“Hold The Front Page!” – Reviewing a Hectic Month of Breaking News in the Payments for Research Business

It says something about the flurry of news in the payments for research business that this is the third time I have written and re-written this blog, only for another piece of news to postpone publication and send me back to the computer once more! In anticipation of the coming summer holidays in the northern hemisphere, I write in hope (rather than necessarily expectation) that the "breaking news" will relent and that this will be the version for publication.

Reaction to MiFID II No-Action Letter Expiry

When the clock struck 12:01 am on Monday, July 3, 2023, time officially ran out on the Security Exchange Commission's (SEC's) 2017 no-action letter (NAL) to the Securities Industry and Financial Markets Association (SIFMA) about payments for research. This was not an uncontroversial move, with lobbying from trade groups including SIFMA themselves. Mark Uyeda, a serving Commissioner on the SEC since June 30, 2022, commented that [8] the relief's expiration could result in "less credible sources, such as internet speculation" taking on new prominence in the market. Calling for the SEC to conduct a "holistic review of the regulatory framework for investment research," he added, "inappropriate and poorly designed restrictions on investment research serve neither investors nor public companies".

Inevitably, given the advocacy seen in the run-up to July 3 calling on the SEC to grant an extension, there has been a market reaction to the letter's lapse, primarily from SIFMA, who was prominent in the advocacy for extension. They released a statement [7] on July 5 expressing their "disappointment" with the decision, suggesting "this lack of action negatively impacts the competitiveness of U.S. markets and research providers and poses a significant risk that impacted buy-side managers will lose access to investment services."

SIFMA went on to say that "by failing to extend the NAL the SEC is not allowing a European requirement that conflicts with U.S. law to directly affect U.S. broker-dealers, even though the European requirement is in the process of being dramatically revised."

Impact of SEC Not Extending No-Action Relief

As we discussed in our June blog, there remain uncertainties about how the expiry will impact payments for research to certain U.S. broker-dealers. But, importantly for investment management firms planning for the future, the SEC has confirmed that Commission Sharing Arrangements, [6] with or without a Research Payment Account, will remain valid.

Despite recent market commentary suggesting the contrary, it is worth reiterating who is adversely impacted by the letter's expiration. If a U.S. broker does not have registration as a Regulated Investment Adviser and lacks a European affiliate with European buy-side clients who pay for investment research through cash or a direct-charge Research Payment Account (RPA), they cannot receive payment without violating U.S. law. All research providers can continue to be paid through Commission Sharing Arrangements (CSA) or a CSA- funded RPA [5].

Progress in Ongoing Legislation in the U.S. Congress

The U.S. House of Representatives' bill providing temporary relief from the applicable rules was passed on July 7, 2023. Representatives voted on a bi-partisan basis to advance the bill, which was sponsored by Rep. Pete Sessions (Republican, Texas) and Rep. Josh Gottheimer (Democrat, New Jersey). "This bill helps to protect U.S. small businesses, families, law enforcement, firefighters and Americans saving for retirement," Sessions said in a statement. "The SEC's failure to extend the MiFID II no-action letter will cause significant reduction in research available to American investors and simultaneously increase their operational costs, causing unnecessary harm for the countless hard-working U.S. citizens saving for the future."

The next requirement for the legislation is a companion bill in the U.S. Senate and this has been introduced by Sen. Jerry Moran (Republican, Kansas). Entitled "Increasing Access to Adviser Investment Act", the Act requires the SEC to extend the no-action determination relating to the provision of research services by broker-dealers. It asks the SEC to carry out a study within 18 months to report on the impact of the no-action letter expiry, focusing particularly on the impact on smaller issuer research provision as well as impacts on investors, pension funds, broker-dealers, other research providers, and issuers.

Potential European Council Changes to MiFID Rules

As referenced by SIFMA in their statement on July 5 [7] (above), the Council of the European Union are considering further revisions to Markets in Financial Instruments Directive 2014 (MiFID II). Proposals could mean that investment management firms are required only to inform clients whether they are paying for research and trading jointly and recording the charges attributable to each. This would take us back to a regulatory landscape similar to the one before MiFID II, and in some respects potentially even before the first MiFID, with a requirement for transparency to clients in trading commissions paid, but removing the requirement to separate disclosure of execution fees paid from research fees paid. However, clients would not be obligated to return to bundled fees, with the option to make separate or join payments for execution services and third-party research services.

The expectation is that the requirement for a separate Research Payment Account would be removed simplifying the process for investment managers and enabling a return to the best practice of Commission Sharing Arrangements (CSAs). This provides a simple model to combine procurement of execution services corresponding to "best execution" practices with procurement of the best third-party research services as required by investment teams. The Council's suggested reforms move much further than the European Commission's suggestions from December 2022, suggesting a partial easing of research payment rules.

