of payment for research. They noted that the need however, for EU firms to separately identify how much of a single bundled commission payment is attributable to research.
Request for no-action relief for advisers to aggregate client (the “ICI Letter”)
The ICI no-action letter grants relief to investment advisers that want to aggregate orders for accounts with differing arrangements for paying for research. In a previous no-action letter, the SEC allowed orders to be aggregated if each participating client in the aggregated order participated at the average share price with all transaction costs shared on a pro rata basis.
The current no-action relief granted by the Division of Investment Management specifically addresses the industry’s concern that MiFID II accounts included in an aggregated order where research is unbundled would result in those MiFID II clients not paying a pro rata share of all costs (i.e., research payments) associated with that aggregated order.
Under the new MiFID II no-action relief, a client order that bundles execution and research services can be aggregated with a client order that unbundles research from execution in certain circumstances. The SEC Staff stated it would not recommend enforcement action if an adviser adopts policies and procedures reasonably designed to ensure that:
- Each client in an aggregated order pays the average price for the security and the same cost of execution (measured by execution rate),
- 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
- The subsequent allocation of such trade will conform to an adviser’s Allocation Statement and/or the adviser’s allocation procedures.
Firms will need to review their existing trade allocation and aggregation policies and review their operational processes to address the new SEC requirements.
Section 28(e) of the Securities Exchange Act of 1934 and MiFID II (the “AMG SIFMA Letter”)
The Asset Management Group SIFMA no-action letter provides relief to money managers who pay for research from MiFID II client RPA accounts, in reliance on the safe harbor of Section 28(e) of the Securities Exchange Act of 1934.
Money managers in the U.S. have historically relied on a client commission arrangement (“CCA”) structure to pay a single “bundled” commission to broker-dealers for order execution. The commission is then unbundled and a portion of the commission used to acquire Section 28(e) eligible brokerage and research services. MiFID II accounts rely on RPA’s, which are similar to CCAs but different in that the research is unbundled before the trade is executed and is an asset of the client and not the firm.
In the AMG SIFMA Letter, the SEC Division of Trading said it would not take action against a money manager seeking to operate in reliance on the safe harbor provisions of Section 28(e) of the Exchange Act if the manager pays for research through an RPA that conforms to the requirements under MiFID II, provided that all other applicable conditions of Section 28(e) are met and:
- The money manager makes payments to the executing broker-dealer out of client assets for research alongside payments to that executing broker-dealer for execution
- The research payments are for research services that are eligible for the safe harbor under Section 28(e)
- The executing broker-dealer effects the securities transaction for purposes of Section 28(e), and
- The executing broker-dealer is legally obligated by contract with the money manager to pay for research through the use of an RPA in connection with a CCA.
How Can Bovill Help?
Our sole activity is the provision of high-quality, technically-focused advice and consultancy services on all aspects of financial services regulation across the globe. We have offices in London, Chicago, Singapore and Hong Kong. We are subject matter experts in MiFID II, and are currently working with a number of our clients as they get to grips with the challenges in the year ahead.
We can help you to mitigate the rising compliance risk associated with MiFID II implementation:
- We can run a gap analysis – using our in-house MiFID II gap analysis framework, we can help you to identify the areas of MiFID II with the greatest impact for your business, and shape a plan to deliver the required change.
- We can perform compliance-focused reviews – we can review the work you have done so far, project plans, proposed solutions and operating models to help you determine whether you are on-track to achieve compliance across the various regulators.
- We can provide MiFID II change resources – our teams of compliance and change experts can be deployed to address specific projects and work streams within a broader MiFID II program – supplementing your existing resources, and tackling some of the trickiest compliance issues.
We can embed MiFID II experts within your change teams – experts on the ground, working alongside change professionals, can be a powerful tool in assuring that compliance is delivered effectively. We can work with your change teams to ensure that MiFID II is interpreted correctly, and the right outcomes are achieved from both a compliance and business perspective.
