Best Execution: Complying With MiFID 2
This article looks at MiFID 2's requirements on best execution and the changes UK firms will need to adjust to
MiFID 2 will bring significant changes to the way in which firms conduct their trading business and the policies and procedures they have in place for informing clients and evidencing compliance. In this article, Emma Radmore looks at the changes MiFID 2 makes to best execution requirements, and the changes firms will need to make to comply with MiFID 2's standards.
What does MiFID 1 require?
MiFID 1 requires (Article 21) that investment firms take all reasonable steps to obtain, when executing orders, the best possible result for their clients, taking into account:
price; costs; speed; likelihood of execution and settlement; size; nature; or any other consideration relevant to the execution of the order. Firms are, though, expressly permitted to follow specific client instructions.
MiFID 1 requires firms to establish and implement effective arrangements for complying with these requirements - in particular each firm must have an order execution policy to allow them to obtain the best possible result for client orders in accordance with the factors listed above. The policy needs to include, for each class of investments, information on the different venues on which the firm executes orders and factors that affect its choice of venue. The MiFID Level 1 text states "it shall at least include those venues that enable the investment firm to obtain on a consistent basis the best possible results for the execution of client orders".
Firms also need to provide appropriate information to their clients about their order execution policy and get prior consent of clients to it. The precise form of information is not mandated, but, if a firm's policy allows client orders to be executed outside a regulated market or a multilateral trading facility (MTF), the firm must tell the client and obtain the client's prior express consent before proceeding to execute their orders outside a regulated market or an MTF. Investment firms may obtain this consent either in the form of a general agreement or in respect of individual transactions.
MiFID 1 also includes a requirement on firms to monitor the effectiveness of their order execution arrangements and execution policy in order to identify and, where appropriate, correct any deficiencies. It specifies that they should regularly assess whether the execution venues included in the order execution policy provide for the best possible result for the client or whether they need to make changes to their execution arrangements. Firms must notify clients of any material changes to their order execution arrangements or execution policy.
Firms must also be able to demonstrate to their clients, at their request, that they have executed their orders in accordance with the firm's execution policy.
MiFID 1 required the Commission to make implementing measures (which it did in the MiFID 1 Implementing Directive) on:
the criteria for determining the relative importance of the different factors that may be taken into account for determining the best possible result taking into account the size and type of order and the retail or professional nature of the client. The Commission said these should be: the characteristics of the client including the categorisation of the client as retail or professional; the characteristics of the client order; the characteristics of financial instruments that are the subject of that order; and the characteristics of the execution venues to which that order can be directed. It notes an execution venue can be any of a regulated market, MTF, systematic internaliser or market maker or other liquidity provider. It goes on to specify that where the client is a retail client, firms should work out the best possible result in terms of the total consideration, representing the price of the financial instrument and the costs related to execution, including all expenses incurred by the client which are directly related to the execution of the order (such as execution venue fees, clearing and settlement fees and any other fees paid to third parties involved in the execution of the order). For the purposes of delivering best execution where there is more than one competing venue the firm could use, it should take into account its own commissions and costs for executing the order on each of the eligible execution venues. Firms should not structure or charge their commissions in such a way as to discriminate unfairly between execution venues;
factors that may be taken into account by an investment firm when reviewing its execution arrangements and the circumstances under which changes to such arrangements may be appropriate. In particular, the factors for determining which venues...
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