The recent report by the FCA on best execution emphasises the extent of the challenge MiFID II poses for the asset management industry. The findings showed most firms had yet to conduct robust gap analysis since 2014 and poor practice, as highlighted in FCA’s thematic review, had not been remedied or even addressed.
It also stated that many firms saw the best execution process as mostly a ‘tick box’ exercise. And alarmingly, it found instances where compliance staff were not sufficiently empowered to effectively challenge the front office on execution quality. The FCA stated that all of the firms they visited had management information that allowed them to accurately view equity execution costs but use of the data was inconsistent.
We as an industry must realise MiFID II is no longer a distant dot on the horizon. Its deadline of January 3rd 2018 is now rapidly approaching and will have far-reaching implications for any firm dealing and processing financial instruments. This is not just a compliance exercise, but represents a profound change for financial markets across numerous areas, demanding an implementation effort and a re-assessment of business models.
The regulation will deliver increased transparency for end investors, but as we can see from the FCA finding it is presenting a stern challenge to providers. Staying ahead of far-reaching regulatory reforms will not be without cost or complexity. The Opimas consultancy, recently suggested the regulation could cost the industry in excess of €2.5 billion to implement.
The regulation will also sweep in era-defining change where asset managers reduce their reliance on sell-side analyst research as the process of “unbundling” begins: where the regulation mandates that asset managers separate out their budgets for research and trading costs, including best execution requirements.
Fund and wealth managers have typically been required to have a stated execution policy. The impending MiFID II regulations go much further – and the question of responsibility is far more complex. The reality is people now expect to get the best price; this is entry level best execution. The focus, driven by the regulatory requirement, is now to continually ensure and demonstrate firms have the right governance procedures and control framework to continually challenge and review performance and policies.
A change in mind-set
The good news is the challenge is surmountable. In our fast-paced industry, MiFID II also presents a rare opportunity for asset managers to really take stock and consider where their capabilities lie and how to streamline their business models accordingly.
Above all, being MiFID II compliant demands a change in mind-set. We must think of best execution as not just an outcome, but as an aspiration; one which encompasses arrangements and processes designed to secure the best outcomes for clients with pre and post-trade monitoring to assess ongoing effectiveness, and with clear and concise reporting to deliver confidence, trust and transparency. By this measure, best execution has to be at the heart of any brokerage in the retail space.
Asset managers must also make sure they are asking the right questions. For example, are the best execution outliers also being monitored regularly, and is that feedback being communicated by brokers? Best execution outliers can often be due to operational factors, and these need to be assessed consistently across multi-venue benchmarks.
Multiple lines of defence
It is also about strong governance which means multiple lines of defence. The first line of defence must be the business, which involves real time monitoring as well as internal committees at a management and board level. Companies also need to consider whether they have the right strategy in anticipation of MiFID II. This means rigorously assessing their existing risk control frameworks.
The myriad of factors going into a trading decision is a major reason why defining best execution is challenging. Governance and effective management of market makers and liquidity providers is crucial.
In light of the changes in regulation, firms must also have a clearly defined execution policy and detailed dealing arrangements and procedures. Through market information analysis, firms should constantly appraise and improve upon these arrangements, while regularly challenging the service provided by market makers.
Creating best of breed partnerships
Asset managers must consider whether they have the requisite resource to bear an elevated scrutiny on internal dealing desks or take the decision to outsource.
Any solution must deliver on technology but also on expertise and experience. There are many existing regulatory obligations such as product governance, suitability, and fees and charges. In this climate, is it realistic to take on the burden of ensuring the optimum delivery of best execution, while concerns around speed of settlement, market impact and liquidity begin to converge with the new regulation?
Outsourcing can bring a synergistic effect, where access to execution tools and cutting-edge technology can deliver unrivalled best execution propositions, allowing a firm to streamline operations and create new value opportunities for existing resources. The increase in efficiencies, created from outsourcing dealing functions can dramatically reduce costs, allowing a business to pass these cost reductions on to the end client. Ultimately, outsourcing should create a best-of-breed partnership where a firm benefits from cutting-edge best execution service at the vanguard of new technologies.
MiFID II comes with major challenges, but it also presents a golden opportunity for asset managers to really consider their business models to concentrate on their core capabilities and stay ahead of the regulatory curve.
Alex Kerry, head of Winterflood Business Services