When MiFID initially outlined best execution, it was a hazy concept. Execution has many parts and their importance changes for each trade. This has left the concept driven more by due diligence than by contractual obligation. Perhaps the contracts are unnecessary.
There is evidence that the best execution agreements promised by the MiFID lie unwritten or unheeded. Last year an Investment Management Association research paper indicated that just 18% of the buy-side firms surveyed had asked the majority of brokers for their best execution agreements. The other 82% asked for best execution agreements from less than two in ten of their brokers. Only 33% of respondents could get their brokers to respond to requests for the documents half the time.
That suggests that MiFID’s commitment to best execution is not taken too seriously by either side. Taking “all reasonable steps to obtain the best possible result for the client” as one European Commission document puts it is a noble, but woolly, ambition. Financial markets are neither noble nor woolly.
The directive’s vagueness makes its definition of best execution nigh on unenforceable. In the first instance, the number of factors that can be taken into consideration when attempting to achieve best execution provide numerous get-out clauses for underperformance. And second, use of terminology such as ‘investment firm’ and ‘client’, rather than ‘broker’, ‘investment manager’ and ‘asset-owner’ has resulted in two layers – equally vaguely worded – of commitment to best execution. The potential for buck passing betrays the spirit of the directive.
More oil on the writhing pig of best execution stems from fragmentation. Fragmentation has multiplied previously unique terminology, making equivocation over agreements a potential hazard. For example, if you have an agreement for your European broker to trade at volume weighted average price (VWAP), you could be forgiven for thinking, for UK stocks, that the calculation would be based on that of the London Stock Exchange. If it were, would that be the order book VWAP or a consolidated VWAP? Or would it be one of the other VWAPs in Europe?
There is a distinct lack of wailing and gnashing of teeth over this apparently vapid notion. The buy-side is not averse to raising concern where it is due, and so we are left to draw conclusions from its silence.
Firstly, there are of course advantages to having such a grey area around execution. A lack of definition allows the broker or buy-side trader to innovate. It allows firms to adjust requirements according to their strategies, rather than suffering from a regulatory straightjacket.
Secondly, firms that buy, be wary. The existence of a goodwill document that enshrines the principles of a buyer-seller contract doesn’t add to that necessary wariness. If anything it offers a false crutch.
Checking on best execution is difficult and buy-side firms are not paid to be auditors. With the best will in the world, brokers are not saints.
At the conscientious end of the spectrum there are heads of trading that have a passion for transaction cost analysis and who will diligently assess their brokers’ execution performance. At the other end of the spectrum there are fund managers that regard execution performance as a strictly secondary element of alpha generation.
This is equally applicable to brokers; some will do their damnedest to find the best price or speed for their client, others will pass the business on to a larger broker – or push it down an algorithm – and hope that they will perform.
Long term, the trend amongst buy-side firms is to move execution responsibilities in-house; self-directed trading has increased in step with widening range of execution options available. That will make best execution agreements a moot point in many cases. There will still be some firms that have not bought in smart direct market access packages, but they will be fewer and farther between.
As the Central European Securities Regulator becomes the European Securities and Markets Authority it is unlikely to have best execution high on its list of priorities.
MiFID II has already drawn the cloud of lobbyists and lawyers that helped make buying and selling a complicated business under MiFID I.
While some hope for regulatory support for dematerialisation to prevent best execution documentation being frozen in time, it does not seem likely, that the MiFID review will overhaul best execution. Perhaps it would be better to warn buyers to beware and leave it at that.
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