The enhanced requirements to evidence best execution under new European Union regulations will spread to the US and Asia as clients will demand more detailed pre-trade and post-trade data.
Under MiFID II, the regulations coming into force in the EU at the beginning of next year, an investment firm must take “all sufficient steps” to obtain the best possible result for its client when executing an order. Firms had been required to take "all reasonable steps" to ensure best execution under MiFID I. Law firm Hogan Lovells said in a blog: “In Q&A earlier this year, the European Securities and Markets Authority confirmed that the requirement to take 'all sufficient steps' sets a higher bar for compliance than the existing requirement.”
Rebecca Healey, head of EMEA market structure for institutional trading network Liquidnet, told Markets Media that MiFID II is a big operational change that will have a global impact.
Rebecca Healey, Liquidnet
“Clients receiving greater transparency in Europe will want the same in the US and Asia,” she added. “Firms are realising that it is a competitive advantage to provide more than is necessary with regards to best execution and unbundling.”
A Liquidnet survey, “Re-Engineering Best Execution,” found that just 6% of asset managers believe they are ready to meet best the MiFID II requirements. The results are based on interviews with 55 heads of trading/dealing across Liquidnet’s member network of asset managers in US and Europe during April and May 2017.
MIFID II extends the best execution requirements from equities into other asset classes such as fixed income and into over-the-counter markets. Therefore asset managers need to have systematic best execution policies, as well as new ways of measuring and evidencing execution outcomes.
Healey said: “The need to formalise the best execution process across asset classes has caused fund managers to go back go the drawing board. The objectives of a systematic best execution policy need to be understood throughout an organisation and there need to be policies and procedures to put them into practice.”
The FIX Trading Community formed a Best Execution working group to help understand the new requirements and devise consistent policies across the industry. Nearly two-thirds, 61%, of the survey respondents said they needed to provide more granular detail to their best execution policies. One third plan to make changes to trading workflow and over a quarter will be investing in technology to ensure a more systematic approach to best execution.
Firms have been used to measuring execution outcomes in electronic equities trading where there is an abundance of market data. However MiFID II extends the data requirements to other asset classes and to voice trading.
“Only 35% of asset managers are receiving all the FIX data they need from brokers to measure best execution,” said Healey. “Comprehensive and accurate datasets are needed outside electronic trading in equities as best execution is extended to areas such as other types of equities trading, fixed income and opaque OTC practices.”
In addition, transaction cost analysis (TCA) has been the benchmark in measuring best execution in algorithmic trading but asset managers are rethinking if this is the best way. In particular, the lack of a viable TCA product in fixed income is causing 39% of asset managers to rethink their use of TCA to deliver best execution, particularly when considering OTC products.
In the Liquidnet survey 70% of asset managers said they are reviewing new liquidity providers outside their traditional brokers and more than two-thirds are no longer choosing where to trade by broker alone.
“They are considering why they choose venues and platforms, the impact of counterparty behaviour and how to capture evidence in an audit trail,” said Healey.
Although MiFID II comes into force in January, Healey said this only marks the start of changes in providing evidence of best execution to clients.
“January will be just the beginning as best execution is an iterative process to ensure that clients receive the best outcome,’ she said. “It is a step change from ad hoc processes to continually looking at client outcomes and ensuring consistent results.”
Hogan Lovells said in a blog, Achieving best execution under MiFID II, that investment firms must take the following factors into account to meet the requirements of the new regulation:
- price;
- costs;
- speed;
- likelihood of execution and settlement;
- size;
- nature;
- or any other consideration relevant to the execution of the order.
These factors should already have been considered under MiFID I but the new regulations detail the relative importance of these factors in determining best execution.
For example, when using more than one venue for execution and there is a fee differential, MiFID II requires firms to provide detailed information to allow clients to understand both the advantages and disadvantages of one execution venue over another. “This should allow the client to make an informed decision rather than simply relying on the firm's pricing policy,” added Hogan Lovells.
For over-the-counter products, firms need to check the fairness of the price proposed to the client through gathering market data used in the estimation of the price of the product and, where possible, compare with similar or comparable products.
Hogan Lovells said: “According to Esma, firms must ensure that the intended outcomes can be successfully achieved on an on-going basis. The requirement to monitor best execution on an ex-ante and ex-post basis means that firms should consider what kinds of analytical tools may help them to compare the quality of execution available from competing execution venues ahead of the trade, as well as post-trade analytics in order to assess the quality of the execution actually achieved.”
