DP06/3 MAY 2006: IMPLEMENTING MiFID’S BEST EXECUTION
REQUIREMENTS – ABI RESPONSE TO FSA DISCUSSION PAPER
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1. Members of the Association of British Insurers are large institutional
investors managing own funds worth some £1.2 trillion as well as third
party funds. Our members have a strong interest in the integrity and
efficiency of financial markets and in promoting the confidence of the
investing public. Matters relating to MiFID implementation are therefore of
fundamental importance.
2. We welcome the opportunity to respond to the FSA’s Discussion Paper
(DP) on Best Execution. We are particularly pleased the FSA has decided
to share its views on how best execution provisions could be implemented
ahead of its formal consultation at the end of the year.
3. A guiding principle should be that best execution results in net saving for
beneficiaries. Regulatory requirements whose compliance costs exceed
the savings achieved are against the consumer interest.
General comments
4. Our members agree with much of what is proposed in the DP. We are
supportive of Chapter 2 and the concept of the chain of execution, as we
believe it accurately illustrates the current process of execution. Both the
portfolio manager and the broker/dealer play some part in providing best
execution and the sum total should add up to the best possible result for
the beneficiary. We have described some practices specific to portfolio
management in more detail in our answer to Q2.1.
5. We also agree with the need to review and monitor best execution
arrangements and policies as outlined in Chapter 4. We welcome the
FSA’s emphasis on flexible and proportionate implementation, in line with
firms’ arrangements and their position in the chain of execution.
6. Our members feel there is no need for the FSA to be prescriptive in
detailing monitoring and reviewing requirements or in their subsequent
supervision. Because fund managers are judged on their overall
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performance, these are commercially driven practices which should not be
turned into a tick-box exercise. It should be left to firms to decide how best
to ensure they are satisfying their obligations and to show that the
appropriate processes are in place. In particular, extensive record-keeping
requirements are likely to provide few benefits for clients while imposing
additional costs.
7. However, we cannot support the proposals outlined in Chapter 3 of the
DP. Our members have been unanimous in their rejection of
benchmarking as an option for satisfying best execution in dealer markets.
They do not believe that price is the right yardstick in this context. As the
main prospective users of the model, they also do not think the
benchmarks would be meaningful, mainly because they would be difficult
to construct for illiquid instruments and would not provide the information
needed.
8. Benchmarking would also increase costs across the industry. These costs
would undoubtedly be passed on to our members’ clients – the endbeneficiaries – with little evidence of corresponding benefits.
9. Most importantly, benchmarking would risk disrupting the current market
structure. The DP offers no evidence that there is a market failure or
information asymmetry that might lead to market failure.
10. In contrast, there is evidence in both the FSA’s Feedback Statement
DP05/5 (Trading Transparency in the UK Secondary Bond Markets) 1 and
the research on European Bond Markets published by the Centre for
Economic Policy Research 2 that large parts of OTC markets are
functioning well.
11. Our members believe that OTC markets have both size and depth, and
are currently functioning well. They would not wish to see a move that
could have a negative impact on liquidity and lead to increased costs.
12. We propose an alternative in our response. It is not an alternative to the
benchmarking itself but an attempt to outline a different approach to
implementation which is based on a copy-out of MiFID provisions.
13. Our proposal applies the analogy of a chain of execution as described in
Chapter 2 of the DP but adjusts it to take into account the distinctive
features of OTC markets. Best execution for dealers in such a regime
would be about process and a description of the way they conduct their
1
http://www.fsa.gov.uk/pubs/discussion/fs06_04.pdf
http://www.cepr.org/PRESS/TT_CorporateFULL.pdf and
http://www.cepr.org/PRESS/TT_GovernmentFULL.pdf
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business, rather than about providing a trade-by-trade proof that best
prices have been attained. It is therefore rooted in MiFID requirements to
ensure the best possible result for the client by applying the firm’s
execution policy.
