Best execution | MiFID II | KPMG | IE

Best execution

Best execution

Changes to the existing best execution regime.

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MiFID II introduces changes to the existing best execution regime. It strengthens the governance aspects of best execution, so instead of firms having to take “reasonable steps” to get the best possible results for their clients, taking into consideration factors such as cost and price, they will now have to take “all sufficient steps” which is a much higher bar. It places a specific obligation on firms to check the fairness of prices proposed to clients when executing orders or taking decisions to deal in OTC products and it also introduces other changes aimed at increasing the scope and transparency.

These changes reinforce the importance of best execution as a key component of investor protection. They will be challenging to implement as evidenced by a number of reviews, conducted by regulatory agencies across Europe, of best execution under the existing MiFID framework. The findings from these reviews is that the level of implementation and convergence of best execution practices is currently quite poor, even though there has been some improvement.

In 2015, ESMA performed a peer review of European regulators and found that there was a low level of supervisory activity devoted to monitoring best execution as well as a low level of understanding by investors. In the follow up report in January 2017, ESMA found a definite improvement in the level of attention being paid to best execution but highlighted the need for continued efforts to ensure compliance.

The Central Bank of Ireland conducted a themed inspection of best execution practices under MiFID in investment and stockbroking firms in 2012. That inspection raised many concerns about the adequacy of policies and the effectiveness of procedures.

The most extensive work in this area has been done by the Financial Conduct Authority (“FCA”), both in a thematic review in 2014 and in its recent asset management market study. Its overall assessment is that investment managers are still failing to ensure effective oversight of best execution and that the pace of change to ensure improved client outcomes is slow.

The FCA’s concerns included;

  • Firms failing to act on the findings of its 2014 themed review;
  • Inconsistent use of management information to accurately view equity execution costs, where some firms could not evidence any improvement to their execution process based on these data and the review of it was largely a ‘tick box’ exercise;
  • Instances where compliance staff were not empowered by senior management to provide effective challenge to the front office on execution quality, leading to poor compliance monitoring;
  • Control and oversight concerns in terms of how investment managers oversee their use of dealing commission;
  • Best execution monitoring in fixed income being less sophisticated than in equity trading. The FCA acknowledges that this monitoring is challenging, but noted that some firms have been more proactive in how they meet their obligations than others, even in less transparent markets.

However the FCA has highlighetd some good practices;

  • Best execution considerations being considered throughout the investment decision making process, and not just by the dealing desk, whereby some dealing teams provided feedback to portfolio managers on their preferred trading strategies;
  • Improvements on the equity side where some firms were focusing on decreasing the cost of trading by using low cost trading venues such as broker-supplied algorithms, direct market access and the increasing use of crossing networks for appropriate trades;
  • Good governance processes in place that challenged the overall costs of execution, renegotiated commissions and identified trends that helped improve future execution, which fed into a high level trading strategy.

To ensure MiFID II readiness and future compliance, firms will need to improve current practices and this is borne out by the experience of regulators across Europe.

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