19 October 2015

TABB: Coming to grips with best execution under MiFID 2

Let’s begin where the article begins, with the requirement that investment firms obtain, “when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order.” Does this language help or hinder our attempts to comply? Unfortunately, the answer is yes. First there are a couple of clarifications – this only applies when an investment firm is dealing with a client, and best execution incorporates any consideration relevant to the quality of the execution.

Perhaps the biggest unanswered question  is what constitutes an order. In markets where participants are used to trading as principal, and a customer requests a quote, if the customer acts on the quote without countering, does that constitute an order? If, after receiving a quote, the customer counters and the dealer accepts the counter, was the counter an order? If any of these transactions – or any others, for that matter – are not deemed to be orders, is all of Article 27 inapplicable to them? The answers to all these questions should be in the final proposed RTSs issued by ESMA in late September. Unfortunately, no such luck. The best execution section covers a grand total of five pages and does not actually contain any proposed regulatory technical standards.

investment firms are left with the following best execution tasks 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 cancelled if not much is happening at that time.

Full article

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