14. We have interpreted the MiFID text as applying the obligation of best
execution to dealers dealing on own account when dealing with retail and
professional clients. We understand the FSA is going to specify in its
forthcoming paper on client classification the circumstances where dealing
on own account may not amount to executing client orders. This would
provide much-needed clarity and pave the way for an industry consensus
on the scope of the obligation. We look forward to commenting on the
paper.
15. The FSA will undoubtedly conduct a full analysis of costs and benefits of
any proposals put forward. We believe these should be defined as widely
as possible, and include the overall costs and benefits to the market and
UK financial services industry. They should also consider the unintended
consequences of regulation, especially in terms of impact on all the
dimensions of market outcome. We are particularly concerned here about
the trade-off between liquidity and transparency in OTC markets.
16. Our answers to specific questions are set out below.
Answers to specific questions
Q2.1: Do you agree with the above analysis which takes a flexible approach
to the application of the requirements to firms in a chain of execution,
depending on the nature of the activities they perform and the degree of
control over the execution of the client orders?
17. We wholeheartedly agree with the flexible approach proposed. The
degree of control and the nature of activities performed by portfolio
managers whom the ABI represents are different to those undertaken by
brokers to whom they may transmit their orders. This is now explicitly
acknowledged in MiFID Level 2 Article 45.
18. We therefore welcome the move away from the one-size-fits-all model
which would have required an unnecessary duplication of effort. Imposing
identical obligations on all investment firms would also have extended the
portfolio managers’ responsibility to the point of actual execution of client
orders - an activity some perform infrequently. This is further explained
below.
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19. Instead, our members agree with the FSA that the chain of execution is
the most appropriate analogy to describe the execution process. It clarifies
that there is a ‘division of responsibility’ (DP p.10) between portfolio
managers and broker/dealers which can be configured in different ways,
rather than residing with one or the other participant.
20. The nature of obligation for portfolio managers will depend on the amount
of control they retain over the execution process. This will vary between
trades and will depend to some extent on the venue chosen. In some
cases, portfolio managers will delegate most of the execution – and
therefore control - over factors specified in Article 21(1) to a broker. In
others, they will be much closer to the trade and deliberately leave brokers
little room for discretion. For example, in the case of direct market access
(DMA), although a broker has a seat on the exchange and ultimately
concludes the trade, he does not actively mediate it in any way beyond
configuring the system used for trading. This means the portfolio
managers’ best execution obligation is correspondingly more onerous.
21. We would, however, caveat our general support for Chapter 2 by
expressing our members’ concern that the examples outlined and the
description of portfolio management in the DP are somewhat cursory and
may signal a lack of understanding of portfolio managers’ obligations and
how those differ from other market participants’.
22. The typical trading process from the portfolio manager’s perspective is
more complex than the examples suggest and can include more links in
the chain of execution. They have a choice of external venues to which
they transmit their orders: regulated markets, MTFs and crossing
networks, and broker/dealers - or a combination of some or all of the
above. Brokers further extend the chain by transmitting orders to different
venues.
23. Portfolio managers can also execute trades themselves by crossing them
internally. Internal crossing represents a sizeable portion of some portfolio
managers’ trading though its importance has decreased in recent years.
Some of our large members can internally cross almost £1bn worth of
trades every year but many put an increasing proportion of these trades
through the market by giving them to brokers to execute at specified
prices.
Q2.2: Do you agree with our views on the relevance of the specific factors
in Article 21?
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24. We agree with the factors highlighted and with the notion that their
relevance will vary between clients and instruments. As explained above,
it will also vary according to the role a firm plays in the execution chain.
25. Because portfolio managers send most of their trades to brokers or
dealers, the factors that inform the choice of those venues are likely to
form a large proportion of their execution policies.
26. The selection of brokers is usually a two-stage process. Initial assessment
is based on a wide variety of factors including credit risk, likelihood of
settlement, strength of relationship and consistency of execution. This is
often done annually or semi-annually. Although the process contributes to
how portfolio managers discharge their best execution obligations, it does
not form a part of a more focused trading decision that takes place at a
dealing desk. Factors such as size, speed and nature of the order are
usually more important at the point of trade.
