Best execution under MiFID II is a holdover from its predecessor, MiFID I, but with two kickers. First, it's much broader in scope, applying to all asset classes vs. MiFID I's equities-only focus. Second, and perhaps more onerously, it's more forceful: iinvestment firms have an obligation to take "all sufficient steps" to execute client orders to ensure the best possible outcome for their customers, compared with MiFID I's mere "all reasonable steps".
The definition of best execution remains basically the same: it requires firms to assess number of key factors to determine best execution, among them price, cost, speed and likelihood of execution and settlement, size and nature of orders. But regulators have made it clear they plan to pay more attention to firms' attempts at compliance, as well customers, will have access to higher quality execution data.
To demonstrate proof of best execution, regulated firms will be required to identify their top five execution venues, in terms of trading volumes, for the preceding year. They will be required to publish a clearly written execution policy accompanied by supporting data. Clients must be notified of any material changes to the policy.
Firms handling client orders will also be required to reconstruct any given trade should regulators require it, and show consistent application of policy across different lines of business, geographical market centres and asset types and classes.
While the direct consequence of MiFID II is a more complex trading landscape, with new venues and enhanced transparency provisions. Yet how that landscape will look, once the dust from MiFID II has settled, remains anyone's guess: there is still a lot we don't know about how the marketplace will absorb and adapt to the new regulation.
What is clear, however, is that unforeseen consequences are sparking new innovations in business approaches and supporting technologies. For example, recent months have witnessed the emergence of new execution venues geared toward specific market needs, such as Large-in-Scale (LIS) or conditional order handling, or auction-on-demand venues.
These innovations - and the general shift toward systematic internalisation for liquidity providers - will have a major impact on how investment firms route their orders. SORs will need to take into account far more parameters than they do now, ranging from different routing cycles for RFQs, periodic auctions, LIS venue rules and more.
This changing environment may require ending the traditional demarcation between OMS and EMS platforms, as the complexity of the post-MiFID II execution venue landscape calls less for a discrete system for sending orders to a destination and more for a platform that addresses work flow seamlessly without the need for multiple external applications.
Consolidation of OMS and EMS functionality has been a trend from MiFID I. Many sell-side firms, however, have developed proprietary systems for EMS, or use a third-party execution broker, which means the EMS part of the consolidated systems are not used to their full potential.
In these cases, firms split off the order to the third party (or dedicated in-house) systems and lose some of the benefits of an integrated system. Other firms, meanwhile, took a simpler approach with MiFID I, opting only to integrate OMS and EMS via staging (by use of FIX messages) and drop copies.
These firms now have to catch up and integrate in order to generate the analytics they need to meet the challenge of best execution under MiFID II. This can be achieved at multiple different levels all depending on spending budget.
With MiFID II imminent, many firms expect their existing ISVs to deliver the functionality they require to meet their expanded obligations. It's unclear, however, how many third-party suppliers are able to meet the new requirements across the board.
What's needed is a truly integrated approach to OMS and EMS, to meet the need for a work flow platform that takes in a broad range of new functions - SI matching, quote publishing, pre-trade risk gateways, tick database and algo tagging/testing - as well as handling higher-level tasks such as 'in-flight' analytics in support of best execution compliance.
Analytics will become increasingly important for those choosing not to take the SOR route to achieving best execution. By integrating analytics at all stages of the trading cycle - pre-, at- and post-trade - practitioners may be able to demonstrate good execution quality without having to implement a SOR.