One of the most important themes of Markets in Financial Instruments Directive (MiFID) II is its “best execution” mandate. Investment firms must take all sufficient steps to obtain, when executing orders of any financial instrument, the best possible result for their clients.
Best execution is focused on achieving the optimum outcome on a consistent basis, and not simply on attaining the best price available at a given time for an individual trade. Several factors must be considered, including explicit costs such as fees and commissions and implicit costs such as those tied to signaling risk. In addition, transaction speed, order size, the likelihood of execution in prevailing market conditions and the certainty of settlement must also be taken into account.
Firms will be expected to show how they have incorporated each of these factors into their best execution procedures, and to support their conclusions with unbiased quantitative analysis, such as transaction cost analysis (TCA).
This emphasis on achieving best execution, and the incorporation of so many elements in its demonstrable realization, means that unsurprisingly the efficiency and accuracy of a firm’s trading system has assumed paramount importance since the implementation of MiFID II in January 2018. Both buy- and sell-side firms need to comply with the tougher regulations, and helping them meet those requirements continues to be a priority for vendor suppliers.
Systems need to be upgraded in at least two fundamentals ways. First, they require new configurations in order to capture substantially more identifying data than before. These include trader details, legal entity identifier (LEI) configurations and codes that explain the reasons for individual trades. Order entry screens must also be enhanced to secure a variety of relevant data points necessary at the time of the transaction.
Second, firms need their trading systems to provide the tools and analysis capabilities that allow them to demonstrate compliance with objective TCA or other trade execution cost measurements. Broker analysis and scoring metrics, access to tick data, and even allocations will all become important for providing firms the level of granularity they need to ensure that their procedures and systems conform.
There are several ways vendors can help institutions implement and maintain their best execution objectives.
Broker analysis dashboards can rank counterparties’ performance by stock, sector, venue and algorithm, and also by order size and trade execution in specific market conditions. Relative performance can be gauged further by collating and storing indications of interest (IOI) and comparing them with actual broker transaction closure. Moreover, visual enhancements can add greater immediate clarity by showing broker scores and by displaying specific IOI-related reports.
Tick data can also be made available, which allows clients to measure execution prices against historical tick movements for performance measurements, such as interval volume weighted average price. In addition, allocation information can be stored in a data warehouse and made available for on-demand retrieval so performance at an account level can also be attributed.
The role of technology vendors is to help ensure that its clients are able to analyze and justify every decision that they make at each stage during the trade cycle. This means giving them access to data, organizing it so it is easily auditable and providing the capability to adhere consistently to their best execution policies.