MiFID II imposes best execution obligations on both the markets at which transactions are executed, as well as on firms who execute orders on behalf of their investors. This article will focus on the latter.
Best Execution, More than Just Best Price
Best execution rules are intended to protect investors by ensuring that investment firms seek 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.” These rules have been a component of MiFID, and are not new. However, MiFID II prompts a few major changes, and casts a wider net across significantly more asset classes, not just equities and equity-like instruments. Four of the biggest high-level changes include:
1.) Increased obligation from “all reasonable steps” to “all sufficient steps”
2.) Best execution to be considered for each class of financial instruments, including fixed income, FX and derivatives
3.) Reporting required on the top 5 execution venues annually
4.) Policy disclosures to be made on the firm's website, and updated annually
The upgrade from "reasonable" to "sufficient" conveys the regulators' view that best execution is focused on the consistency of overall execution quality over the reporting period, as opposed to achieving the best price for a given trade. Furthermore, it emphasizes the infrastructure needed to support and to measure these results. These would include the best execution policies, data capture and retention, summary execution reporting, and periodic adjustments to improve these overall quality levels.
RTS-28 Disclosures on Policy and Top Five Venues
The Regulatory Technology Standards (RTS) developed by ESMA help to guide the specifics of best execution. RTS-28 specifically, is intended to enable the public and investors to evaluate the quality which results from a firm’s execution practices. Although MiFID II goes into effect on January 3, 2018, RTS-28 disclosures must be published on or before April 30th, 2018, and should detail previous best execution policies and include a summary of venues.
At a high-level, RTS-28 includes:
1.) An annual report stating the policy that the investment firm follows to execute client orders
2.) Distinction between client orders executed directly on venues and those executed through brokers
3.) Analysis on the top five execution venues for each class of financial instrument and the quality of execution obtained, including number and share of orders executed at each
The data component of RTS-28 can be the most burdensome to manage, depending on the size of the firm and the complexity of their investment strategies. In order to rank the top venues as required, data capture at the transaction/order level will be required. Different report formats apply to retail client orders versus professional. Although directed orders are included in these aggregates, they must be broken out and reported as a share of the overall totals.
In addition to the total executed metrics, the data must support reporting segregation according to security type, as defined in RTS 28, and by whether the order was active or passive. This is RTS 28 terminology describing whether the order decreased liquidity by lifting an offer or hitting a bid (active), or added to it by, for example, coming in between bid and offer (passive).
Securities financing transactions are excluded but are reported separately under its own (more compact) report format. Orders for "eligible count-parties" (who do not provide investment advice) are exempt from the best execution rules.
Many firms are using Transaction Cost Analysis (TCA) platforms to help to satisfy RTS 28 reporting. In our next article, we’ll take a closer look at TCA and evaluate if TCA platforms are adequate to support best execution requirements, as defined by the RegTech standard.