By Matt Gibbs, Vice President, Product Management
This is the second in the webinar series, Tackling the Challenges of MiFID II, hosted in December 2016 by Matt Gibbs of Linedata and featuring a panel of industry experts: Andrew Glessing - Alpha Consulting; Chris Gizmunt - Linedata; Martin Godsk Hansen - Axxsys; Michael Sparkes - ITG; Philippe Carre - Ullink. The first discussion, in September 2016, highlighted the revised Markets in Financial Instruments Directive, widely known as MiFID II, best practices for project structure, governance, use of external parties and planning approach.
At the center of the investment process under the Directive, best execution is one of the most important aspects of MiFID II. Our panel of market experts offered up their insights for best execution around multi-asset, critical reporting tools and the buy-side’s expectations of vendors.
3 key points to know about Best Execution:
- It is the responsibility of the Asset Manager to validate client allocation prices.
- All asset types must be considered separately.
- Internal policies must be transparent and constantly reviewed.
As we edge closer toward the current January 2018 deadline, firms must eventually come to grips with best execution, beginning with how to assess, synthesize and crunch an increasing number of data points and then how to effectively present and report when required.
The challenge of deriving and reporting Best Execution is driven largely by the interplay of market structure, regulation, and behavior.
When we look at behavior, we see that previously best execution was largely left in the hands of the broker. Now the onus is shared by the Buy side, who can no longer rely only on a counterparty for confirmation that best execution has taken place. Instead, they will now have to prove this independently. Buy side participants are mandated to consider additional factors in their efforts to attain best execution. Some of these factors include the size and nature of the trade, the likelihood of execution and settlement and all associated costs. More effective use of data will both facilitate and encourage the change in behavior that is the quest for best execution.
Additionally, market structures will play a significant role in the best execution algorithm. Outside of the more obvious differences between an order book and request for quote style of markets, thought must be given to how specific structures can be analyzed. Even an order book-style market offers many differing placement options. Identifying the most appropriate method of placement for the client at any given time given the variables is an intriguing challenge.
The process, initially scoped in MiFID I, can be seen as moving from adolescence to adulthood.
Previously best execution was defined in generic and high level terms, and is now more accurately defined, partly in an effort to get more consistent and meaningful outcomes. Moreover, there is a much broader awareness of the need to monitor and capture data. Analysis of that data is at the core of proving best execution.
The question for the market is – How can asset managers and industry groups work with regulators to come to a common understanding on what best execution practices and measurement will be? Very soon, both the buyside and the sellside will have to reach a level of agreement with regulators on:
- Firm governance structure
- Escalation process
- Ability to show evidence of Best Ex consistency
Ultimately, adoption and compliance is about putting together a comprehensive best execution policy, across all asset classes, as well as a repeatable process to execute on that policy. Asset managers will have to prove that they have a repeatable process that results in a consistent behavior that meets those agreed regulatory demands.
Of course, working through this will vary across asset classes and even within asset classes (small cap vs large cap equities, for example). To complicate things further, the type of clients on behalf of whom the trade is being done (retail vs. institutional, for example) may require a different best execution strategy. This might force a buy-side trader to adopt new workflows that don’t currently exist under MiFID I.
Are vendors working closely enough together to give the buyside the tools that they need for executing their own BestEx policies?
But is there a gap between what the buyside needs and what is currently available? In most cases… yes. This is because what is required didn’t exist prior to the MiFID II best execution directive. Although some, most or all of the data required to prove best execution has historically been available to the buy-side, it is often times spread across multiple platforms. This data now needs to be aggregated, crunched and assessed on a significantly timelier basis.
One silver lining in all this is that asset managers can leverage these required changes to make their workflows more effective and ultimately better evaluate the brokers with whom they do business.
Transaction Cost Analysis (TCA) has been used as a proxy for best execution by many in equity trading for some time now. New regulation should make pure, post-trade TCA a smaller, but still very significant, piece of the best execution puzzle. Pre-trade TCA will likely play a bigger role than it has in the past; especially for more illiquid securities.
At a high level the analysis is simple: 1. Get all the data in one place, 2. Organize in a way that is satisfactory to the regulator. The reality unfortunately is much more complicated.
MiFID II adoption is an iterative process and still has room for interpretation within the regulatory framework.
European regulators are encouraging firm readiness through resources like the FCA’s dedicated MiFID II website but MiFID II adoption, and especially best execution, is still a subject of significant debate.