U.K. Investment Research Review

In December, the U.K. Chancellor of the Exchequer, Jeremy Hunt announced that he would launch an independent review into financial services investment research and its contribution to U.K. capital markets competitiveness [9]. The review was part of work to increase the attractiveness of the U.K. as a location for large and small companies to raise capital and potentially "roll back" certain pieces of European legislation post Brexit. Rachel Kent was announced as Chair of the Review and she called for evidence on April 3, 2023. Following a consultation period, the Review was published on July 10, [11] and importantly, was referenced by Chancellor Jeremy Hunt in his annual "Mansion House Speech" on the same day [12].

Hunt commented: "The government welcomes Rachel Kent's excellent Investment Research Review published today and has accepted all recommendations made to it. We therefore welcome the FCA's commitment to start immediate engagement with the market to inform any rule changes on removing the requirement to unbundle research costs by the first half of next year. This will ensure we are better able to fund quality research into the new Silicon Valley sectors." A senior politician referencing such a Review and publicly accepting its findings gives a strong indication that we can expect most or all the recommendations to be included in future legislation.

The Kent Review reinforces the importance of a healthy and dynamic research industry in the U.K. and includes evidence of a decline in research production especially among smaller issuers. The "flagship" recommendation is a new Research Platform, potentially paid for from a levy on the industry, "freely available" to investors and designed to encourage increased research production. The Panel, stated as not necessarily being a permanent feature but with the aim of kick-starting research production in the U.K., would be set up by HM Treasury and the FCA.

New Flexibility in U.K. Payments for Research

Moving on to payments for research, it is Rachel Kent's recommendations that have created the potential for a significant rolling back on U.K. rules. Since MiFID II, many U.K. investment management firms have used their own resources (or "P&L payments" as they are often known) to pay for research and Ms Kent links this trend to the current decline in research production. She also references the complications involved in the management of research payment devices since MiFID II, with the separate requirement to manage Research Payment Accounts with additional regulatory reporting seen as a factor in this downward trend.

Ms Kent does not however dictate how firms should pay for their research going forward, instead envisioning a regulatory environment that allows investment managers to choose the model or models that work best for them and their customers. She lists that managers could use their own resources (P&L), bundled trades (potentially rolling back regulations to the early 2000s, even before the Paul Myners Report and CP176 [13]), direct charge to customers, or a charge to end investors separately through commissions. On the latter point, she mentions Commission Sharing Arrangements by name as a potential structure for managing this. For methods involving a charge to customers, pre-approval, evaluation of service, and reporting to clients are envisioned, all aspects that are already familiar to investment management firms, especially since MiFID II, and which speak directly to the capabilities of our Research Manager product.

We have continued to speak to clients and other buyside firms since MiFID II and have commented publicly on what we have seen as a trend for U.K. buyside firms starting to look at models other than P&L for payments for research. The "Kent Review" potentially offers far greater flexibility for U.K. investment management firms - with their clients' approval - to select and pay for the best research services, free of burdensome administration like Research Payment Accounts.

The Review is comprehensive and runs to 82 pages, but if you have any questions about the findings or our Research Manager product, please contact me at: francis.land@spglobal.com. S&P Global Market Intelligence will continue to monitor developments closely and advocate for solutions that promote transparency and efficiency in the industry.

Statements by persons who are not S&P Global Market Intelligence employees represent their own views and opinions and are not necessarily the views of S&P Global Market Intelligence.

1] SIFMA, SEC Staff No-Action Letter (October 26, 2017)

[2] William Birdthistle, Director of the Division of Investment Management, SEC, Remarks at PLI: Investment Management 2022 (July 26, 2022)

[3] H.R. 2622, " a bill to amend the Investment Advisers Act of 1940 to codify certain Securities and Exchange Commission no-action letters that exclude brokers and dealers compensated for certain research services from the definition of investment adviser, and for other purposes,"(May 24, 2023)

[4] Letter to William Birdthistle (March 8, 2023)

[5] Anna Sandor, SEC Staff (May 19, 2023)

[6] Gary Gensler, remarks to reporters. Politico - (June 7, 2023)

[7] Statement from SIFMA on SEC Not Extending MiFID II No-Action Relief (July 5, 2023)

[8] Statement from SEC Commissioner Uyeda (July 5, 2023)

[9] U.K. government website: "Call for Evidence - UK Investment Research review" https://www.gov.uk/government/publications/investment-research-review/call-for-evidence-uk-investment-research-review

[10] Bloomberg article - MiFID U-Turn Plan Would Reverse Ban on Free Research for Clients (June 20, 2023)

[11] UK Investment Research Review https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1168719/UK_INVESTMENT_RESEARCH_REVIEW_-_RACHEL_KENT_10.7.23.pdf (10 July 2023)

[12] UK Government Website https://www.gov.uk/government/speeches/chancellor-jeremy-hunts-mansion-house-speech (10 July 2023)

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