BEST EXECUTION – THE FCA’s YELLOW CARD.

There is no doubt that the Financial Conduct Authority’s (FCA) review of 36 retail banks, investment banks and wealth managers made for uncomfortable reading. Firms were not specifically named but the industry as a whole was shamed in its inability to meet their best execution obligations. Trading costs increased and returns reduced but material losses suffered were not quantified.

The FCA did show though that every basis point saved in all trading by all market participants could translate into £264 m in additional annual returns for customers. However, firms failed to make the grade due to their failure to grasp the key elements of best execution as well as incorrect implementation of policies. In fact, the review found that many firms frequently tried to limit their best execution obligations to clients with some using prohibited “carve-outs” or agreements in which customers allow firms to opt out of rules.

In addition, one group the FCA cited excluded all algorithmic trading from its best execution obligations while many still relied on single trading venues despite the fragmented European equities trading landscape. These results may be surprising given the reams of material, not to mention airtime, the original MiFID was given back in 2007. It was difficult to turn in the City at the time without bumping into a roundtable, seminar, White Paper or report discussing these shiny new best execution requirements.

There are many reasons that these practices fell through the net. Fear that customers would simply switch to a rival if they were unhappy is one but poor oversight and order execution were also blamed.  The regulator pointedly noted that the monitoring not only missed all relevant asset classes but also did not reflect all of the execution factors which firms are required to assess or include adequate samples of transactions. Moreover, it was often unclear how monitoring was captured in management information and used to correct any deficiencies.

In addition, there didn’t seem to be anyone in charge plus reviews tended to focus on process rather than client outcomes, with insufficient input from the front office. Equally as worrying, firms were often unable to demonstrate how they managed conflicts of interest when using connected parties or internal systems to deliver best execution for their clients.

Given MiFID II’s 2017 deadline, firms could be lulled into a false sense of security of having plenty of time to rectify their mistakes. However, those firms who put their clients’ best execution interests high on their priority list will have the edge in not only restoring market integrity but also stealing a march on their competition.

Lynn Strongin Dodds

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To download the FCA report ‘Best Execution and Payment for Order Flow’ (TR14/13) click here

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