Unbundling Investment Research costs from Trade Execution costs (US)

In response to concerns that investors could lose access to valuable research, the US Securities and Exchange Commission (“SEC”) has issued three related no-action letters designed to provide market participants with greater certainty regarding their US regulated activities as they engage in efforts to comply with MiFID II by 3 January 2018. It has provided temporary relief for thirty months from MiFID II’s implementation date.

At the same time, the European Commission has issued an FAQ on MiFID II interaction with third country broker-dealers.

Historically, full service brokers in the US did not “unbundle” the costs of research (whether Investment Research or otherwise) from execution services. This model conformed to the so-called brokers’ exemption from the definition of an investment adviser in Section 202(a)(11)(C) under the Investment Advisers Act of 1940, as amended.

Arguably, the brokers’ exemption would no longer be available if a broker separately charged for the provision of research services, as is required by MiFID II.

The temporary no-action relief allows compliance with the new MiFID II research provisions while respecting the existing US regulatory structure and provides SEC staff with sufficient time to better understand the evolution of business practices after implementation of the MiFID II research provisions.

In the US, money managers often use client commission arrangements to obtain brokerage and research services from a broker-dealer, using a single “bundled” commission that is separated after execution to pay for order execution and research.

Under MiFID II, money managers may make payments to an executing broker-dealer out of client assets for research alongside payments for order execution, and the executing broker-dealer must transmit the payments for research into research payment accounts (“RPAs”).

The relief allows money managers to operate within a safe harbour if they make payments for research to an executing broker-dealer out of client assets, alongside payments for execution through an RPA that conforms to the requirements of MiFID II, and the executing broker-dealer is legally obligated to pay for the research, provided that all other applicable conditions are met.

Chris Cummings, CEO of the Investment Association said: “… it is clear that this package of measures addresses a key outstanding challenge for our industry with regard to the implementation of MiFID II.”