27. Execution policies define a set of parameters investment managers use to
trade but cannot be a template for every trade undertaken: a policy cannot
in advance configure a set of variables applicable to every situation. We
believe the emphasis should be on processes rather than on trade-bytrade obligations.
28. This is particularly acute when assessing costs. Explicit costs are easy to
take into account and many of our members are already transparent about
their commission charges and other fees and accountable to their clients
through the Pension Fund Disclosure Code.
29. Implicit costs are more problematic and the DP acknowledges in footnote
21 that they are inherently hard to assess. As far as we are aware, there is
no commonly accepted methodology for estimating costs of, say, market
impact or the opportunity cost of failing to get a fill. They can only be
measured with some accuracy after the event.
30. It is these costs that are important to large investors. Our members
confirm that they do not always choose brokers with lowest commissions
or counterparties offering the lowest prices. Instead, what matters to them
are factors such as confidentiality, speed, commitment of capital and the
ability to deal in volume required or execute large orders smoothly – all of
which are instrumental in minimizing implicit costs.
31. However, although an execution policy will only be able to assess implicit
costs in a general way and not ascribe them monetary values, it should be
sufficiently detailed to explain to clients how those costs are managed.
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Q2.3: What additional costs will the requirements to have an execution
policy and execution arrangements impose on your firm?
32. Many of our members firms already have commercially driven execution
arrangements in place. The implementation of MiFID means they will
formalize them in execution policies, if they have not done so already.
Many have already put in place relatively sophisticated arrangements as a
result of the IMA/NAPF Pension Fund Disclosure Code. They have
already absorbed some of the initial cost. We therefore do not anticipate
that the additional costs of creating policies will be significant – though the
application in dealer markets depends on the final shape of the proposals.
33. Some firms might consider increasing the number of brokers they use if
they feel that would better satisfy their best execution obligations. This
would increase their costs, both initially and on an ongoing basis but these
ought to be offset by better execution quality.
Q2.4: Do you agree that price and cost are the most important factors for
retail clients?
34. In principle, yes but it is important to add that some investment managers
acting under discretionary mandates may undertake orders on behalf of
retail and professional customers at the same time and allocate the deal
across the respective funds. In such an order, factors other than cost and
price may be relevant. The fund manager should be free to decide how to
achieve the overall best result for his or her clients. Recital (67) of the
latest Level 2 draft recognizes that other factors apart from price and cost
may be given precedence in so far as they are instrumental in the delivery
of the best possible result:
Speed, likelihood of execution and settlement, the size and
nature of the order, market impact and any other implicit
transaction costs may be given precedence over the
immediate price and cost consideration only insofar as they
are instrumental in delivering the best possible result in
terms of the total consideration to the retail client.
Q2.5: What information will be appropriate in order to enable clients to be
sufficiently informed about the execution arrangements of the firm and how
will this differ as between retail and professional clients?
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35. We do not believe that overly detailed disclosure will help clients make
informed choices about the quality of execution arrangements. From the
viewpoint of investor protection, it is hard to see how a plethora of
information would be valuable.
36. Excessive information disclosure runs the risk of turning best execution
into a trade-by-trade obligation – something MiFID clearly states it is not.
Our members believe that their clients are interested in the overall
performance of the fund rather than trade-by-trade performance and that
the costs of providing information should not outweigh the benefits.
37. Information disclosed to clients should therefore be a high-level summary
of the firm’s policy and describe a general approach the firm is taking to
execution. Firms must be able to confirm that they have followed their
policies. Competitive pressure between fund managers will also serve to
ensure adequate disclosure to clients.
Q2.6: Are there any best execution issues unique to UCITS management
companies?
38. We are not aware of any issues unique to these companies.
Q3.1: Do you agree that under MiFID there may be demand from retail and
professional clients for best execution in relation to financial instruments
typically available from dealers? If so, how significant is this likely to be?
