Based on interviews with dealing and compliance teams from ten buyside firms Buyside Best Execution observes how buyside institutions have responded to MiFID’s best execution requirement and its impact on their work.
The obligation requires investment firms to demonstrate care and prudence when executing a client trade. The principle of the requirement is the promise of an investment firm to provide best execution to clients. This principle has led firms to adopt best execution policies that mandate certain internal practices, which are designed to prove that best execution was sought for each client trade. Though this report focuses on MiFID’s best execution requirement it is effectively a global obligation with US and Asian regulators having similar obligations.
Best execution is most often boiled down to the requirement to secure the best price but this approach presents problems when prices are not readily available for specific instruments or large sizes.
In quote-driven markets, the convention of securing three quotes and then selecting the best price is common, but this does not necessarily prove best execution – it only proves “not worst” execution. In highly liquid, electronic markets best execution is demonstrated using a reference market price. In relatively illiquid markets, such as large voice executed corporate bonds and credit, demonstrating best execution is difficult as there is rarely a reference price. In these illiquid markets, liquidity is sourced by voice rather than electronic means. These voice trades generally provide the best value for clients but, conversely, are the most onerous in terms of the obligation as the recordkeeping overhead is significant.
Best execution requires diligent recordkeeping so that evidence of compliance is collected and auditable for every trade. Buyside firms use a plethora of technology solutions to aid in recordkeeping and reporting, ranging from pen-and-paper or Excel-based approaches, to execution note-taking functionality in an OMS or EMS – no solution seems to adequately address the labour-intensive recordkeeping overhead – there is a significant opportunity for an ISV to plug this gap.