I’m a little late on sharing my thoughts on the recent MiFID developments and the SEC’s latest comments, but as many of you know, I’ve written pretty extensively about my personal views on the unbundling portion of the regulation, and the flaws with the current MiFID II unbundling approach.
Last month, the SEC confirmed that they will not be extending the no action letter past July next year. No hard dollar payments in the US. You can read a good summary of the speech here.
Among the broader MiFID II regulatory package, the original purpose of unbundling was to reduce ‘conflicts of interest’ between asset managers and brokers who offered both research and execution services. The high-level idea being that by ‘bundling’ the two services to clients, asset managers weren’t always meeting their best execution requirements, as they may have simply been trading with the same firms that provided them research. To unbundle, those costs were to be split out, measured, and the research portion to be either absorbed by the firm, or passed back to the asset owners themselves.
To an industry outsider, that might seem logical: split out the costs, provide more transparency, put a price on everything. The problem is that it’s not how the industry works today, nor how the industry ever worked. We forget that formal research was originally designed to market deals and educate investors, for the benefit of the brokerage and corporate. Yes, it’s evolved and grown since then, with a deeper value proposition, but even at inception, it was part of a bundled offering. The same goes for trading colour, desk strategists, and even sales commentary. It’s part of servicing the clients to ultimately sell a service: trading.
I won’t go into all the reasons why I think unbundling is flawed, and why I think unbundling was ultimately a mistake (you can read my previous pieces for that), but I do want to highlight what I think is the genius strategy and tactics employed by the SEC in their approach to unbundling in the US.
When MiFID II was originally announced, the assumption was that the US would follow European regulation, as asset managers would have to operate at ‘the highest global level’ in their fiduciary duty. Europe was effectively setting a new high bar, and potentially exporting their regulation to the rest of the world.
The SEC could have said no, and rejected it outright, they could have said yes, and accepted it, but instead, masterfully, they said “we’ll see” – and issued a no action letter. It was genius and win-win, and gave them an option on the regulation:
- If unbundling ended up being a net positive to the industry, the US regulators could adopt it, and avoid the growing pains felt in the first wave of ‘unbundling’, and the regulatory and compliance pains. Additionally, the tools, software, and processes need would already be developed
- If unbundling ended up being a net negative for the industry, the US regulators could reject it, restate their current approach to payments for research, and move on
Now of course, that’s the benevolent read on the situation. The more adversarial read could be that the SEC was against unbundling from outset, but knew the FCA was the prime architect of the MiFID II unbundling rules, which Germany and France opposed, and that if they waited for Brexit, the regulatory power would shift from the UK to mainland Europe, and simply waiting for that eventuality would make their eventual opposition and defeat of the regulatory change much easier. We’ll never know.
Here we are five years later, and the SEC has officially ended the grace period. Unbundling will not make the voyage across the ocean to the US. The no action letter will expire next July, and the industry will have to rely on CSAs and soft dollar payments in the US. The FCA (one of the main architects of the regulation) have been softening their stance for a while now, including ‘exemptions for rebundling” based on market cap that were passed last year. With Brexit behind them and more regulatory power moving to mainland Europe, how long will Germany and France (who were against unbundling) tow the line, or will they push a reversion to the US approach? My money would be on the latter. In fact, I would make an 80% confidence bet that the unbundling portion of MiFID itself is removed or essentially defanged in Europe itself in the next three years.
The last five years have been a grand experiment, but I would argue created more problems than it solved. The SEC has seen the experiment, and decided it did not like the outcome. It reminds me of a quote which captures the issue perfectly:
“Life is really simple, but we insist on making it complicated.” – Confucius
The markets are the same way. Regulators are acting in good faith to solve potential problems, but end up making things more complicated in the process.
The markets are simple, but we insist on making them complicated.
It looks like the SEC is choosing the path of simplicity.
Other posts you may find interesting:
Asset Manager or Asset Owner – who votes?
Are Research Marketplaces officially dead?
The path to Rebundling is going to be messy