Tag Archives: MiFID

MiFID I/II: Best Execution and Investment Management in the UK

UK regulator the FCA recently published findings from supervisory work in relation to best execution of client orders at investment management firms in the UK.  This followed on from an FCA thematic review into best execution in 2014.  The FCA’s findings were that these firms were still failing to ensure effective oversight of best execution and they had largely failed to take on board the findings of the thematic review.

In this piece, I outline what best execution is, what the FCA would like investment managers (IMs) to improve on and the key changes to the best execution obligation under MiFID II.

What is Best Execution?

Under MiFID I as implemented in COBS 11.2 of the FCA Handbook, the overarching best execution obligation requires firms, when executing client orders, to take all reasonable steps to obtain the best possible result, taking into account a range of execution factors – price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order.  Where a firm executes an order on behalf of a retail client, the best possible result must be determined in terms of total consideration (total price and all costs).

The FCA’s Questions for Improvement

The FCA expects IMs to have a strategy to ensure that all relevant parts of their business are compliant in ensuring best execution. There should also be clear management responsibility and co-ordination between the Front Office and Compliance to ensure a robust monitoring framework.

In order to improve their approach, the FCA now wants IMs to consider the following 7 questions in relation to best execution and make improvements where necessary:

  1. Who would the FCA hold responsible if the firm fails in its obligation to ensure it consistently achieves best execution?
  2. Do we have a comprehensive strategy for overseeing best execution?
  3. Have we tested that funds and client portfolios are not paying too much for execution? Where we identified they have paid too much did we compensate the investors?
  4. Does our order execution policy accurately reflect our firm’s business model rather than being a generic policy?
  5. What trades or trends have been identified as deficient through our regular monitoring?
  6. Is our gift and entertainment policy in line with the guidance set out in the FCA’s Finalised Guidance 14/1 and the 2012 guidance re conflicts of interest?
  7. Have our staff been adequately trained to ensure they understand what best execution means and its consequences? How can we evidence this to the FCA?

Interestingly, IMs were not looked at as part of the FCA’s 2014 thematic review on best execution, which focussed more on sell side firms. The FCA has conducted a separate study into the asset management industry in 2016 although this is still at an interim report stage and only contains passing references to best execution.

The thematic review is worth reviewing in detail not least because it contains many informative examples of good and poor practices at firms in relation to best execution.

Best Execution and MiFID II

The EU Markets in Financial Instruments Directive 2014/65/EU (MiFID II) will apply from 3 January 2018 and places a specific obligation (Article 27) on firms to execute orders on terms most favourable to the client.

Best execution: key changes under MiFID II, Level 1, Article 27:

  • Firms will be required to take all sufficient steps to achieve the best possible results (Article 27(1)), rather than all ‘reasonable’ steps as currently required;
  • There is an explicit prohibition of remuneration for executing client orders which is contrary to the rules on inducements or conflicts of interest (Article 27(2));
  • A requirement for all trading venues to publish data on the execution quality obtained (including price, costs, speed and likelihood of execution for individual financial instruments) at least annually, which will assist firms in delivering their monitoring requirements (Article 27(3));
  • Requirements for firms to provide information to clients on execution of different classes of financial instruments, detail on how they have applied the execution factors and obtain the prior consent of clients to the order execution policy (Article 27(5));
  • A requirement on all firms to publish data on the top five trading venues where they executed client orders and information on the quality of execution obtained on an annual basis (Article 27(6)).

MiFID II Article 27 will also be supplemented by Level 2 measures: Regulatory Technical Standards (RTSs) No. 27 on execution quality data to be provided by trading venues and RTS No. 28 on the annual report by firms on the quality of execution on identified trading venues.

Next Steps and Conclusion

The FCA says it will revisit best execution in 2017 to see what steps IMs have taken to assess gaps in their approach and how they can evidence that funds and client portfolios are not paying too much for execution. If it finds that IMs are still not fulfilling their best execution obligations, the FCA will consider making more detailed investigations into specific firms, individuals or practices.

Such an investigation would be the last thing an IM would want and so it would be prudent for IMs and other firms to consider the questions for improvement outlined above, the detailed findings of the thematic review, the changes being brought by MiFID II and to then take the appropriate steps in relation to best execution.



