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| Best execution - MiFID - an outline of CESR's consultation paper | ||
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| Given the important role which best execution will play in the achievement of MiFID's goals, The Committee of European Securities Regulators ("CESR") issued a consultation paper (the "Consultation Paper") in February seeking to identify and propose solutions to a number of issues that had arisen in respect of this requirement, writes Joe Beashel. | ||
The best execution obligations under the Market in Financial Instruments Directive (2004/39/EC) (the "Level 1 Directive") and (2006/73/EC) (the Level 2 Directive")(collectively "MiFID") form an important cornerstone in the regulatory architecture of MiFID which seeks to achieve an efficient market that protects investors, by fostering competition between trading venues and increasing investor confidence. Given the important role which best execution will play in the achievement of MiFID's goals, The Committee of European Securities Regulators ("CESR") issued a consultation paper (the "Consultation Paper") in February seeking to identify and propose solutions to a number of issues that had arisen in respect of this requirement.
The Consultation Paper does not address the scope of application of the best execution requirements, which will be the subject of a future consultation paper, but does seek to identify the requirements, similarities and differences under Article 21 of the Level 1 Directive, which applies to investment firms that execute client orders ("Article 21 Firms"), and Article 45 of the Level 2 Directive, which applies to portfolio managers and entities that receive and transmit orders to third parties ("Article 45 Firms"). A firm may be an Article 21 Firm or an Article 45 Firm depending on whether it executes the order itself or passes it on to somebody else who then executes the order. Despite the differences in language, the Consultation Paper confirms that both Article 21 and Article 45 require investment firms to take all reasonable steps to obtain the best possible result for the execution of client orders, taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order (the "Factors"). Article 21 Firms are required to establish an execution policy, provide details of the policy to clients who must consent to the use of the policy and be able to demonstrate to clients that the policy has been followed. Article 45 Firms are subject to the same requirements, however they are not required to obtain consent or demonstrate to clients compliance with the policy. The Consultation Paper provides that the policy will only detail the most important and relevant parts of the Article 21 Firm or Article 45 Firm's execution arrangements. In particular, a policy should include details of a firms execution approach, the venues or entities which the firm uses, the different factors that the firm will consider when executing an order and should explain how the policy will provide the client with the best possible result. The Consultation Paper identifies a number of Factors that should be considered and prioritised when executing an order for clients and which should be included in the policy. The priority given to each Factor will, according to Article 44(1) of the Level 2 Directive, depend on the characteristics of the client, the order itself, the financial instrument and the potential execution venues. In the case of retail clients, Article 44(3) of the Level 2 Directive provides that "total consideration" should be given a high priority and the Consultation Paper seeks to extend this to professional clients by requiring that price and cost should merit a high relative importance. Total consideration represents "the price of the financial instrument and the costs related to execution, which shall include all expenses incurred by the client which are directly related to the execution of the order" In identifying venues that will be included in a firm's policy, the Consultation Paper provides that the reliability and quality of the venue should take precedence, followed by the costs of that venue and it also provides that in some circumstances it will be permissible to have only one execution venue or only use one entity where this is monitored and reviewed and any deficiencies corrected. In drafting the policy, each firm should account for the different types of client it has and their order types, the instruments that it handles and the relevant market structures and execution venues available for those instruments or at a minimum provide details of how it handles different classes of instrument. The Consultation Paper does not provide a detailed list of what each policy should contain, but simply states that it should be sufficient to allow an investor make a properly informed decision. Failure to provide sufficient information may invalidate any policy consent given to an Article 21 Firm. It also provides that the policy must be presented in a comprehensible form, possibly as a single document, and be provided in a durable medium or by means of a website in certain conditions. The Consultation Paper also seeks to address the apparent differing interpretation of "prior consent" in respect of the policy and "prior express consent" in respect of executing orders outside a regulated market or MTF in Article 21. It provides that prior consent may, in some jurisdictions, be tacit, whereas prior express consent would require a written signature or an equivalent means such as an electronic signature. This may create logistical problems for repapering clients as a result of MiFID in respect of executing such orders. The fundamental difference between Article 21 Firms and Article 45 Firms lies in the fact that Article 21 Firms will generally execute the client order whereas Article 45 Firms will generally pass the order to an intermediary that then executes the order or to an intermediary that may perform a part of a function before passing it to another investment firm that will execute the order so creating a chain of execution. This chain of execution will be subject to the best execution requirements under Article 45 and each firm in the chain should be examined to ensure they are fulfilling the requirements. In this regard, Article 45 Firms are required to review the execution approaches of each intermediary they use before they are appointed and on an ongoing basis to ensure that it fulfils its obligations under Article 45. Interestingly, the Consultation Paper does not indicate that such an intermediary should be an Article 21 Firm, although this would obviously contribute greatly to evidencing compliance with the firm's own obligations under Article 45. No doubt this will put a premium on MiFID compliance and may lead to a number of non-EU firms adopting the MiFID approach to execution. The Consultation Paper also confirms that the approach taken by an investment firm to monitoring the obligations under Article 21 and Article 45 should be similar despite the fact that the wording is different. Article 45 Firms will, however, have the additional requirement to monitor the execution quality of the intermediaries they use. The Consultation Paper describes this as a review of the quality of the results based on the Factors that the intermediary has delivered in comparison with the results that were possible. The policy should be reviewed at least annually and whenever a material change occurs. Materiality is based on the nature or scope of any change as it affects the execution policy and would include changes in the types of instruments the firm executes and the introduction of new or improved execution intermediaries to the market. In reviewing the policy, the Consultation Paper provides that it is not necessary to review every transaction to ensure that best execution was achieved but that appropriate sampling, based on a cross section of typical transactions would suffice. In addition, it states that different firms along the execution chain may need to take different approaches to the way they review their policy based on the role they play in the chain. The Consultation Paper is helpful in a number of respects. In others, such as language used to describe the differences between firms that execute client orders (Article 21 Firms) and those that receive and transmit orders to other firms (Article 45 Firms) requires some clarification. It is likely the final guidance paper will address these issues though unfortunately, like all things related to MiFID, it will not deal with every possible issue. This inevitable fact should not take from the helpful guidance that is being provided and the final paper will be a significant source of clarification on this important topic. |
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Joe Beashel is a partner in the Banking and Financial Services Department at Matheson Ormsby Prentice and is Head of the firm's Regulatory Risk Management and Compliance Group. He can be contacted by phone: +353 1 619 9000 or by email: joe.beashel@mop.ie |
