Authorities released last month a review of Europe’s 2010 Markets in Financial Instruments Directive, or MiFiD.
Specifically, the European Securities and Market Authority published a peer review on the way in which the national regulators in Europe have supervised and enforced the MiFid provisions concerning firm’s obligations on best execution. Alpha seekers would be well advised to review this report an early warning of the sort of continued regulatory tightening that may be in store.
Paris-based ESMA found a “low level” of supervision and proposed various improvements.
Articles 21 and 44
By way of background, MiFiD addresses best execution in two Articles, 21 and 44. The first of these mandates members states to “require that investment firms take all reasonable steps to obtain, when executing orders, the best possible results for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature, or any other consideration relevant to the execution of the order.” Member states will also require “that investment firms provide appropriate information to their clients on their order execution strategy” and the member states will monitor or assess (the two verbs are used as synonyms) such matters as whether the “execution venues included in the order execution policy provide for the best possible result for the client.”
Article 44 goes into more detail into how investment firms are to determine the relative importance of the various components of best execution. For example, how measure speed against price or costs? The answer to that question depends upon whether the firm is executing on behalf of a retail client or a professional client. In the case of a retail client, best execution requires more careful attention to the “total consideration” paid by that client than it would in the case of a professional. The retail client is presumably the one otherwise in danger of being snowed by a flurry of different-but-related expenses.
Article 44 also tells the member states that the specific meaning of “best execution” depends on whether a firm is executing in a context in which there is more than one competing venue. A firm has to do the comparison shopping on behalf of its clients (both professional and retail) when the state of play makes that feasible.
Why ESMA is Unhappy
The newly released report tells us that ESMA is unhappy with the national “competent authorities” (CAs) because they tend to see the best execution of orders “in terms of best price and not with regard to the analysis of the other execution factors, even in markets where there is a certain level of dispersion and where several execution venues exist.”
Part of the problem, ESMA thinks (consoling a bit with those under review here) is that the CAs don’t have the information they would need to be more rigorous. CAs reviewed “commented that it is a significant undertaking for them to analyze this information” even where it exists. That is: there is no European consolidated tape. And perhaps the adjective in the phrase “competent authorities” is to be understood as a courtesy rather than a description.
Another issue: hometown bias. “[A]ll the CAs seem to disregard that investors might wish to invest in securities which are not listed in the domestic market or are foreign securities. As a result it seems that there is no real assessment of whether orders should have been executed outside their national markets.” Yes, they use the unqualified term “all” in this connection.
Still another issue, the CAs own databases. In one case (the headline-evoking case of Greece), ESMA observes with palpable disapproval leaking through the bureaucratese that the authority’s database “only keeps information on enforcement decisions taken by the CA’s Board of Directors” whereas everyone else has databases that allow “internal sharing and processing of some intelligence or other sources supporting supervision of best execution.”
Even within that everyone-else category, though, there is a great disparity of content and structure to these databases. Some focus on complaints, others on risk assessment analyses or audits, etc. In roughly half, but only half, of the CAs surveyed, the “database facilities and the information stored allow [the CAs] to compare firms and define priorities on the basis of the applicable risk-based approach,” says ESMA.
Expect more pushing and tugging along all of these lines, as the nation-states continue to act as nation states, subject to their different domestic constituencies, and thus continue to produce results much more divergent than the continent scale honchos can approve. The changes will likely go beyond tongue-clucking by ESMA or in Brussels.