MiFID II (Markets in Financial instruments Directive II), a regulatory framework implemented by the EU, addresses various aspects of investment services, including the unbundling of research from trading fees. Despite MiFID II’s requirement for unbundling, major investment advisors chose to absorb these costs, possibly to circumvent regulations by shifting bundled commissions to non-EU funds. Together with his peers, Rafael Zambrana conducted research to investigate whether asset managers operating in both the EU and the US bypass MiFID II requirements by shifting soft dollar payments to their US funds and examines the impact of this practice on fund performance in both regions.
For those who were unable to attend his presentation, a summary is available below:
“First of all, as SEC Chairman Christopher Cox explains, ‘soft dollars are essentially credits earned from brokerage commissions that a broker-dealer’s customer can use to pay for research reports or other things of value. They represent the assets of investors, although investors themselves neither monitor nor approve the accumulation and spending of these assets.’
Our research focuses on the cross-border impact on asset managers regarding the bundling of trading costs and research expenses, particularly in the context of MiFID II regulations. Under the new regulation, research that was acquired by management companies of funds subject to EU regulation could no longer be bundled through the payments of soft dollars, and instead must continue to be charged directly to fund investors or absorb these costs internally. This aimed to foster increased transparency in fee setting and improve accountability among management companies.
However, every major investment advisor chose to absorb these costs, suggesting that asset managers were bypassing these requirements, by shifting soft dollar payments to their US funds. We therefore wanted to find out if those asset managers operating in both the EU and the US were managing to avoid the regulation.
Our methodology involved identifying EU funds with US counterparts, termed ‘twins,’ sharing the same managers and investment style, sold in both regions. The analysis employed a difference-in-difference approach around EU regulations to compare the behavior of twins versus non-twins and additionally twins that use soft dollars versus those that do not.
The results indicated that US twin funds experienced an increase in both per-share and total commissions following MiFID II unbundling requirements. The commission increase amounted to 3.5 basis points(bps) as a percentage of total net assets and 11.2 bps per share. Notably, the rise was primarily driven by twins utilizing soft dollars compared to other twins. Therefore, the increase in soft dollar payments was associated with a decrease in US twin fund performance and a slight increase in EU twin performance.
We conclude that brokerage commissions rise for US funds subject to the unbundling rule, with research costs seemingly shifted to US investors, where the use of soft dollars remains permitted. This practice leads to a decrease in performance of US twin funds, while their EU counterparts experienced an increase in performance. The findings suggest that rather than mitigating agency costs, they are merely transferred from a more regulated market to a less regulated one. We therefore emphasize the need for internationally coordinated actions to address such issues effectively in global financial markets”.
View the research in full via: Joint Spring Seminar 2024, United Kingdom • Inquire Europe (inquire-europe.org)