An influential advisory group to European securities regulators has come out strongly opposed to a potential ban on paying for investment research with client commissions. When combined with the universally negative comments submitted by other constituencies, the prevailing opinion is that European regulators will pull back from a ban on research commissions.
The Securities and Markets Stakeholder Group (SMSG) is an advisory group appointed by the European Securities and Markets Authority (ESMA), the European-wide regulatory authority whose members are the financial markets regulators in each of the 28 member states. The SMSG is comprised of academics, consumers and financial institutions representing various securities market constituencies. It is a frequent commenter on ESMA’s technical standards and guidelines, and is considered an impartial viewpoint.
The SMSG has submitted a 29-page comment letter on ESMA’s 500 page draft MiFID II regulation which focuses on a few key issues, one of which being investment research. In no uncertain terms, the SMSG opposes the ESMA draft language impacting research: “We strongly advise ESMA to reconsider their stance by deleting the paragraph relating to investment research.”
Quibbles with intent
Partly the SMSG’s opposition is based on technical grounds. It believes that the original MiFID II language was intended to address concerns about inducements paid to retail financial advisors, and that the application of the language to institutional investment research is a stretch:
“The SMSG completely disagrees with the qualification of research as an inducement, and does not even see it as being a non-monetary benefit. It notes that the Level 1 text never considered investment research as an inducement and logically never directed either the Commission or ESMA to work in this direction. Research is not an inducement for the distributor, but an additional service that is aimed for the benefit of the client.”
The SMSG also cites policy reasons for dropping the proposed language. It argues that small cap stock coverage will decline, that smaller asset managers will be disadvantaged, and that a ban on research commissions will create an unlevel playing field for European asset managers relative to US asset managers since the SEC is unlikely to follow suit.
From what we are hearing, the SMSG issues are similar to views held by other European regulators. As we noted in the past, the Autorité des Marchés Financiers (AMF), the French securities regulator has publicly expressed concerns about adopting changes that would reduce the volume of research, which a research commission ban would certainly do. The AMF also worried about the impact of a ban on French asset manager profit margins, and that smaller asset managers would be less able to afford research than larger managers, putting them at a competitive disadvantage.
As we have previously noted, there is broad opposition to the proposed ESMA language banning research commission payments. There are over 200 comment letters on the ESMA website comprising an estimated 10,000 pages of text, much of it focused on the inducements language and most of that negative. If the ‘heft test’ has any sway with ESMA, it will amend the draft language.
Even the independent research community opposes the ESMA language. EuroIRP, the European trade association for independents, called the draft language a “dangerous compromise” that is sweeping enough to severely impact the research market but not broad enough to prevent loopholes that investment banking research could exploit. Investorside, the US trade association for independents, expressed similar concerns.
There is a widespread rumor that the draft ESMA language pertaining to investment research was in fact drafted the UK Financial Conduct Authority (FCA). Apparently ESMA delegated sections of the draft rules to various constituent regulators, and supposedly the FCA was assigned the inducements section.
According to the rumor, other European regulators, notably the German and French regulators, feel that the FCA co-opted the inducements language to its own ends. If true, the language is likely to be amended because voting on the final language is based on each country’s GDP, giving Germany and France the deciding votes.
However, even if the MiFID II language is ultimately de-fanged, the unbundling issue doesn’t go away. The FCA is on the warpath on this issue, and its latest regulation passed in May is already having a big impact. Although it clearly hoped that it could ride the coattails of MiFID II, the FCA has already demonstrated its willingness to act unilaterally.
The next step is for ESMA to publish a consultation paper which is expected between December 2014 and March 2015, which will contain the next version of inducements rules. This issue will remain on the front burner for the foreseeable future.