Wall Street Stuck in Legal Stalemate Over Research Payments

  • Europe’s upcoming MiFID II regulations clash with U.S. system
  • Possible solutions such as RPAs and subsidiaries seen flawed

Wall Street banks may not be able to sell their U.S. research to European asset managers because a regulatory conflict between the two regions looks unlikely to be resolved before a January deadline.

A new European Union directive that says banks must charge for research separately from broking services clashes with the U.S. regime, which bans this approach unless lenders register as investment advisers. That’s something American banks want to avoid because it creates a fiduciary duty to clients and limits their ability to trade, according to two people familiar with the matter, who asked not to be identified because they’re not authorized to speak publicly.

“Meeting the requirements of the fiduciary duty that would be imposed raises very significant operational and cost issues,” said William Yonge, a London-based partner at law firm Morgan Lewis. “This is a disproportionate solution for accepting cash from EU managers who are merely receiving research from their broker-dealer under MiFID II.”

This vast regulatory overhaul comes into force Jan. 3 as Europe’s way of improving transparency in financial markets after the 2008 global crash. MiFID II covers everything from the platforms on which firms can trade to how they report transactions, yet the changes to the way research is shared and paid for are among the rulebook’s most controversial aspects.

‘Live Issue’

“This is a live issue -- we are a global research business with global clients,” said Terry Sinclair, a London-based director in Citigroup Inc.’s research division. The bank is having “discussions with regulators but won’t comment on their potential outcome.” He declined to comment on the possibility that U.S. banks may deny research to some European clients.

From next year, EU investment managers must either pay for analysis out of their own profit-and-loss accounts or through research payment accounts, or RPAs, which are linked to dealing commissions. Yet both unbundling options appear to conflict with U.S. law to varying degrees, according to legal sources contacted by Bloomberg News.

For their part, U.S. lenders are concerned that the Securities and Exchange Commission won’t provide an exemption allowing them to accept hard cash for research in Europe, according to a bank executive and legal experts, who asked not to be identified before additional guidance has been provided by regulators.

No Compromise

At least one Wall Street bank is already considering withholding U.S. research from asset managers in the EU because of the lack of a regulatory compromise, people familiar with its plans said, asking not to be named because the issue is unresolved.

Officials from Bank of America Corp., Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley declined to comment.

“One way banks can comply with the rules is by not sending U.S. research to clients in London,” said Rob Moulton, a London-based partner at law firm Latham & Watkins LLP. “It’s the ultimate extreme of this standoff.”

Breaking the stalemate would mean either the U.S. or EU side having to back down. Moulton said the SEC is reluctant to provide a dispensation to fix a “European-created problem” and the Trump administration has other priorities for Congress and wants less, not more, regulation. Spokesmen for the SEC and the European Commission declined to comment.

For a QuickTake on the MiFID II rules, click here.

U.K. asset managers Baillie Gifford and Woodford Investment Management Ltd., which between them manage more than $160 billion, said they’re aware of the conflict and are expecting regulatory guidance. Unlike most of their competitors, the two firms already started paying for research separately from other services several months ago.

In an October 2016 letter seen by Bloomberg News, European Parliament lawmaker Markus Ferber pressed the Commission for “clear and tangible guidance” on how firms should get around the rule clash, “instead of just reiterating high-level principles.” The reply said Europe has already provided resolution in the form of the RPA option, which should satisfy both U.S. and EU law.

Bankers and lawyers including Latham & Watkins’s Moulton are less confident, saying that under RPAs, research would still be billed separately from other services.

“Global asset managers have been slowly learning that a number of MiFID II research-unbundling rules conflict with U.S. regulatory practice, including the ability to use RPAs,” Michael Mayhew, CEO of Integrity Research Associates LLP, wrote in a May 22 note. U.S.-based money managers “face considerable difficulties.”

Subsidiary Solution?

Another solution that has been mooted is for U.S. banks to circumvent SEC rules by channeling research via their London branches.

Asset managers and lawyers are dubious about this, too. While U.K. subsidiaries tend not to be subject to SEC regulations, if the research is generated in the U.S., or the British unit has American clients, then that nation’s rules may apply, said Morgan Lewis’s Yonge.

“Where you’ve got international organizations, you make use of your different locations through staffing or secondments in Europe,” he said. “But it would have to be in substance. You’d have to have the expertise on the U.S. market here in the U.K. affiliate, or at least some of it.”

In the absence of further guidance from regulators on the stalemate, banks and money managers continue to search for a feasible workaround.

“Fund managers remain committed to obtaining the research they need to make the best investment decisions for fund investors,” said Eva Mykolenko, responsible for securities regulation at asset-management trade body ICI Global. “They are working with their brokers on solutions.”

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