39. The FSA is undoubtedly aware of the existing uncertainty around client
classification. It arises because portfolio managers seek to match the
classification of their underlying clients so they could be granted
appropriate protection, while broker/dealers prefer to trade with them on
market counterparty basis. ABI members’ clients are usually classified as
professional.
40. In the case of very large firms, the request is frequently granted. For the
rest, particularly for smaller firms, the classification status is often unclear:
a firm may send a rebuttal letter to a broker/dealer, who may in turn
respond with his terms of business, and the stand-off is allowed to
continue even though trading takes place.
41. The feedback from our members suggests that many will continue to seek
to opt down in this way under MiFID, irrespective of the venue chosen or
the instruments traded. They will therefore expect to receive best
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execution from both brokers and dealers in order to extend maximum
protection to their clients. This is so that, when they pass orders for
execution, portfolio managers can be certain that those aspects of the
trade over which they have little or no control comply with Article 21(1) in a
way that allows them to satisfy their wider obligations under Article 19.
42. Some of our members have informed us that they will trade as eligible
counterparties in dealer markets. They will therefore have the full duty of
best execution to their clients.
43. We are aware of arguments that best execution should never apply in
OTC markets because the absence of agency obligation when a dealer
deals on own account is presumed to mean there is also no customer
order and therefore no execution.
44. We would argue that the need for client protection in financial markets
arises irrespective of the function in which the firm has chosen to act. We
therefore support the assertion FSA made in CP154 on Best Execution
that the concept of best execution should refer to transactions executed as
both principal and agent (p.36). There may, however, be circumstances
where firms dealing on own account are not executing a customer order
and we understand the FSA intends to clarify the scope of the obligation in
its forthcoming paper on client classification.
45. MiFID is clear in applying the obligation to dealers. Level 2 Recital (69)
explicitly states that:
Dealing on own account with clients by an investment
firm should be considered as the execution of client
orders and therefore subject to requirements under
Directive 2004/39/EC and, in particular, those
obligations in relation to best execution.
Also Level 2 recital (70) says:
The obligation to deliver the best possible result when
executing client orders applies in relation to all types of
financial instruments.
46. Implicit in the same Recital is an assumption that even bespoke
instruments are subject to best execution, even though the obligation may
be framed differently:
Best execution obligations should therefore be applied
in a manner that takes into account the different
circumstances associated with the execution of orders
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related to particular types of financial instruments. For
example, transactions involving a customised OTC
financial instrument that involve a unique contractual
relationship tailored to the circumstances of the client
and the investment firm may not be comparable for best
execution purposes with transactions involving shares
traded on centralised execution venues.
47. The Recital confirms that the contractual relationship between the dealer
and the portfolio manager triggers the obligation.
48. Although Recital (69) in Level 2 states that a quote may constitute a
specific client instruction – which would take precedence over the best
execution obligation according to Article 21(1) - it also says that the quote
would have to meet ‘the investment firm’s obligations under Article 21(1) if
the firm executed that quote at the time the quote was provided’. This
clearly brings it back to having to take all reasonable steps to obtain the
best possible result for a client.
49. However, although brokers and dealers are both subject to best execution,
we believe their obligations are not identical. This is because both the
capacity in which they act and the markets in which they operate are
different. (Please see our answer to Question 3.2. for further comments on
this issue.)
Q3.2: Do you consider that the benchmark execution model may provide a
useful additional approach by which dealers may be able to satisfy the best
execution requirements? If so, in what markets will it be of most use?
50. We recognise that the benchmarking model outlined in the DP is an
attempt to resolve some of the inherent problems of providing best
execution in dealer markets and we welcome the opportunity to comment.
51. Our members do not believe the model would work in practice and they
therefore do not think it could provide an additional approach by which
dealers might be able to satisfy their best execution requirements.
52. There are several reasons for their opposition. They do not think the
benchmarking model is practicable for the reasons set out below, nor do
they believe it would provide the level of protection envisaged. The results
it would produce risk being irrelevant at best and misleading at worst.
