MiFID II is a piece of European legislation aimed at European financial markets. While this suggests its authority is geographically limited, the reality is that its impact is far-reaching. Not only will it impact trading across the globe, but its influence is likely to stretch into the culture of regulation more generally.
Non-European entities fall under MiFID II if they are either ‘beneficial’ or ‘exposed’: ‘beneficial’ because they are the beneficial owners of European-based companies or beneficiaries of funds of European investments, and ‘exposed’ because they may have exposures through MiFID II covered European assets that are held, bought, or sold on European regulated exchanges and platforms.
An obvious problem for such institutions is analyst research. MiFID II requires asset managers to unbundle research costs, no longer covering market analysis costs with trading fees. The panoply of services attached to trading must now therefore be bought and sold as separate services. The problem for US-based institutions is that brokers cannot receive direct payments for research unless they are formally registered as investment advisors, in theory meaning they will not be able to provide research for European clients.
To assist the transition, the Securities and Exchange Commission has just granted a 30-month grace period to all US brokerage firms, assuring the industry that it wouldn’t take action against firms not registered as investment advisors who received direct payments for research.
This essentially buys the SEC time to assess their next steps, during which one assumes they will ask an important question: why is the EU producing this regulation and not the US?
Supporters of MiFID II contend that Europe will emerge with a system described by BloombergView as “much better suited to modern investing”. Regulators will be equipped with a broader and clearer view of the industry, while the ultimate effect of unbundling research could drive down trading costs, improve the research quality, and give investors a better picture of how their money is being managed.
Given all these advantages, it seems likely that other regulators will follow ESMA’s example. Larry Fink, chief executive of BlackRock, told the FT recently that “the trend… is probably movement towards that fiduciary standard worldwide”. So will the SEC follow ESMA on the path it has already started down?
Whether or not the US does follow suit is something that we shall just have to wait and see, but it raises the question of how change in the industry is driven. It doesn’t just come from regulators, but from investor demand.
The Council of Institutional Investors, which claims to be the ‘voice of corporate governance’ and have 120 members with combined assets exceeding $3tn, warned back in November 2017 that US institutional investors would be disadvantaged if they were unable to pay for research directly but their European peers could. Some take this further however, and argue not only that regulatory divergence might be problematic, but that there are genuinely beneficial reasons to adopt some of MiFID’s initiatives.
The SEC’s 30-month grace period simultaneously provides an opportunity for market participants themselves to assess the impact of MiFID II. One possible effect outside of Europe is a move towards increased ‘regulatory initiative’ on the part of firms, building on a growing trend of proactively adopting what they view to be the regulations that best serve their clients, even when they are not yet fully implemented across all the markets in which the firm might operate.
Unbundling research, or offering greater transparency, might be attractive to clients and prompt firms to implement these initiatives – whether or not they are required by the local regulator. Such a tendency may herald a significant cultural shift, whereby firms’ behaviour is less frequently prescribed by major pieces of top-down regulation and more often motivated by client needs. This can only be a good thing, as firms take greater responsibility for their role in the financial ecosystem.
The interconnectedness of global financial markets means that no market in one part of the world is completely unaffected by the regulation applicable in another. If this trend grows, it seems possible that the thrust of change in the industry will come less from the regulators than the regulated, and the clients whom they serve.
All market participants outside of the EU will be affected by MiFID II in some way. How the rest of the world chooses to respond to the gradual implementation of Europe’s new legislation is what will determine its real impact. This will not just consist of its quantitative impact on the balance sheet, or even of the attainment of its intended effects in the sphere of transparency, but in the qualitative bearing it could have on the manner in which our industry regulates itself on a global scale.