The FCA, the chief financial regulator in the UK, recently highlighted that investment managers have not been particularly engaged with assuring best execution for their clients. With the upcoming changes to the financial regulatory framework since the beginning of 2018 and the introduction of MiFID II, companies are expected to focus more effort on the matter.
Best execution monitoring is one of the key sections of MiFID II. Companies are obligated to check the fairness of prices proposed to clients when executing orders or taking decisions to deal in OTC products.
According to the FCA, some firms have been addressing the issue and are showing ‘good practice’, however the bulk of the industry is trailing behind.
New FCA Best Execution Review Incoming
The UK regulator is not going to review the practice for the last time this year and next time there will be consequences. An official statement on the matter reads: “We will be revisiting best execution in 2017 to see what steps investment management firms have taken to assess gaps in their approach to achieving best execution.”
Firms will be expected to provide evidence that funds and client portfolios are not spending too much on their execution costs.
“If we find that firms are still not fulfilling their best execution obligations, we will consider appropriate action, including more detailed investigations into specific firms, individuals or practices,” the FCA highlights.
What do you think is the FCA’s message to the industry?Finance Magnates reached out to Pete Eggleston, co-founder and Director of BestX. The company is focusing its efforts on providing software that enables clients to define, achieve and demonstrate best execution.
I think one of the key takeaways is that best execution is a core component of best practice in the industry and is not simply a requirement to satisfy, for example, MiFID II obligations. The forthcoming Global Code of Conduct for FX is another key milestone in defining such best practice, and continues the development of the principles set out in the FCA’s Thematic Review, which needs to be take very seriously by all market participants.
The other key takeaway is that the regulators are clearly looking for evidence of best execution policies to be defined, implemented and recorded for all asset classes (both exchange traded and OTC) and for all transactions (voice, electronic etc).
How can investment managers effectively oversee best execution practices?
A systematic approach is required, using technology that is flexible enough to allow the implementation of a manager’s specific best execution policy. Once implemented, the process of trade analysis and exception reporting should be automated, producing easy to understand output that allow the results to be actioned and decisions made. This positive feedback loop is a key component of any best execution process.
What are the main technological developments in this direction?
There are a number of developments aiding the implementation and measurement of best execution, including the increasing use of electronic trading which provides a rigorous audit trail for the lifecycle of a trade.
In addition the growing use of cloud computing, and improved technologies to crunch large data sets in real-time, allows best execution analytics to be deployed at the point of trade and also allows large volumes of results to be analyzed to help improve performance over time.
How can clients ensure that they are getting best execution?
A rigorous and systematic process is required, measuring execution performance versus a representative and independent market data set. Once such a framework is established, an exception process can be implemented whereby trades that have breached the specified thresholds are flagged as outliers, which then require an explanation and approval.
On any specific trade random market movements can result in unsatisfactory execution performance – the key is to monitor every trade, understand the outliers and review results strategically over time to see what changes can be made to improve performance. This requires analysis of large samples of trades but it is not simply a ‘big data’ project. Conclusions and actions need to be defined from the best execution analysis, so ‘smart data’ as opposed to simply ‘big data’.