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Last issue I wrote about the second Markets in Financial Instruments Directive (MiFID II) and absence of routes to an effective remedy. While the Securities Financing Transactions Regulation (SFTR) has just gone live, MiFID II is heating up once again. A slew of reports and legislation has or is due, to be released.
When I wrote my last piece - MiFID II: A damp squib, I was quite unaware that only a few weeks earlier, the High Court had released a judgement that included a comprehensive review of the very points I had argued in my article.
Readers will be reassured that the England and Wales High Court’s findings are entirely the same as mine, these can be located on Bailii’s website in commercial court decisions.
I recently met with the CEO of the rapidly expanding fintech – SteelEye and we lamented the lack of enforceability of best execution and availability of APA data (which must be made available for free after 15 minutes but rarely is).
Regarding best execution, this is the obligation that broker crossing networks, systematic internalisers, and investment firms must take “all sufficient steps” to obtain the “best possible result” for clients when executing orders. For professional clients, the best possible result is defined by six concrete factors: price; costs; speed; the likelihood of execution and
settlement; size; nature of the order; and any other relevant consideration.
Back in 2014, the UK’s Financial Conduct Authority (FCA) noted in their Thematic Review entitled, “Best execution and payment for order flow” that, despite MiFID II best execution requirements, most firms are not doing enough to deliver best execution through adequate management focus, front-office business practices or supporting controls”. They noted further that a one basis point of cost-saving could translate into a £262 million in additional client returns.
Under MiFID II, best execution sits within a framework, as I explained in summary in 2017:
1. It starts with client onboarding. All clients must now be categorised into retail, professional, or eligible counterparties – implications for best possible result definition.
2. There must be a suitability test to understand the client’s needs, investment objectives, risk tolerance, ability to bear loss etc.(precise details differ according to retail/pro.)
3. The firm must understand the client’s execution priorities, perhaps on a class of instrument basis and document these ideas in an order execution policy document which must be agreed prior to order execution. This links into the above seven best possible result discussion and is an opportunity to define the relative importance.
4. For over-the-counter and bespoke instruments, the investment firm (INVF) must check the fairness of the price by gathering market data and comparing the price, perhaps augmented by FV calculations.
5. INVFs must monitor the effectiveness of the order execution and execution policy, in particular whether execution venues included in the order execution policy provide the best possible result with the client.
6. There must be a client limit order policy to handle unexecuted orders in equities. In the aforementioned High Court case, target Rich International argued that the popular forex broker FXCM was liable because it had breached MiFID best execution and order execution policy obligations.
It was argued that “the [FCA’s] conduct of business sourcebook (COBS) rules were implied into the agreement as a matter of law, and that this was necessary to give effect to MiFID under European law. The same argument was said to create parallel duties of care in tort.” Both arguments were rejected.
For this reason, it is critical that firms realise that none of MiFID II is directly enforceable unless the provisions are expressly copied into the contract. Firms ignore this at their peril: as the judge held, “Over the last decade, the English and Scottish courts have been presented with a number of cases in which claimants who allege that they have been the victim of regulatory misconduct have sought to advance causes of action against authorised entities for breach of FCA rules.”
It is, perhaps, disappointing that the claimant brought this case to court in the first place as it was hopeless.
As for the industry, it bemoans regulation and prefers self-regulation. Regarding best execution, the acid test is this: firms should insist on express terms in their contract that bind the broker to the order execution policy and best execution provisions. If brokers agree, then the industry can rightly claim self-regulation is appropriate, and vice versa.
In the coming months, I will be contacting buy-side trade bodies to draft joint letters to the commission urging the instatement of civil liability for MiFID II breaches – as was originally intended.
