Mimicking MiFID II: Three potential outcomes of CSA unbundling in the US

European broker-dealers will face a number of operational adjustments under MiFID II, but one proposed change has small and mid-sized firms on edge more than others: the unbundling of trade research and execution fees.

Input provided by the European Securities and Markets Authority in late 2014 laid the framework for a new standard under which broker-dealers would have to charge separately for the two services. Though industry regulators hope this separation will improve transparency, firms worry the switch could be the end of commission sharing agreements, not to mention a blow to revenues.

If MiFID II results in smoother, more honest European market dealings, there's speculation it would only be a matter of time until the Securities and Exchange Commission follows suit. Any move to unbundle CSAs in the United States would be met with questions and concerns, but the outcomes of such regulation would be less clear.

Implications for US broker-dealers
When new capital markets regulations are proposed, firms are quick to criticise how the laws will escalate compliance burdens and the cost of staying in business. Should the US mirror MiFID II, however, the impact on broker-dealers may not be entirely negative. Consider these three effects of CSA unbundling in the US:

• Broker-dealers of all sizes will be impacted. It's a common industry perception that tighter capital markets regulations make it more difficult - and expensive - for smaller firms to operate efficiently. This has certainly been the case since Dodd-Frank came into effect in 2010, but MiFID-inspired rules would impact US broker-dealers of all sizes. Europe's new standard stipulates that commissions and soft dollars may only be applied to research if firms disclose each separately. Faced with a similar directive, some US firms may try obtaining consent from each of their clients on an approved research budget. The more clients a broker-dealer services, the more arduous a task this approval process will be.

• Execution costs probably won't rise. Again, during periods of overregulation, the prevailing fear among organisations is that expenses will spike. Some might argue that unbundling commission and research costs will decrease client demand for research, subsequently driving up execution fees to compensate. Given how competitive commission rates have become in the last decade, however, this is unlikely. Any effort to raise execution costs would stir up conflict with the buy-side, a risk most broker-dealers want to avoid.

• Research processes and tools will need to adapt. If stateside regulations made buying research more difficult, it's plausible that some clients might shift their attention to exchange-traded funds to minimise costs. Realistically, there will always be a need for high quality research, but legal complexity will force broker-dealers to change their methods accordingly. To comply with regulations similar to MiFID II, firms would have to create more accurate research spend projections for the year ahead. Generating accurate forecasts in a time when global economy-shaking events can unfold in minutes is no small feat. Fortunately, this opens the door for firms to develop and embrace new technology that lends a new degree of efficiency to research planning and management.

It's still too early to precisely gauge how MiFID II will play out in Europe, let alone how a sister regulation would fare elsewhere. Regardless, the potential for CSA unbundling in the US is not unthinkable. The onus falls on broker-dealers to understand how such a shift would affect their operations and profitability, for better or for worse.

By Mike Plunkett, board member at Firm 58 and former president of North America at Instinet