Because of this, the overall costs of developing, implementing and
reviewing the model, and the likely market disruption it would cause,
would significantly outweigh its benefits.
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53. It is also not clear how the FSA proposals would apply when dealers are
located in third-country jurisdictions – or even within the EU should
member states choose to adopt different approaches to implementation.
Absence of market failure
54. Benchmarking is based on an assumption that best execution in dealer
markets cannot be achieved or demonstrated without some kind of price
comparison. This in turn implies that financial instruments are currently
traded at suboptimal prices and that there is therefore a market failure.
55. The FSA’s own Feedback statement on DP05/5 (Trading Transparency in
the UK Secondary Bond Markets) and the research published in May by
the Centre for Economic Policy Research on behalf of a number of trade
associations (including the ABI) both confirm that there is no market
failure. They conclude that the market is functioning well and that spreads
are tight.
56. Both also warn that increasing transparency may damage liquidity. The
FSA says in the Feedback Statement that ‘transparency is not an end it
itself’ as ‘the ultimate aim should be to have markets that are fair, orderly
and clean’ (p. 3).
57. Although price comparison may be an important aspect of investor
protection, there is no evidence in either paper that it would improve the
functioning of dealer markets. In any case, the nature of investor
protection ought to be proportionate to the largely wholesale nature of
these markets.
58. Our members strongly believe that there is no market failure. Because
dealer markets are relatively illiquid and decentralised, with limited preand post-trade transparency, the process of price discovery is constrained
by their structure. It is not the same as for very liquid equities: unlike
brokers, dealers are not in a position to search the market in order to
prove that the price quoted is the best possible result for the client. In
addition, some instruments traded over the counter are so bespoke that
price comparison can be meaningless.
Absence of information asymmetry
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59. The FSA claims in Chapter 3 of the DP that there is information
asymmetry between dealers and their clients, which weakens the position
of the latter and restricts their ability to receive best execution.
60. Our members do not believe this is the case – with a caveat that access to
information will always to some extent depend on the firm’s size and the
accompanying market power.
61. Dealers may have access to IDBs and the advantage of knowing their own
book but portfolio managers may have a better overall view of the market
and the ability to compare quotes from several dealers. The growth of
trading platforms such as Tradeweb has also increased the amount of
pricing information available to portfolio managers. New solutions are
evolving all the time.
62. CEPR research on European Bond Markets concludes:
…the main dealers say they have no need for greater
transparency – they have access to MTS data, and
their inter-dealer market is in any case an institutional
markets, with large information flows. Big investors, too,
have a lot of market information. The large buy-side
institutions will have many dealers contacting them
directly. Conversely, they value their relationships with
dealers in the OTC setting. If they have a big position to
switch, they normally don’t parcel it out but give it all to
a single dealer to ‘work the order’. They find no problem
with best execution. P.56
Cost
63. The overall costs of benchmarking accumulated along the execution chain
are likely to be prohibitive. The costs to dealers of developing and
implementing the model would be passed on to buy-side investors. In
addition to these ‘external’ costs, portfolio managers would have to bear
the cost of analysing individual dealer’s benchmarks. This process would
absorb time and resources, particularly when benchmarks are derived
from complex internal pricing models or established by extrapolating from
indirectly referable prices. The resulting delay may in turn reduce the
number of trades portfolio managers are able to do. Ultimately, this would
hinder their ability to implement their investment strategies successfully.
64. There are also costs to the market as a whole if dealers choose to
withdraw liquidity altogether. There is a risk that this may happen if the
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costs of running a dealing function turn out to be so high that the banks’
capital may be more profitably employed elsewhere. Although it is more
likely that dealers would choose to deal with eligible counterparties only, a
situation where some dealers can afford to offer regulatory best execution
and others cannot may make some of the latter exit the market.
65. These multiple costs will ultimately be passed on to end-beneficiaries.
Whether they would be offset by keener pricing is contestable - FSA’s
Feedback Statement on bond market transparency concluded that
spreads are already tight and the market is functioning well. Again, the
absence of market failure means the gains from regulatory action would
be limited.
