Making the Best of it: Best Execution in Europe

Citi’s Salvador Rodriguez and Daniel Mathews explain how best execution has evolved alongside MiFID and how the latest proposals are likely to affect buy-side and sell-side trading desks.

How is best execution under MiFID II different from MiFID I and from pre-MiFID? Where have we come?

Daniel Mathews, Citi: Although we are referring to MiFID II, we are at the early stages of the MiFID II legislative drafting process. The European Commission (EC) published its proposals last October,T and there will be a number of amendments proposed by the European Parliament over the coming months. The Council of the European Union (EU) will also table amendments and ensuing agreement between the EC, the European Parliament and the Council of the EU (27 member states) will then be required. It is not yet clear what MiFID II and MiFIR will look like in final form as there are a number of key areas which are acknowledged by both sides to need addressing. What is clear is that there will be significant changes to the drafting that is on the table at present.

Salvador Rodriguez, Citi: With the MiFID II process we have seen closer alignment between buy-side and sell-side interests. There is more cooperation between the buy-side and sell-side with a view to what may or may not come out of MiFID II; and this in itself, is a clear improvement from the earlier iterations, which is encouraging for the business at large.

DM: Certainly, the meetings we have had with the buy-side indicate that they are taking far more interest in what MiFID II will mean for them; they want to participate in the debate and are keen to understand what we are doing from a sell-side perspective.

Tools and strategies that have become accepted best execution for many brokers are now under review (e.g. broker crossing and the Systemic Internaliser (SI) regime). How difficult will it be to provide comparable offerings within the SI framework?

DM: One of the current challenges is understanding how the SI regime will operate under Ferber’s proposals and understanding the unintended (or intended) consequences of the amendments, such as ‘all OTC trades must be conducted under the SI regime’. The scope of the SI only extends to liquid stocks, so what happens to non-liquid stocks? Can we trade them outside an SI? Will all risk trades need to be executed within SI and therefore within published firm quotes, even though a risk trades to client may warrant a price outside firm quotes? At the moment, there are many unanswered questions raised from Ferber’s proposals concerning what the SI regime actually means for us and our clients.

SR: As Dan has alluded to, many of the requirements have fallen into the lap of the sell-side. From a trader’s point of view, the tools, strategies and decisions around how to execute a trade will probably not change significantly. Traders will continue to send VWAP or participate with volume-type orders. Naturally, there are pending questions around how risk is employed and whether firm capital can be used within an OTF environment. As a broader business, how clients and orders interact with risk, and how we internalize house flow, are wide-ranging questions. There is no one clear answer; it is a multi-layered problem and there are still grey areas to be resolved.

From which of the MiFID updates will institutional investors notice the biggest change in execution quality and/or strategy?

SR: The MiFID proposals will clearly affect everyone. Under the Commission’s proposals, a BCN would be an OTF and an SI is not a venue. I think this needs to be unpacked. Legally the classifications are fairly clear – you can trade on either a trading venue (RM, MTF, OTF) or OTC and if the latter then to the extent the trading is systematic and frequent then the firm must be an SI. As Dan says though, Ferber’s amendments have muddied the waters so that it’s not clear how an SI is intended to function. Our job is to figure this out through dialogue with our buy-side clients, and we have been seeing many of them recently on market structure road shows, explaining where the current process is at and the areas still to be resolved.