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In Context: Markets in Financial Instruments Directive (MiFID) II

Over the last year, Callan has been fielding questions from both asset owners and asset managers regarding MiFID II. There is certainly some confusion among US-based asset owners utilizing Europe-based money managers (and/or US-based money managers with operations and portfolio management teams located in Europe) specific to MiFID II compliance.

Estimated reading time: 2 min, 33 sec

What challenges does MiFID II raise for asset owners? 

There is a need for transparency and the costs of research and execution must be disclosed and understood. Soft dollars will continue to exist until all investment managers are able to pay for research in hard dollars. MiFID II, as we understand it, has been introduced to obtain full disclosure and transparency in the use of research dollars in Europe. However, there seems to be a variety of potential outcomes that depend, in part, on the interpretation of the rule.

Will this spill over to US-based fund sponsors and asset managers? 

The last time I checked, MiFID II could be on a collision course with the safe harbor rules of the Securities Exchange Act of 1934 regarding the usage and permission to combine research and trade execution costs. It is unlikely that the European Commission intended to force the US to revise the 1934 Act through an act of Congress, an outcome that is equally unlikely. Will the SEC grant regulatory relief on MiFID payments for US investors and asset managers?

Does this impact the actual management of the portfolios?

Anecdotal evidence suggests that there will be around a 15% reduction in costs to investors through the MiFID II initiative. But aside from the cost savings, it is important to consider what the real impact to performance going forward could be. How will research be digested in the construction and management of client portfolios?

Do you have any concerns regarding how asset managers pay for research under the Directive? 

We believe that full transparency and disclosure on the usage of research (soft dollars) is a good thing. If the research costs would be subject to client acceptance, is it possible that asset managers will no longer have full investment discretion with the portfolios they are entrusted to manage?

Could US asset owners end up footing the bill for research costs that benefit asset managers’ European clients?

This is perhaps the single greatest concern for US institutional investors, who are already juggling a variety of compliance considerations. The actual results  of implementation of MiFID II remains to be seen.

Other key questions:

  • Will US institutional investors utilizing a European money manager (or US-based money manager with operations and portfolio management teams in Europe) be required to decipher these requirements and decide the research cost budget?
  • Does this end up introducing additional investment oversight and administrative cost burdens that must be monitored?
  • Will impacted investment managers have to run two sets of portfolios for the same mandate?

Related reading: See “MiFID II research rules to add fiduciary layer for asset owners,” from the October 17, 2016 issue of Pensions & Investments. (Please note a subscription to P&I may be required.)