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Best execution: Turn MiFID II requirements into business benefits

From regulation to business enhancements

Read the interview and learn about:

  • Best execution and transaction cost analysis (TCA) in fixed income and OTC derivatives
  • Going beyond MiFID II compliance to analyze the entire trade blotter
  • Combining trade metrics with liquidity metrics to improve future outcomes
Best execution for MiFID II 

Paul Williams, EMEA Head of Business Development for Pricing and Analytics, ICE Data Services.

Achieving compliance with the best execution requirements of MiFID II is one of many changes facing investment firms. This article looks at how firms can leverage the new requirements, together with innovative analytics and tools, to drive business enhancements.

Best execution requirements are changing significantly under the second Markets in Financial Instruments Directive II (MiFID II), which comes into force on January 3, 2018. Under the new regime, investment firms will be required to take “all sufficient steps” to obtain best execution for their clients, where the original MiFID directive specified “all reasonable steps”.

On the surface, this change may seem like a matter of semantics; but in practice, it will require comprehensive trade reviews to be integrated into a firm’s activities. What’s more, firms must continue to strive to achieve best execution on a consistent basis. While this does not mean obtaining the best possible result for clients on every single occasion, it does require firms to “verify on an on-going basis that their execution arrangements work well throughout the different stages of the order execution process”.

This represents a significant step change for most investment firms. As per guidance issued by the European Securities and Markets Authority (ESMA), firms will need to work towards compliance by strengthening their systems and controls, so that any potential deficiencies in the order execution process can be identified. Examples of such strengthening measures include: ensuring that sufficient data is captured around the trade to be able to run analysis; and making certain that effective oversight measures are in place.

Firms must also conduct pre- and post-trade analysis to identify any issues with execution quality, as well as ensuring the results of such monitoring are properly escalated to senior management and/or relevant committees where necessary. Finally, firms must feed the results of this analysis back into their execution policies and arrangements, as a way of driving process improvements.

More than meets the eye

MiFID II also makes it clear that firms must take into account a number of different factors such as, “price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order”. And they must do this across all asset classes. As such, best execution is becoming less of an ad-hoc compliance concept and more of systematic process – one that needs to be deeply embedded within the organization.

Against this backdrop, investment firms are understandably looking for new data feeds and performance measurement tools, to help them evaluate the quality of their execution and prove best execution. One of the challenges, however, is that MiFID II requires best execution to be demonstrated across many asset classes, including markets such as fixed income and OTC derivatives, for which reference pricing and analytics can be harder to source.

The good news is that a handful of market data vendors have developed innovative solutions to help firms with their processes. One area of particular demand is to establish reference benchmarks for price-driven analysis. ICE Data Services[1] offers one example of a solution that can be used for this analysis, providing streaming updated, evaluated pricing throughout the day for instruments across the liquidity spectrum.

In addition to helping create a post-trade measurement by providing reference pricing for the time of trade, such a solution can also be used for pre-trade price discovery. This is a critical compliance element since there is a requirement under MiFID II for firms to systematically check the fairness of the price on all OTC products. To do this, firms must gather the relevant market data, use appropriate valuation systems and compare, with similar products, wherever possible.

Again, vendors can assist here, providing live market data and reference pricing on OTC products, including OTC derivatives, to help with the new pre-trade checks that MiFID II demands. For firms to truly benefit from a vendor solution, however, it is important to ensure that any external data feeds, such as benchmark pricing, will integrate directly into the firm’s existing workflows and order management system (OMS).

Over and above

While compliance with MiFID II is undeniably driving greater interest in best execution, investment firms are not just analyzing the execution of their trades because of regulation. Some firms are proactively embracing the momentum generated by MiFID II to conduct more in-depth transaction analysis in search of business, process and organizational benefits – not least improved trading performance.

The practice of transaction cost analysis (TCA) is therefore becoming more widespread. TCA is essentially the study of trade prices to determine the opportunity cost of the trade, as well as its performance relative to the market during, and around, the period of trading. TCA therefore involves measuring trades against a reliable benchmark.

