How Mifid has made its mark in the US

Fund managers across America, nudged by the SEC, seek to replicate European rules

The launch of Mifid II represented Europe’s biggest shake-up in the relationship between banks and investors in a generation. Now an unusual switch from US regulators may help elements of it to spread across the Atlantic. In March, Dalia Blass, director of the Securities and Exchange Commission’s investment management division, took Wall Street by surprise, saying she would allow fund managers to effectively circumvent her agency’s own rules that bar them from paying banks directly for research in the US. The remarks were the latest twist in a saga over investment research, a vital cornerstone of financial markets that has been thrust into the spotlight with last year’s passage of Europe’s Mifid II directive. For big fund managers, the urge is to avoid regional clashes while setting new contractual terms with the investment banks that dominate the research business. “Our desire remains to have a global approach to research,” said Marc Wyatt, global head of trading for investment house T Rowe Price. “The worst thing would be to ignore the issue. If we do that, both parties will wake up in a ‘Mad Max’ world.” Mifid II rules require asset managers to break out the money they spend on investment research — from analyst reports to conference attendance and meetings with corporate executives — from the commissions they pay brokers to trade stocks and bonds. But US regulation is a roadblock in that context, as it prohibits brokers from accepting direct payments for analysis. That cements the practice of paying through trading commissions.  A 30-month exemption has allowed US banks to accept payments from European fund managers. Now, Ms Blass of the SEC has signalled that the regulator would support routes around the US rules that fund managers have crafted, allowing them to strike a unifying standard for research payments. Whether this will take hold is unclear. “The big, $64,000 question is to what extent asset managers will pay for research in the US,” said Sandy Bragg, principal at Integrity Research Associates. “That’s still a very open question.” The Mifid Effect The EU’s sweeping transparency regulations have forced a change in the way financial firms do business. Over one year on, some are warning Mifid has gone too far. Part One  Where now for the rules that rocked European finance? Part Two  How Mifid has made its mark in the US Part Three  Gatecrashing the corporate access party Part Four  More small companies are stumping up the cash for research on themselves  Part Five Opinion — Mifid II is contributing to the death of European investment banks MFS Investment Management provides an interesting case study. The $472bn Boston-based fund group pays for research in the EU, and last year devised a mechanism to sidestep US rules: it would pay for research with trading commissions, but tally the amount and reimburse clients each year. Industry juggernauts T Rowe Price and Capital Group have since also declared a desire to pay for research in the US, although the details remain elusive. “We have to work through our operational considerations as well as counterparty responses, which are complex,” said Mr Wyatt at T Rowe. The chasm between EU and US rules has alarmed institutional investors. Amy McGarrity, chief investment officer for Colorado Public Employees Retirement Association, this year alerted the SEC to an instance where a US investor was subsidising a European client. The $50bn pension fund has a unique viewpoint. It outsources the bulk of its portfolio to fund managers, but oversees one segment internally. In this role, it too has created a workaround. “Seeking the best research instead of being forced to trade with a broker gives us the ability to choose,” Ms McGarrity said. “As a result of our efforts we have gotten better research at a better cost.”  These solutions are changing the investment banking business, irrespective of US regulation. As asset managers or institutional investors look to trim costs they will concentrate negotiating power with a slimmer list of the largest brokers. “Clearly Mifid is deflationary, and what it means is the number of banks that will be able to support credible, global research platforms will be fewer,” said Simon Bound, global head of research for Morgan Stanley. “This will further concentrate the equities business among bulge bracket brokers.”  Such a scenario would cut the ranks of analysts and shrink research coverage, particularly among small and midsized companies — with potentially dire consequences. “In the small and mid-cap space, research begets liquidity,” said Mr Wyatt, referring to the ease of buying and selling a stock or bond. “Research increases interest in an opportunity, deepens the market and allows an asset manager to take a more meaningful position in a company’s stock.” In the worst-case scenario, this would then thwart smaller companies from coming to the public markets, after years of dwindling initial public offerings. “No single asset manager could possibly give themselves the depth of coverage that sellside research provides — it’s impossible to replicate,” said Kevin Cronin, global head of trading for Invesco. “It’s an entire ecosystem that benefits from broker research. It’s not just asset managers, but retail investors and smaller companies in the capital markets.” To read more from this series, go to ft.com/mifid