The 3rd of January 2018, the entry into force of MiFID II/MiFIR, is a date that many will remember in the Financial Industry, just like the UK Bing Bang (1986), or the introduction of the first ever adopted financial regulation, i.e. the Security Exchange Act of 1934.
One subject matter has specifically crystallised most of the critics: Best Execution rules. All but very few have strongly pushed back on Best Execution related provisions, with the intention of watering down the new features, especially the ones related to increased transparency & investors protection.
While MiFID II did not materially amend the overarching obligation to obtain the best possible results on a consistent basis when executing client orders, it has set a higher bar for compliance, and introduced new reporting requirements. The new framework moved from a higher‑level set of rules to a more prescriptive one, with well‑defined organisational and reporting requirements.
With MiFID II, firms have to strengthen their arrangements, such as front-office accountability, monitoring capabilities and appropriateness of their systems and controls. Additionally, where MiFID I required firms to establish and implement an order execution policy, MiFID II is now prescribing in details the mandatory contents of that policy.
MiFID II set of rules are specifically directed at increasing the transparency of the way firms organise their order execution arrangements. The new rules were constructed with the intention of facilitating clients scrutiny on the service provided, and compensate for information asymmetries between clients and services providers. In order to give effect to this, MiFID II has introduced two new reporting requirements: one for trading venues, SIs, market makers & liquidity providers (RTS 27), and the second one for investment firms executing (transmitting) client orders (RTS 28).
(Please note that some firms, depending on the type of products traded, must produce both the RTS 27 & the RTS 28: SIs or certain liquidity providers).
To do / Not to do
- Article 27(5) of MiFID II requires firms to include in their order execution policy in respect of each class of financial instruments, information on the different venues where the investment firm executes its client orders.
It means that for each class of financial instruments (as listed within Annex I, RTS 28), firm’s must list in their order execution policy the actual venues used. Stating, for instance, that the firm uses RMs, MTFs, OTFs and other liquidity providers will not meet the compliance threshold. Please note that it is possible to aggregate the classes of financial instruments as listed in Annex I as long as they are identified and the name of the venues used remains properly disclosed.
- Article 27(5) of MiFID II requires firms to provide their clients with appropriate information on their order execution policy.
The Directive uses the words “appropriate information on” and indicates that the information provided shall clearly explain, in sufficient detail and in a way that can be easily understood by clients how the orders will be executed. The precise list of information to be provided is listed within Article 66(3) of the Commission Delegated Regulation. Please note that Article 66(9) adds that where an investment firm executes orders for retail clients, it shall provide those clients with a summary of the relevant policy, focused on the total costs they incur.
Most firms choose to provide their clients directly with their order execution policy as an aim to be more exhaustive, hence this approach may not satisfy the regulator for two main reasons:
- The elements listed in Article 66(3) are falling short of the contents a comprehensive policy should include: order execution monitoring, governance, internal arrangements & procedures, record keeping, training, monitoring of compliance with the policy, review & updates … etc. A policy needs also to be signed-off by Senior Management & approved by the Governing Body.
- The requirement on firms is to present that information in a way that can be easily understood by clients, which means that it has to be tailored to the firm’s client’s types. Internal policies & procedure formats are rarely drafted in such a way.
Consequently providing clients with the firm order execution policy may not be the best course of action. Please note also that the actual requirement is not to provide clients with the policy but with either “information on” or with a “summary of” that policy (like for instance in Article 47(1)(h) in relation to conflicts of interest).
- Where providing the services of portfolio management or reception & transmission of orders, do firms need to obtain prior consent on their order execution policy?
The requirement to obtain prior consent on the order execution policy stems from Article 27(5), second paragraph: “Member States shall require that investment firms obtain the prior consent of their clients to the order execution policy”.
The Best Execution related requirements applicable to portfolio managers & RTO firms stems from Article 24(1) & 24(4) of MiFID II. Those requirements are detailed within Article 65 of the Commission Delegated Regulation and do not require those firms to obtain the client prior consent on their order execution policy, but only to provide the clients with information on the policy they have established in accordance with Article 66 (2) to (9).
(Please note that where a firm also execute orders on behalf of its clients then, the above does not apply).
- RTS 27 reporting for market makers and other liquidity providers
Article 27.3 states that for financial instruments not subject to the trading obligation each execution venue makes available to the public, without any charges, data relating to the quality of execution on that venue and that periodic reports shall include details about price, costs, speed and likelihood of execution. We have established that “execution venues” for the purpose of “Best Execution” are defined as trading venues, SIs, market makers and other liquidity providers (Art. 64 of the Delegated Regulation). Consequently market makers and other liquidity providers have to comply with RTS 27 and report quarterly on the quality of execution. It ensures that both OTC trades as well as transactions pursuant to the pre-trade transparency waivers that are carried out on-book and off-book, but under the rules of the venue are reported. (Please see ESMA Q&A for additional information).
It may seem that MiFID II has drastically changed the previous best execution framework, but it has only level-up the compliance and transparency thresholds. If you need any assistance or have specific questions on Best Execution related requirements, please contact us.
Useful reference: Best execution and implementation challenges