Although TCA began in the equities space, its application has historically been limited in other markets due to structural differences and lack of reference benchmarks. However, it is now gaining far greater traction across other asset classes with new solutions coming to the market which enable firms to analyze their trades against various relevant benchmarks at individual trade level and at group level based on certain trade characteristics.

Trade context

We are also seeing a growing number of firms looking for additional analytical measures to apply context to their trades. If a client’s own trade data is compared to a sufficiently extensive database of market information, it is possible to run sophisticated analysis to form distribution patterns and provide metrics and percentile-based scores for an individual trade within the context of similar trades.

For fixed income securities, it is possible to ensure sufficient volumes of data are available to score the security effectively by analyzing comparative differences of trade prices to benchmarks.  This enables trades that took place at different times and/or in comparable securities to be included. Thescoring can also into account the size of the trade and whether it is a buy-side or sell-side trade, since those factors will heavily influence the outcome of a trade. 

Putting metrics to work

On the back of the metrics produced, firms can start to identify any outliers and investigate the reasons for these, or look at trades at an aggregated level to discern important trends in their trading activity. For example, firms could use the scores to conduct an analysis on their counterparties and venues, calculating an average score for all their trades with any given counterparty or venue.

Clients can also feed in additional elements, such as portfolio strategy, to build up an even clearer picture of how their trades are performing. Firms can then leverage this scoring information to demonstrate the benefits of their decision-making to clients – as a competitive differentiator.

Another tangible benefit of trade scoring is helping firms towards their MIFID II requirements to demonstrate assessments of the quality of execution obtained from venues and produce the RTS 28 report that must be provided annually to investors. This report requires firms to publish their five most-used trading venues, by trading volume and per sub-asset class, provide an assessment of the quality of execution obtained for each of those five venues and give details of the process used in the assessment. Robust trade metrics can help provide that qualitative understanding.

Liquidity matters

Elsewhere, firms are becoming increasingly interested in additional factors that influence the outcome of a trade.  These include, for example, the role that liquidity plays in the outcome of a trade. These might range from a simple liquidity score, including ranking how one security compares against another, to a more applied analysis such as the projected trading volume and capacity of any given security on a given day. With the right data and technology, it is also possible to analyze the time to liquidate a given security or potential market impact, based on the position size.

Armed with these liquidity analytics, forward-thinking firms are marrying them with their trade analytics to understand how liquidity is impacting the trading outcome, and ultimately the quality of execution. If, for instance, a firm carried out a trade that was much larger than the projected capacity for that instrument on the day of trading, this could explain why that particular trade delivered a much lower score than expected. In turn, firms can use this information not only to shore up their regulatory obligations, but also to improve their processes for the future.

Going the extra mile

In the run up to January 2018, it is inevitable that firms’ main focus will be ensuring they have all the relevant reporting and investor protection elements in place for MiFID II compliance. Thinking longer-term, however, firms have a unique opportunity to leverage new solutions, alongside new regulatory processes, and the trade data they are gathering, to help improve performance for their clients.

About the author

Paul Williams is EMEA Head of Business Development for Pricing and Analytics products at ICE Data Services, which is part of Intercontinental Exchange (NYSE: ICE). 


1. ICE Data Services is the marketing name used for Interactive Data Corporation and its subsidiaries globally, including Interactive Data Pricing and Reference Data LLC, a registered investment adviser with the U.S. Securities and Exchange Commission.  Evaluated pricing (including fixed income evaluations), Continuous Evaluated Pricing, end‐of‐day evaluations, evaluated pricing for listed and unlisted ADRs, and Fair Value Information Services and any other investment advisory services with respect to securities are provided in the US through Interactive Data Pricing and Reference Data LLC and internationally through Interactive Data (Europe) Ltd. and Interactive Data (Australia) Pty Ltd. 

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