Here we aim to briefly show how MiFID II will change best execution practices and what will be needed by investment firms in order to meet the regulators’ demands.
1. Obligation and fairness
Under MiFID I firms were obliged to take “all reasonable steps” to achieve the best possible results for their clients. MiFID II extends this, requiring firms to take “all sufficient steps” this means best execution will be significantly more burdensome. As there will be an obligation to execute orders considering: price, costs, speed, size and likelihood of execution/settlement.
Firms will have to to check the “fairness” of the proposed price by gathering data used in the estimation of the price and compare with similar or comparable products.
The addition of these two words, obligation and fairness means firms will undoubtedly have to make changes to current practices and policies.
2. Total consideration
This represents the price of the financial instrument and the costs relating to execution including all expenses incurred in the order execution, including venue fees and fees paid to third parties involved in the execution of the order.
Best execution for retail customers is assessed on the total consideration of the trade, whereas cost remains as one of the key factors for both professional and retail clients.
There are 2 types of costs:
External costs
These include: commissions, fees, taxes, exchange fees, clearing and settlement costs or any other costs passed on to the client by participating intermediaries.
Internal costs
These represent the investment firm’s own remuneration (including commission and spread) for completing the transaction. Where more than one execution venue is available, the firm’s internal costs need be taken into account when assessing where to execute the order.
3. Disclosure of execution venue costs (fees & prices)
When there is more than one possible venue to execute an order, an investment firm’s own commissions and costs for execution on each venue need be taken into account. If fees applied by the investment firm differ from one execution venue to another, then sufficient information needs to be provided to the clients which allows them to understand the reasons behind the decision to use one venue over another.
Where a the firm invites a client to chose the execution venue the information provided needs to be “fair, clear, not misleading and sufficient to prevent the client choosing one execution venue or entity rather than another on the sole basis of the price policy applied by the firm”.
This disclosure means there is a high probability that investment firms will need to look closely at their there data and systems requirements.
4. Client instructions
There is an exception to Article 27 of MiFID II, when a client gives a specific instruction to the investment firm. However, there should be no inducement form the investment firm to make this instruction when the investment firm ought reasonably to know that the instruction is likely to prevent it from obtaining the best possible result.
5. Disclosure of execution policy
MiFID II requires investment firms to establish and implement an order execution policy.
There has been a subtle change to the MiFID I regulations regarding the wording of this requirement. In MiFID II information provided to clients must explain clearly “in sufficient detail and in an easy to understand way”.
The information must be customised
A list of factors used must be disclosed Investment firms need to provide information showing how the best execution factors are considered
Such information needs also to summarise: how venue selection occurs, specific execution strategies employed, the procedures and processes used to analyse the quality of the execution obtained and how the firm monitors and verifies the results.
As onerous as it may appear we at Objectivus suggest firms need to consider whether they need to undertake a repapering process when updating their execution policies and obtaining consent from their clients.
6. Routing client orders
MiFID II states that firms routing client orders to a particular trading venue or execution venue shall not receive any remuneration or benefits, even if they are disclosed to the client.
At Objectivus we believe this is one of the most significant changes to MiFID I’s best execution policy and reinforces the FCA’s approach of specifically banning payments for order flow between brokers and market makers.
7. Disclosure of data relating to execution quality
Trading venues, systematic internalisers and other execution venues are required to make data relating to the quality of execution of transactions available to the public at no charge.
This will obviously come at a cost to the venues which will have initial implementation cost as well as raised marginal costs from the increased frequency of publication.
8. Disclosure of top five execution venues
Investment firms who execute client orders will be obliged to summarise and make public on an annual basis for each class of financial instruments the top five execution venues of trading volumes where they executed client orders in the preceding year and information on the quality of execution obtained.
In our view at Objectivus, investment firms should consider whether they need to start reviewing their systems to ensure the required data is available and start capturing this as soon as possible.
9. Monitoring obligations
MiFID II requires investment firms to monitor the effectiveness of their order execution arrangements and execution policy in order to identify and correct any deficiencies. This must be carried out on a “regular basis”. Firms also need to notify clients of any material changes to their order execution arrangements or execution policy.
We look forward to further clarification of the phrase “regular basis” to be provided by ESMA later this year.
10. Material changes
MiFID II obliges investment firms to notify clients of any material changes (significant events of internal or external nature that could impact the parameters of best execution) to their order execution arrangements or execution policy.
We believe this means changes to the cost, price, speed, size and likelihood of execution/settlement. It is important that firms carefully determine policies and procedures to identify when a material change occurs.
In conclusion, changes to best execution proposed within MiFID II are likely to lead to large costs which will have an effect on systems, training and data. It is our advice at Objectivus that market participants should start implementing based on what they currently know to save on time, resources and money, as soon as possible.
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