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Conference call: best execution and MiFID II

Chris Hamblin, Editor, London, 14 June 2017

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At our recent conference in London on the subject of preparations in the wealth management industry for the European Union's second Markets in Financial Instruments Directive, one panel looked at the issues surrounding "best execution," among other things.

On the panel were Colin Berthoud, the co-founder of TIM Group; Roddy Buchanan, the head of wealth management at WH Ireland; and Jonathan Wilson of Cordium, the regulatory business consulting firm. They were addressing a large audience of wealth managers who were preparing with some trepidation for the MiFID II deadline of 3rd January 2018.

Buchanan said that his aim was to give the audience a practical perspective from a front-office viewpoint, particularly in respect of best execution. He thought that "superficially, when one looks at the new text that has been provided, a lot appears not to have changed a great deal."

Jonathan Wilson agreed: "Some of the articles at a high level haven't changed much at all but we'll get the detailed guides and so on. That's where the implementation issues lie."

To break or not to break the rules?

Chairman Bruce Weatherill reminded the audience of the opening address of Stephen Hanks from the Financial Conduct Authority at the same conference (see here) and pointed out an important pitfall that might await them: "He came out with a very encouraging but a really sort of difficult concept as far as I'm concerned, which is 'do your best by 3rd January 2018, providing you're in the right direction, and we understand you might be breaking rules but don't worry, we won't be doing anything about it because we understand it's going to be difficult.'

"It's a really difficult concept when you know you're not complying with the rules and they say 'don't worry.' After all, they are the judge, the jury and often the executioner in these areas, so I think that 'best endeavours' are going to have to be pretty robust before we get to the launch of the red-carpet event on 3rd January."

All reasonable and sufficient steps

The chairman asked the panel to explain the difference between "all the reasonable steps" that firms must take under MiFID I, and "all sufficient steps" that they must make under MiFID II.

Jonathan Wilson replied: "I think this phrase has caused some interest. If you look at the ESMA guidance, it really revolves around process. When you start to unpack that, I think the FCA really probably don't view that there's much change. They view the bar has been set and I think they view that firms are not demonstrating sufficient steps to achieve that bar.

"Things have not changed in terms of best possible result has always been a requirement of regulations and the focus on execution practice has been a key part of that.

"The European Securities and Markets Authority (ESMA), like the FCA, have talked about intended outcomes, [saying] that fund managers have responsibilities to show on an ongoing basis (and not on an individual trade basis) that they are achieving the best outcomes for their clients."

Wilson also observed that IT systems were crucial. He acknowledged the fact that firms were developing IT at a furious pace with regard to "disclosure transparency around the venues publishing their prices, brokers publishing their top five counterparties, managers publicising their top five counterparties, and then this kind of 'kick' clause around the information around your monitoring approaches, which goes down to the level of Regulatory Technical Standard 28."

ESMA’s RTS 28 is to do with the publication of conclusions that firms draw from their detailed monitoring of the quality of execution obtained on their execution venues. Wilson added: "That is a huge data conundrum in terms of how you can access that data and make the evaluation not only around what your broker's achieved for you, [but also] what's happening across the industry.

"And so [what] ESMA is saying in terms of ‘all sufficient steps’ is: where is the transparency in our process? Is there clarity around what you're seeking to achieve? Is that clarity around how you're going to measure that and report on that, and can you show that to us? Because they're expecting a process to actually change things and improve, so they're expecting firms to find outliers. They want to have processes in place that identify those outliers...so there's an assessment made and they can see the improvement, so I think 'all sufficient steps' is about the sufficiency of the process that you've established.”

When asked to compare the two phrases in the different versions of MiFID, Roddy Buchanan said that he was reminded of the legal differentiation between "reasonable endeavours" and "best endeavours." Noting the need for "absolutely complete clarity...around the prohibition of the use of payments for order flow,” he made an observation about the information that one is expected to disclose to one's clients.

"As Jonathan mentioned, the requirements go beyond that which was put down in MiFID I, but the FCA (and the FSA before it) has made it very clear that they expect firms to go beyond the letter of that which was written in MiFID I. I find a bit of a contradiction in terms of the information that one is supposed to be disclosing to one's clients because, on the one hand, one is required to introduce far greater transparency. One is required to introduce a far greater level of detail and yet, on the other hand, one is required to put it in a language which is easily understood by clients. To me, that is a bit of a contradiction. It places a huge burden on firms both in terms of data collection, then analysing that data, drawing up appropriate comparisons and then disclosing that information back to clients on a regular basis.

"So I think that when one looks at the difference between 'reasonable steps' and 'sufficient steps,' sufficiency in my book is all about having procedures, having policies, documenting them, adhering to them, making sure that they are working in terms of providing the best possible outcome and if they're not working, then a determination to go back and fix those factors to ensure that the best possible result is achieved."

Adapting 'best execution' policies to real life

Jonathan Wilson thought that some compliance people had missed a criticism that the FCA had made, "namely that a lot of the 'best execution' policies were written effectively by people like me, from a compliance perspective. They weren't being adapted to the strategies that they were pursuing. I think that's why the front office have got to get involved in writing those 'best execution' policies."

Colin Berthoud added: "I think we've heard something this morning from Stephen Hanks about 'best efforts,' [which is another phrase to go with] 'all reasonable steps' and 'all sufficient steps.' What might happen in practice? I think we'll see what's happened with previous legislation. There will be some goody-goodies who are there on Day One, then you'll have a majority who will be watching what the goody-goodies are doing, and try and come in very quickly after that, and then there'll be the laggards who might not get anything done for some time. It will be regionally distributed as well, so here in the UK they might be slightly ahead. They might have more relaxed attitudes in other countries."

Moving towards a cliff edge

Bruce Weatherill agreed with everything the panel had said and had a few words to say of his own: "If you're moving towards a cliff edge, with a very steep drop to the end, one reasonable step would be to have a rope up. That's a reasonable thing to do. When it gets to sufficiency, it's got to be demonstrated that you told everybody about the rope, you explained what was going on on the other side of the rope, you had some examples of what people did when they did fall over the rope...so there's a huge amount of documentation.

"It takes me back to the time when I was a professional witness in a court case against an asset manager. The level of data that people expect you to have collected when you're going down the 'sufficiency' route is very very difficult [in terms of] 'reasonable steps' because every time you go into a meeting, do you tape everything that was said in the meeting, every comment, [every bit of] body language? I think this whole data collection is a worry."

Compliance Matters will publish other highlights from the conference – and indeed from this panel – in due course.

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