Timing
66. Our members are concerned about the time it would take to implement the
benchmarking model and the effect any delay would have on firms’ ability
to implement MiFID before November 2007.
67. The delay would be particularly acute for portfolio managers. As second in
the chain of execution in the majority of cases, they would have to wait for
broker/dealers to decide on their business models and establish suitable
execution arrangements before they can fully implement their own. In
particular, the shape of portfolio managers’ execution arrangements would
depend on whether broker/dealers decide to adopt a model where they do
not offer best execution but deal on eligible counterparty party basis only.
68. Our members have indicated that they would prefer to have their MiFIDcompliant execution policies in place by the end of 2006 if those are to be
given time to bed down before the final implementation deadline. Any
delay would make this impossible.
Super-equivalence
69. We believe that the benchmarking proposal goes beyond the MiFID
requirements and it is therefore super-equivalent to the Directive.
Considering the limitations imposed on member states wishing to
introduce additional requirements created by Level 2 Article 4 (1), we
would question the rationale behind and need for a complex model not
required by the Directive and not in the interest of UK markets.
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70. If a wider policy change is intended by the DP – such as making the
market more suitable for retail investors or increasing transparency – then
this ought to be done over a longer timescale, in consultation with industry
and after extensive cost-benefit and market failure analyses.
Alternative approaches and copy-out
71. FSA claims in the DP that benchmarking is only one option for providing
best execution in dealer markets. It goes on to highlight the alternatives in
3.13.
72. We would argue that they are not really alternatives as such, as they
assume either no best execution provision at all or the creation of an
interposing broker. Both would alter the market by adding another link in
the chain of execution (in the case of former, they would effectively block
off direct access to dealers by retail and professional clients).
73. Neither of the two options suggested is particularly attractive to portfolio
managers, as both imply additional costs and possible market disruption.
Our members would either have to provide best execution themselves or
they pay commission to an interposing broker.
74. Instead, we believe that the best way to implement MiFID provisions is by
copy-out. This would preserve the current market structure, while
imposing additional checks and balances which would fulfil FSA’s policy
objectives of investor protection and market efficiency as stated on page
21 of the DP.
75. The template for such an approach is already sketched out in Chapter 2 of
the DP through the concept of an execution chain. Our answer to
Question 2.1 outlines our understanding of the chain and the division of
responsibility. Both the portfolio manager and the broker will play some
part in providing best execution and the sum total should add up to the
best possible result for the client even if the extent of respective
obligations differs.
76. In dealer markers, as elsewhere, the emphasis should be on process. This
would mean that dealers – like brokers or portfolio managers – would
have to have execution policies and arrangements in place.
77. The fact that they are dealing on own account means their scope for
assessing various factors under Article 21(1) is limited. We agree with
IMA’s response which states that this in reality means that dealers’
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policies would have a relatively narrow focus, covering, for example,
speed of execution, size of order and nature of instruments.
78. In an illiquid and decentralised market with little pre- or post-trade
transparency, meaningful price comparisons are limited. MiFID talks about
taking all reasonable steps to obtain the best possible result for the client.
We believe the structure of OTC markets means it is not always
reasonable for dealers to search for other prices. Price may therefore
feature in their policies only for some types of instruments in certain
circumstances.
79. For example, where instruments traded are relatively liquid, dealers may
be in a position to describe the process used to inform price formation.
That could include checking prices posted on electronic networks and
inter-dealer broker screens. But the extent to which this can be done will
be contingent on what is being traded and how, so the same process will
not be applicable in all circumstances.
80. Price may feature more prominently in portfolio managers’ policies but
would be based on limited pricing information, again depending on the
venue and the instrument traded as well as size of the order and other
factors. This is because the price references a portfolio manager has are
the alternative prices obtained from competing dealers and other pieces of
information such as bond yield data or indicative prices from trading
platforms. Where there are lots of dealers and a reasonable amount of
liquidity, this is practicable. For example, Tradeweb allows portfolio
managers to compare several dealers’ quotes in real time and preserve an
audit trail of execution. It is increasingly being used for small trades.
