The globalization of financial markets has brought about a number of challenges, one of them being the extraterritorial reach of US regulation. Overseas banks and corporations have long protested against the imposition of regulations crafted in Washington, which they are obligated to implement despite their own local laws. However, it seems that Wall Street is now experiencing the same predicament. In particular, US banks and brokers with European clients are scrambling to deal with the impending loss of a previously granted “free pass” that shielded them from complying with EU rules on how research is paid for by clients.
The Markets in Financial Instruments Directive (Mifid II), which came into effect in 2018, fundamentally altered the broking industry in Europe, unbundling payment for research from trading costs and mandating that clients pay for research services directly. This was intended to address concerns about opaque relationships between banks and fund managers. However, in the US, research services are typically bundled with trading costs, making the transition difficult for Wall Street. Adding to the challenge is the requirement for any party selling research to adhere to US regulatory requirements, which necessitates registering as an investment adviser.
The five-year waiver from US regulators that protected banks and brokers from having to comply with these rules is shortly set to expire. The industry is now scrambling to navigate the regulatory muddle. Some banks, like Bank of America and Jefferies, have already registered units as investment advisers, proving that it is possible to do so without compromising investment banking activities. However, not all banks are set up in the same way, and some may struggle more than others to comply.
Apart from the regulatory challenges, there are concerns about the impact of Mifid II on research budgets. According to British estimates, European investors slashed research budgets by 30% following the introduction of Mifid II, while French estimates indicate that the figure was more than half. Advocates of unbundling believe that it presents an opportunity to enhance transparency and help midsized investors, while others are simply seeking clarity on the matter.
In a twist, the US House Financial Services Committee recently approved a bipartisan bill that would extend the waiver for another six months and urge the SEC to re-examine the issue, taking into account Mifid II’s impact. While the bill is unlikely to be passed before the deadline, it could still come into force in the near future. Sifma, the US industry association, has repeatedly called for an extension of the waiver and highlighted European proposals for “rebundling”, citing concerns that a fall in the number of analysts selling research has hurt smaller companies. However, a 2022 SEC paper found that the impact of Mifid II on coverage was “inconclusive, unclear, or difficult to isolate”.
Although there is a certain irony in Wall Street’s complaints about extraterritoriality, given its own global ambitions, the problem remains a serious one for US banks and brokers. As the deadline approaches, the industry is working hard to comply with the EU’s regulatory requirements and address the associated challenges.
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