16 October 2015

TabbForum: Coming to grips with best execution under MiFID 2

Neither the final RTSs nor the May 2014 discussion paper address this critical section, so investment firms are pretty much flying blind when it comes to the executions themselves. And nowhere do the ESMA documents discuss how the execution requirements will be enforced, except via the recordkeeping section. As a result, there are 5 tasks investment firms must tackle before MiFID 2 becomes effective at the end of 2016.

·         Initiate conversations with your regulators – Since so much of Article 27 is still up in the air, the first step is to engage your regulators in a series of conversations about implementation and enforcement. In many cases the regulators are grappling with the specifics as much as the firms are, so an open discussion will probably pay big dividends.

·         Identify all the business areas that are involved – The term “investment firm” covers a very wide range of activities, from a pure dealer to a pure customer to financial service provider, including activities that only touch markets tangentially. Thus, a firm must undertake an exhaustive survey of all its activities in or around financial instruments to make sure that it doesn’t miss an area that has a hidden best execution responsibility.

·         Prepare policies and procedures – Some of the P&Ps are cut and dried, such as no compensation of any kind for order flow; but others are very much judgment calls. What counterparties are exempt from the best execution requirements? What constitutes an order? What execution agreements must we have with what counterparties? What monitoring and alert functions must we have to ensure compliance?

·         Review your trading technology – Everyone is acutely aware of the recordkeeping requirement involved in best execution, but compliance will also place significant demands on order management systems, on-boarding systems and trade booking systems. Firms that attack their technology requirements early (and probably often) will be in a better competitive position in early 2017, because they will be able to respond to customer inquiries or take advantage of market opportunities without having to stop and second-guess themselves.

·         Educate traders, salespeople and asset managers – Since MiFID 2 changes many trading practices in many venues, an early and ongoing training program is a necessity. ESMA, among others, has indicated that it will be evolving its regulation and enforcement, so a one-and-done approach to training will leave you vulnerable. Regularly scheduled sessions are the only answer, since they can be abbreviated or canceled if not much is happening at that time.

By now, every market participant is used to the ceaseless march of regulatory change, but the best execution component appears to be among the worst designed and most difficult to get one’s arms around. However, it is coming on us nonetheless. Perhaps we would be allowed to observe that the best place for a best execution requirement was in the drafting of the rule itself.

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