81. However, this is often not possible. For example, in emerging markets
stock, a portfolio manager may build up a trade with one dealer over
several conversations. If he did this with several dealers but then did not
buy, his ability to trade with them in future would be jeopardized. In other
cases, he might get the first call from a dealer and accept on the spot. It
would be up to him to judge whether the price constituted the best
possible result for the client.
82. In cases such as these, where the opportunities to ‘shop around’ are
limited (other examples include where there is only one dealer in a
particular instrument or the instrument is entirely bespoke), a portfolio
manager would have to explain in his policy the process he goes through
in order to fulfill his obligation of best execution. Very often, the focus
would be on ability to trade at all and on speed and efficiency with which it
can be done. Price might be third or fourth in the level of importance.
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83. Rather than being an absolute guarantee of best execution, dealers’
execution policy would basically be a series of checks and balances
designed to align the interests of dealers and their clients. This, together
with the more general duty on all investment firms under Article 19, the
conflicts of interest provisions and the competitive pressure all dealers
face in a dynamic marketplace, all serve to minimize risk and enhance
investor protection.
Q3.3: What would be the likely costs of this approach?
Please see our answer to Question 3.2.
Q3.4: What particular characteristics of reference prices make them
suitable benchmarks for particular instruments or in particular
circumstances?
Please see our answer to Question 3.2.
Q3.5: Do you agree that a dealer could construct prices by extrapolating
from indirectly referable benchmark prices and thereby satisfy MiFID’s best
execution? Please give examples for specific financial instruments.
Please see our answer to Question 3.2.
Q3.6: In what circumstances could financial or economic indicators or
indices be relevant benchmarks?
Please see our answer to Question 3.2.
Q3.7: Would dealers consider charging clients an additional fee or
commission for providing best execution?
84. We cannot comment on sell-side dealers’ intentions and ultimately this will
be a commercial decision for them. From the portfolio managers’ point of
view, a fee would further increase costs that would have to be passed on
to clients.
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85. Also, although a fee may allow both parties to consider the costs and
benefits of execution in a more explicit manner, we believe that best
execution should be an integral part of the overall service provided.
Q3.8: Are there any circumstances in which an execution model which
uses internal benchmarks could be sufficiently robust to satisfy the best
execution requirements? If so, what?
Please see our answer to Question 3.2.
Q3.9: What are your views on the possible benchmarks identified in
paragraph 3.43?
Please see our answer to Question 3.2.
Q3.10: Would trade associations be willing to develop such benchmarks for
the purposes of best execution? If so for what products / instruments?
86. As a trade association representing portfolio managers, we do not believe
it would be appropriate for us to develop benchmarks in this area. If the
development of benchmarks is indeed the role of trade associations – and
we would question the whether it is - then it ought to be left to those
representing broker/dealers.
Q3.11: Do you agree that the benchmark execution model can work for
financial spread bets and CFDs?
Please see our answer to Question 3.2.
Q4.1: Do you agree with our analysis of the requirements to review and
monitor?
87. We acknowledge the need to review and monitor best execution
arrangements and policies if portfolio managers are going to be able to
demonstrate that the right processes are in place. But these have to be
carefully calibrated to ensure they are supported by cost-benefit analysis.
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This is why we welcome the DP’s emphasis on flexible and proportionate
implementation, in line with firm’s arrangements and its position in the
chain of execution. We particularly support the point made in 4.23 of the
DP that portfolio managers are not in a position to and should not be
expected to monitor all the steps undertaken by broker/dealers on their
behalf.
88. Few of our member firms currently have formal best execution policies in
place but most have various procedures for monitoring and reviewing their
execution arrangements. Some of the controls currently used do not stem
directly from but contribute to the monitoring and reviewing obligations.