MiFID II: Jargon-buster

The EU Markets in Financial Instruments Regulation EU/600/2014 (MiFIR) and Markets in Financial Instruments Directive 2014/65/EU (together referred to as MiFID II) will apply from 3 January 2018.  This date is much closer than it seems and banks and investment firms are currently scrambling to implement MiFID II-compliant measures in their systems, controls and client documentation.

MiFID II replaces and partially recasts the existing MiFID regime under the directive 2004/39/EC (MiFID I) and in many places introduces new concepts or extends the meaning of existing concepts.

In this piece, I consider some of the main new MiFID II concepts and the inevitable jargon that goes with them.

Algorithmic or high-frequency trading (HFT): trading in financial instruments by a computer algorithm with limited or no human intervention.  MiFID II will require such trading to be conducted by authorised investment firms, be supervised and have controls and other safeguards to ensure it does not cause any disruption in the market.

APA (Approved Publication Arrangement): MiFID II introduces the concept of an APA who will assist in price discovery by publishing post-trade transparency data.  An APA could be a new market participant or a new activity conducted by Trading Venues such as exchanges.  An APA will be subject to authorisation and organisational requirements.

ARM (Approved Reporting Mechanism): a new concept introduced by MiFID II for enabling transaction reporting by investment firms to regulators.  An ARM will be subject to authorisation and organisational requirements.

CTP (Consolidated Tape Provider): MiFID II envisages a new provider that will consolidate post-trade disclosures and make them publicly available (a continuous electronic live data stream providing price and volume data).  A CTP  will be subject to authorisation and organisational requirements.

DRSP (Data Reporting Service Provider): an APA, ARM or CTP.

Financial Instruments: this is a wider concept under MiFID II and refers not only to shares and other “transferable securities” but also to money-market instruments, units in collective investment schemes, emission allowances and derivatives such as options, futures, swaps and forward rate agreements.

Independent Advice: the provision of personal recommendations to a client.  MiFID II will oblige firms to ensure that staff are not remunerated or assessed in a way that could conflict with the duty to act in a client’s best interest.

OTF (Organised Trading Facility): a trading venue for bonds, structured products or derivatives (i.e. non-equity financial instruments).  This is a new concept and MiFID II will now regulate OTF platforms (e.g. broker crossing networks).

MTF (Multilateral Trading Facility): a venue where financial instruments can trade outside of a regulated market e.g. an internal matching system at a firm that executes client orders in shares.  This is a MiFID I concept but MTFs (as also OTFs) will now need enhanced financial resources, measures for risk management and conflicts of interest identification.

Post-trade transparency: publication of transaction data via an APA by the operators of Trading Venues or SIs immediately following a trade – to be available on commercial terms immediately or for free after 15 minutes.

Pre-trade transparency: continuous publication of bid and offer prices of financial instruments by operators of Trading Venues (e.g. exchanges) or publication of firm quotes by SIs, in either case, before a trade takes place.

Regulated Market: a stock market or exchange regulated by an EU member state for trading in publicly-listed financial instruments e.g. the London Stock Exchange.

SME Growth Market: a new category of MTF that will enable small and medium-sized entities (SMEs) to access capital.  At least 50% of the issuers on such an MTF must be SMEs.

SI (Systematic Internaliser): traditionally called “market maker” this is an investment firm which routinely deals on its own account by executing customer orders in shares outside a Trading Venue such as an exchange.  MiFID II will extend this concept to cover all financial instruments not just shares.  SIs will also need to publish firm quotes and post-trade data.

Trading Venue: an OTF, MTF or Regulated Market.  MiFID II will require Trading Venues to have better systems, controls and circuit-breakers and there will be rules on minimum tick size (price increments).  They will also need to publish annual data on execution quality.

Transaction Reporting: MiFID II envisages the reporting of transaction data by investment firms that execute transactions in financial instruments to the regulator (e.g. the FCA) within 1 day of the trade via an ARM.

TTCA (Title Transfer Collateral Arrangement): this not a MiFID concept as such but MiFID II prohibits firms from entering into TTCAs with retail clients and obliges firms to consider the appropriateness of a TTCA for the other categories of clients – i.e. professional clients or eligible counterparties.