Time Is Running Out for Asset Managers to Fix Research Payments

“What’s the biggest danger? That no one shows their cards until the day before and we’ve got chaos,” says Mike Carrodus of Substantive Research.

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In five months, a Securities and Exchange Commission no-action letter is set to expire with little fanfare — except perhaps from the independent research providers it threatens. The letter allows European asset managers a workaround for some of the complex regulations they are subject to when dealing with U.S. brokers. After June, European managers will need to pay for research from U.S. brokers through trading commissions.

Although there are a handful of potential fixes, asset managers are unprepared for the changes to investment research, according to a survey by Substantive Research, which is expected to be published on Monday. Substantive Research is an analytics firm for the buy side.

The no-action letter solved a problem after European regulatory regime MiFID II, which became effective in January 2018, unbundled trading commissions and research bills. The rules pushed European asset managers into paying for investment research in cash, a fundamental change to the market. At the time, the SEC issued a no-action letter that allowed European investment shops to also pay U.S. brokerage firms in cash. Although the letter was not intended to be a permanent solution to the different rules governing payment for research in Europe and the U.S., the SEC said last summer that it would not extend the letter past the expiration date in July.

The majority of managers (73 percent) do not believe that brokers will become registered investment advisors, which would allow them to take payments directly. Only 7 percent of asset managers believe brokers will register as RIAs, with 20 percent being unsure, according to the survey.

Mike Carrodus, CEO of Substantive Research, told Institutional Investor that the finding can be explained by managers finally understanding why brokers are hesitant to become RIAs. For one, “it doesn’t solve the issues and it creates compliance and operational burdens,” said Carrodus.


In addition, becoming an RIA doesn’t help sort out the question of what to do with insights on trading. “No one has figured out what to do with sales and trading color because when you’re supplying research through the investment advisor entity, that is research content. That is not sales and trading color. And their understanding of flow and what’s really going on from a trading perspective is key to the research product.”

The survey also found that another potential fix — the creation by European asset managers of a complex system to generate commissions from trading under MiFID II — isn’t likely. Forty-three percent of respondents said they “definitely would not adapt their processes.”Carrodus said that this solution is complex and expensive, particularly for smaller firms.

Even though 47 percent of asset managers “would rather not” take this route, Substantive Research did find that 10 percent of respondents are “prepared to create new structures if required.” As Carrodus noted, these managers are thinking, “We know it’s a lot of work, we know it’s a ridiculous thing to have to do, but we’re prepared to look at it as a solution.”

The third viable solution would be for European asset managers to pay U.S. brokers entirely in Europe for research used in both regions and covering both markets. In fact, 60 percent of respondents expect the market to coalesce around this option.

But that will ultimately hurt any smaller U.S brokers that don’t have European operations and who, according to Substantive Research, would be “frozen out, as they simply don’t have sufficient amounts of European revenues to justify fixing it all from their side. But from the perspective of European asset managers, losing access to these niche U.S. brokers may be seen as necessary collateral damage in the quest to keep processes simple and straightforward.”

“The problem with paying through Europe is that it looks like managers are trying to get around the rules,” Carrodus said in the interview. “And the closer you are to the SEC as an organization and the more you feel you’re covered by them, the more worried you are about that,” he said.

But the irony of the SEC not continuing its no-action relief is that it will hurt U.S. buy-side firms and niche U.S. brokers — not necessarily European ones. “Europeans will take a little more bulge bracket research instead of those from niche American firms. And they will pay everybody in Europe as long as the brokers facilitate that solution.”

Carrodus is concerned that everybody is waiting and watching to see how their peers are going to move before making a decision. “What’s the biggest danger? That no one shows their cards until the day before and we’ve got chaos,” he said.