89. For example, it is standard practice to have in place a clear segregation of
duties between account managers and in-house dealers. Any anomalies
in prices or other factors which contribute to providing the best possible
result for clients are thus more likely to be detected. Most firms also
conduct counterparty polling at least annually, where brokers are
assessed both from a fund manager’s and trading desk’s perspective (i.e.
on the basis of execution quality, advice, research ideas and so on).
90. There are also controls designed specifically with best execution in mind.
Most firms, for example, use compliance monitoring to evaluate
transactions against firm’s internal arrangements and policies. Most use
sampling as a way of checking for discrepancies. There are also
occasional annual reviews of end-to-end arrangements and policies and
their ongoing delivery of best possible result for the client.
91. Member feedback suggests that they believe these arrangements to be
sufficient to ensure the quality of execution for their clients. A more
prescriptive approach risks turning what should be a commercially driven
practice into a tick-box exercise where the costs would undoubtedly
outweigh the benefits.
92. The quality of execution attained by our members is ultimately reflected in
the performance of funds they manage. That competitive pressure is
enough of a motive to monitor performance. The variety of controls in
place, coupled with the experience, skill and judgment of portfolio
managers and their dealing desks, preclude the need for heavy regulation.
They also ensure that losses from individual trades are likely to be small
so there is little incentive to monitor extensively. The costs of data
collection and analysis alone are likely to exceed the savings made.
Q4.2: On monitoring: do you agree with the comparisons suggested in
paragraph 4.11? If not, how would you assess the effectiveness of your
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arrangements? Will firms monitor their trading on a daily, weekly or
monthly basis?
93. In principle, we agree with the comparisons outlined in 4.11. However, we
would like to register some concern about the tone of both the question
and the monitoring section in the DP. They both seem to imply that
assessments could be conducted on a trade-by-trade basis. Not only
would trade-by-trade assessments provide little discernible benefit but in
some cases they would not possible at all. The execution a firm gets
cannot be measured against an absolute standard – it is not what the
Directive requires anyway – but should be seen in the context of that firm’s
execution policy.
Q4.3: On reviewing: do you conduct qualitative or quantitative reviews of
brokers, regulated markets or MTFs now? If so, how frequently?
94. As a trade association, we are not in the position to answer this question.
However, we believe most of our members have a system in place where
both fixed income and equities counterparties are reviewed by fund
managers and dealing desks. Some firms also periodically review trading
volumes and compare them to counterparty review results.
Q4.4: Please estimate and explain any incremental costs that you will incur
to comply with these requirements.
95. If the requirements are implemented in a principles-based way, then the
costs should not prove to be onerous for firms.
Q4.5: Do you agree with our analysis of how the requirements to review
and monitor might apply in dealer markets? In particular, will dealers be
able to compare and evaluate benchmarks?
96. Our answer to Q3.2 explains we do not believe that benchmarking is a
suitable way of demonstrating best execution.
Q4.6: Have you considered what data you will need to review and monitor?
97. A post-trade review of execution quality will be relatively straightforward
for liquid securities. However, in OTC markets where there is no posttrade transparency, the processes of reviewing and monitoring will be
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constrained by the lack of available data. The emphasis will instead be on
pre-trade controls (such as obtaining competitive quotes) to ensure the
best possible result for the client.
Q4.7: Have you considered any changes that may be needed to order
management systems to capture data for monitoring?
98. There is still uncertainty about the structure of the market post-MiFID
implementation so we believe it may be too early to consider these
changes.
Q4.8: Will execution venues provide data to firms to demonstrate their
execution quality and compete for order flow?
99. We cannot comment on firms’ intentions but we may in any case have to
wait for markets to take shape once the regulatory requirements are clear.
Q4.9: What other approaches do you suggest to demonstrate that client
orders have been executed in accordance with a firm’s policy?
100.
We believe the process-driven approach described in our answer to
4.1 should be sufficient to demonstrate that orders have been executed in
accordance with firm’s policy.
Q4.10: Is there a role for an industry-led initiative to address these issues?
101.
Depending on the final shape of the proposals, there may be room
for some industry guidance.
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