“Best Execution” – is it sufficiently well-regulated?

“Best Execution” – is it sufficiently well-regulated?

The requirements on firms to obtain best execution for orders from clients or placed on their behalves is again under scrutiny at global and European levels. Both IOSCO and ESMA issued papers at the end of last year.

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The papers focus on an analysis of the current rules in different jurisdictions (noting where new regulation is soon to come into effect) and on the extent to which national regulators actively supervise firms’ compliance with them. In particular, ESMA’s paper covers the current EU rules (MiFID I) and notes the changes expected under MiFID II.

IOSCO is consulting on order routing incentives, in its ongoing effort to protect investors. Its report examines the regulatory conduct requirements for firms to manage conflicts of interests associated with routing orders and obtaining best execution. It does not at this stage propose any next steps and is, therefore, in practice no more than a useful summary of current requirements and a request for additional views.

The paper notes that only Canada applies specific regulations to address the provision of additional goods and services alongside order execution, but that a number of national regulators apply rules on the recipients of bundled services such as “soft dollars”. Such bundling is prevalent in the market in the area of research and corporate access. It notes, however, the imminent changes to rules in the EU under MiFID II, and in Hong Kong and the US.

ESMA’s first peer review found that the level of implementation of Best Execution provisions, and the level of convergence of supervisory practices by national regulators (NCAs), were relatively low, with 15 NCAs found to be not applying or only partly applying criteria considered essential for ensuring effective Best Execution in practice.

The second review issued at the end of last year reports on follow-up work, which began in September 2016, to assess whether NCAs have addressed the deficiencies identified in the first review. There have been clear improvements since the first review:

  • several NCAs indicated that they had introduced or reinforced risk-based supervision of Best Execution;
  • several NCAs reported specific action directly targeting Best Execution through thematic work, in the form of desk-based reviews or on-site visits to review a sample of client orders; and
  • five NCAs reported they have taken action that addresses the previously identified deficiencies.

However, among the NCAs that were not in a position to show progress, some indicated that the first peer review report had not yet been considered fully. Others provided reasons similar to those expressed in 2015, such as internal organisational issues or specificities of national markets that result in potential breaches of Best Execution being considered low risk by investors.

Implementation of MiFID II in January 2018 will provide a further opportunity for all NCAs, in conjunction with ESMA, to move to convergence of Best Execution and other conduct of business requirements. In the light of the responses from some NCAs to this second peer review, it remains to be seen whether such convergence will take place in the short term.

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