With MiFID II Quickly Approaching, Challenges Still Remain
Just three months remain before the rollout, on Jan. 3, 2018, of one of the EU’s most ambitious, yet controversial packages of financial reforms: MiFID II. Right across the bloc, firms are in full implementation mode, despite some requirements still being poorly understood or lacking clarity and key pieces of market infrastructure still being designed. For those with the bandwidth and foresight to look ahead, the question remains: What will Day 1 of MiFID II actually look like?
One area of moderate concern for MiFID II stakeholders refers to an unintended, but serious, conflict between two integral components of MiFID II and MiFIR: the trading obligation (TO) and best execution. Under the TO, any shares that can be traded on an EEA venue must be traded on an EEA venue. The mandate was meant to sweep up any remaining OTC cash equities trading (in liquid shares), but it has had an unintended consequence on shares with dual-listings outside the EU. For example, the most liquid exchange for an Apple share may be NYSE, but the TO mandates that a firm must trade on an EEA venue even though it might be less liquid, and could mean settling for a higher spread and elevated transaction costs. Thus, the question becomes: Are firms required to pursue best execution at all times for cash equities trading? Or are they to follow what is stated under the TO?
Granting equivalence to non-EEA venues, from the perspective of regulatory oversight and client protection, would effectively render the NYSE an acceptable trading venue. This is expected to be the route that solves the issue. However, with further stumbling blocks in the negotiations between the EU and US being reported, concerns are likely to mount as we move closer to the deadline without a deal on equivalence being struck. Where such a deal does not resolve the matter, the UK FCA has already suggested it expects best execution mandates to outrank the TO.
Indeed, with the upgrade from “all reasonable” to “all sufficient” steps, along with the expanded requirements regarding the quality of execution reports (RTS 27) and top-five venue reports (RTS 28), it is clear EU regulators see best execution mandates as an integral component of the regulations transparency drive. In response, there has been an explosion of multi-asset TCA tools and services.
With such stringent best execution mandates emboldening the expectations of clients, “sufficient” does not provide an absolute benchmark against which to assess an order execution policy, but it does suggest that if one firm tightens their policy, then maybe the others need to re-assess whether theirs is sufficiently tight. With starting positions yet to be declared, brokers and broker-dealers are scrambling to provide more meaningful benchmarks and TCA solutions embedded with richer functionality in order to prove to clients the quality of their execution. So, while brokers have been trying to convince each other that they are hardly changing their generic, best execution policies, TCA vendors are enhancing their solutions in an arms race to deliver the best best-execution compliance. What is certain is that the best execution bar is about to be raised.
Whatever stage they have reached, all market participants will welcome statements like the one made in September by Mark Steward of the UK FCA, stating that the agency’s approach on day one will not be to strictly enforce all obligations, but instead to take a proportional approach, targeting in particular situations wherein there was deliberate neglect or no genuine attempt made to be ready.
Some market commentators have been quick to talk up apparently unclear clarifications, but regulators have been taking questions for two years now, and the published answers have often referred to the recitals that provide context for each legislative article. So, in most cases, the intent behind each obligation is available to discover for quite some time and the scope for claiming insufficient clarity is disappearing as fast as the time left before “M-Day.” You have been warned!