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Digital Subscriptions > The Hedge Fund Journal > Issue 122 - May 2017 > MiFID II Research Regime

MiFID II Research Regime

Effect on US investment managers

SIMON CURRIE, WILLIAM YONGE, TIMOTHY W. LEVIN, THOMAS S. HARMAN, STEVEN W. STONE AND BRIAN J. BALTZ, MORGAN LEWIS

The MiFID II regime will have significant ramifications for US investment managers and their use of client commissions to obtain research— especially as cross-border impacts have yet to be addressed by global regulators.

With the January 3, 2018 effective date of the Markets in Financial Instruments (MiFID) II regime looming over EU investment firms, many investment managers are struggling to deal with the changes affecting inducements and research. Some of the most challenging issues include determining the purchase price of research, assigning value to research internally, reconciling the cost of research to multiple clients, determining mechanisms for payment, and the clashing of EU and US regulatory regimes. Absent regulatory relief from either US or EU regulators, conflicts between regulatory regimes could force US broker-dealers to curtail providing research or execution services to covered investment managers.1 The issues and incompatibilities between the EU and US regimes are extensive and will affect US investment managers in many key ways.

As of January 3, 2018, EU investment managers will effectively no longer be able to use client dealing commissions (commonly referred to as “soft dollars”) to pay for research from broker-dealers. Rather, EU investment managers must either pay for research out of their own pockets (i.e., out of profit and loss (P&L)) or reach agreement with clients to have research costs paid by clients through so-called research payment accounts (RPAs) funded either by a specific research charge to the client or out of dealing commissions, provided that the research element of the commission is priced separately from the execution element (i.e., “unbundled”).

For US investment managers subject to the MiFID II regime (which is itself a matter subject to considerable uncertainty), this potentially means either (i) treating EU clients differently or (ii) coalescing around the MiFID II standards and relinquishing important safe harbors from liability under Section 28(e) of the Securities Exchange Act of 1934 (Section 28(e)). All of this is subject to forthcoming guidance from the European Securities and Markets Authority (ESMA) and regulatory authorities in EU member states (and possible “gold plating”2 of the new rules by them), not to mention the likelihood of further complications with Brexit and third-country regulation in the EU.

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