On Oct. 26, 2017, the US Securities and Exchange Commission (“SEC”) published three temporary no-action letters providing US broker-dealers and investment advisers relief in the conduct of their business activities with entities subject to the European Union’s Markets in Financial Instruments Directive (“MiFID II”), which will go into effect on Jan. 3, 2018. The no-action relief, described in further detail below, permits:
On the same day, the European Commission released its own FAQ to clarify how asset managers subject to MiFID II research provisions can purchase research services from US and other non-EU broker-dealers.
MiFID II will eliminate the ability of certain EU asset managers to pay for research services together with executions through a bundled commission payment and, instead, requires them to pay for research separately from execution services, either through direct payments from asset managers’ own funds or from client accounts (through an RPA).
MiFID II also affects US managers to the extent that they are:
US broker-dealers have been concerned that this provision of MiFID II would require them to register as investment advisers if they provided research to these asset managers on hard dollar payment terms, and US investment advisers were unclear as to how their Exchange Act Section 28(e)-compliant research purchase practices would be affected to the extent that they obtained research in compliance with MiFID II unbundling requirements.
The SEC’s no-action relief, which was designed in conjunction with European regulators and the European Commission, confirms that money managers and broker-dealers will continue to benefit from the protection provided by Exchange Act Section 28(e) and will not be in breach of US federal securities laws when complying with MiFID II unbundling requirements. The no-action relief also ensures that EU asset managers will not have their access to research from US broker-dealers severely limited.
Division of Investment Management No-Action Relief
The first MiFID II no-action letter1 allows US broker-dealers, without having to register as an investment adviser, to provide research services to EU asset managers that are subject to MiFID II.2 These EU asset managers will be required, under MiFID II, to pay for research services from:
(collectively, “Research Payments”).
US broker-dealers that provide research services to EU asset managers expect to receive Research Payments for their research services and, absent the no-action relief, receipt of Research Payments might have subjected the US broker-dealers to the substantive provisions of the Advisers Act as well as potentially the registration provisions of the Advisers Act. The no-action relief states that a US broker-dealer providing such research services for cash consideration will not be deemed to be an investment adviser providing investment advice under Advisers Act Section 202(a)(11).
This no-action relief, which will expire thirty (30) months from Jan. 3, 2018, is intended to provide the SEC with sufficient time to better understand the evolution of business practices after the implementation of MiFID II. The SEC also notes that this no-action relief will allow the industry time to review, comprehend and implement the guidance and evaluate impacts on their business models. It will also allow the SEC time to monitor and assess the impact of MiFID II requirements on the research marketplace and affected participants in order to ascertain whether more tailored or different action is necessary, such as formal rulemaking.
The second MiFID II no-action letter3 provides relief for SEC-regulated investment advisers that aggregate client orders while accommodating differing arrangements regarding the payment for research that will be required under MiFID II. After MiFID II goes into effect, some clients within a given aggregated order may pay total transaction costs that include the cost of execution as well as research services, while other clients may pay different amounts in connection with the same order (i.e., for execution only) because of varying research arrangements or because the investment adviser elected to pay part or all of the research expenses for such clients with its own funds.
This no-action letter allows investment advisers to continue to aggregate client orders while accommodating differing research payment arrangements, provided that:
Division of Trading and Markets No-Action Relief
The third no-action letter4 allows an investment adviser that pays for research through an RPA to continue to rely on the safe harbor provided by Exchange Act Section 28(e) when the investment adviser makes payments for research to an executing broker out of client assets — alongside payments to the executing broker for execution — with the research payments credited to an RPA administered either by the executing broker or a third-party administrator. This no-action relief, however, will only apply if the following four conditions are satisfied:
European Commission Views
In a coordinated action, the European Commission published FAQ guidance addressing two concerns surrounding the application of MiFID II to EU asset managers and non-EU managers contractually required to comply with MiFID II unbundling rules (“Third-Country Delegates”) when they obtain research from third-country (i.e., US and other non-EU) broker-dealers.
The European Commission issued the following welcome clarifications:
While the steps taken by the SEC no doubt temporarily reduce the burden on US broker-dealers and asset managers of complying with MiFID II, preserve investor access to research, and accommodate the EU’s changes without materially altering the US regulatory approach, it remains to be seen whether this interim approach to addressing conflicting US and EU requirements will be viable in the long run.
In addition, investment advisers subject to SEC regulations that will be directly or indirectly covered by MiFID II will have to finalize any needed amendments to their expense review and allocation policies to confirm that they satisfy MiFID II as well as the new conditions and expectations set forth by the SEC and European Commission guidance.
1. Securities Industry and Financial Markets Association (Oct.26, 2017) [SEC No-Action Letter].
2. Section 202(a)(11)(C) of the Advisers Act generally excludes from the investment adviser definition any broker or dealer who performs investment advisory services (i.e., who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities) and whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.
3. Investment Company Institute (Oct. 26, 2017) [SEC No-Action Letter].
4. Asset Management Group of the Securities Industry and Financial Markets Association (Oct. 26, 2017) [SEC No-Action Letter].