by Michael Gorman
The time for general discussion of MiFID II is now over for European banks, trading venues and asset managers with deployment mandated for less than a year away. Market participants have earmarked budgets, with tier one banks alone expecting to spend $40 million each to comply with the new rules, and the process of retooling and designing new infrastructure from the ground up has begun.
Commentators and vendors have spilled much ink about the requirements in, and the implications of, the new rules. Less concentration has been paid to the practical, implementation requirements for meeting the best execution. Given where we are on the calendar, it is time to start organizing for implementation.
MiFID II and Best Execution
It is often said that MiFID I was about the ‘spirit of best execution.’ Under MiFID II, that spirit has morphed into ‘quantitative proof of best execution’ for clients who request it, regulators who audit it, and the service to which it must be reported (e.g., systematic internalizers reporting under RTS 27). Coupling this changing paradigm with MiFID II’s extended instrument scope into non-equities creates challenges for implementation that the entire industry is now facing.
Let’s address a few key implementation issues:
MiFID II, from a policy perspective, seeks to push OTC markets to venues. Accomplishing this requires changing attitudes and increasing the cost of continuing to operate bilaterally. This is quite clear for firms who choose to, or by definition, will be systematic internalizers for certain financial instruments.
FX markets are a good example. Most firms employ manual trading techniques, i.e., employ voice trading where all quotes are not captured. For firms that anticipate being a systematic internalizer, MiFID II is going to require new policies, procedures, and workflows — demanding a cultural shift on the trading desk. The additional build is also likely necessary to capture quotes. Depending on the trading platform, a simple manual GUI, like Kx for Flow, can ease the way to comply, allowing them to quickly capture the prices they quote to clients by phone or chat. This manual GUI would capture data like trade type, currency pair, bid or offer, price, volume, etc. Most firms are looking to deploy these with as much automated fill as possible—to reduce time and cost of compliance.
With a system built on Kx technology, which seamlessly scales to many terabytes of data, there is no loss of speed or performance as volumes rise.
Proving Best Execution – Employing TCA?
Another key challenge is what tools does a firm employ to demonstrate ‘quantitative proof of best execution’? Transaction cost analysis (TCA) has been refined in the equity markets, where it uses a small number of highly liquid instruments with known and trusted pricing sources to provide a robust metric for firms to employ.
As we know, the fixed-income markets operate differently. Trades are larger and less frequent than in equity markets, making TCA more difficult (but not impossible) to deploy. But quite similarly to the equity markets under MiFID I, the industry is seeing more electronic trading in fixed-income, which in turn is creating greater amounts of rich market data to employ in tools like TCA.
Increased electronic trading is occurring across all non-equity asset classes, spurred by the regulatory requirements in MiFID II (and in other jurisdictions). From an implementation perspective, this is leading to considering vendors who not only possess a strong understanding of the asset classes but present extensible solutions that can incorporate new market data seamlessly, operate a multi-asset class environment, employ robust time-stamping and include market replay functionality to evolve as the amount of electronic trading increases. Many firms are looking for ‘strategic solutions’ as opposed to tactical ones deployed for prior regulatory change.
Reporting Best Execution
From an implementation perspective, software solutions that can handle regulatory reporting, in addition to providing quantitative analytic tools are particularly attractive. RTS 27 (for venues) and RTS 28 (for all investment firms) will increase data demands and, for some firms, will require new solutions to make the data available for reporting. Whilst reporting is not ‘real-time,’ both RTS 27 and 28 require marshaling more data and creating greater transparency for the market. Working with a software solution that has already mapped the data points required and can integrate seamlessly with reporting, and other key requirements of MiFID II best execution will help to accelerate compliance in 2017.
Capturing and analyzing data for proving and reporting best execution is a key MiFID II challenge. What’s more, it cannot be considered in a vacuum. Any software solution implemented to satisfy these regulatory requirements must be flexible enough to account for changing market behavior and evolving market conditions. As we often say, regulatory compliance is about data and systems—having the right data available, understanding how it needs to be presented, and having systems with the functionality needed to send it where it needs to be.
To complement Kx Systems’ product solutions, the company is supported by First Derivative’s Regulatory & Compliance consulting practice, which combines subject-matter expertise, strong product knowledge, and data & technology DNA to offer a range of consulting services that can accelerate implementation for MiFID II and MiFIR. Read more here.