Best execution practices – what a difference a year makes

A year ago, both buy- and sell-side companies were actively preparing for overwhelming change instigated by the then-forthcoming MiFID II (Markets in Financial Instruments Directive). Among many changes were those relating to best execution practices, which hold investment companies responsible to a higher standard. These companies must now take “all sufficient steps”, rather than “all reasonable steps” to achieve best outcomes for their clients. Investment companies must also collect and report a range of data to provide transparency around how they performed relatively to these standards, in theory allowing their clients to compare brokers and trading venues.

A long and rocky journey

In H2 2017, companies were completing their regulatory interpretation, workflow architecture and technical implementation for data capture and compliance. Best execution policies were updated, procedures modified and governance upgraded to ratify and monitor implementation of those policies. Buy- and sell-side companies were tasked with identifying and, to some extent, justifying their execution factors.

While these changes seemed overwhelming at the time, the hard work of MiFID II best execution is only now beginning... Many of the new best execution-related requirements are experiencing their first iterative cycle in production. These include, at the highest level:

• Preparing for the reporting and data tsunami related to MiFID II Regulatory Technical Standards (RTS) 27 and 28 (best execution)
• Making adjustments to close gaps found between policy and actual performance

MiFID II RTS 27 requires companies to include several execution factors for securing best execution on behalf of their clients, including “price, costs, speed, likelihood of execution and settlement, size, nature or any other relevant consideration”. It allows for investment companies to prioritize those factors themselves, while at the same time requires them to be transparent regarding their relative priority. Investment companies must assess their performance against these priorities, and review the RTS 27 reports of execution venues. Regulators expect substance to these responsibilities, and it is assumed their evaluations to be iterative.

With changes come different challenges

Some large companies will struggle with complexities brought upon by cross-geography, cross-divisional policies supported by disparate systems and data stores. End clients are benefitting from the intent of the regulation and emerging transaction cost analysis (TCA) tools available to provide transparency into performance. However, vast resources have been poured into reports mandated by RTS 27/28 for which end clients will struggle to find relevancy and consistency.

On the other end of the spectrum, smaller investment companies may not suffer from their larger peers’ byzantine systems. However, the expectations of their clients are rising with the regulatory tide.  While they enjoy a strong and intimate relationship with their clients, the increased hurdles related to regulatory compliance, breadth and depth of coverage, and performance transparency raise the stakes of remaining in the game. A realistic risk to their clients is that these boutique investment companies may no longer be able to afford to service them.

SIX is a trusted partner for best execution and the reference market for Swiss shares

The Swiss stock exchange run by SIX is well-positioned to facilitate creative solutions between its diverse member base in order to meet the expectations of the evolving environment. This includes best execution obligations. SIX knows its members, both local and remote, as evidenced by the quality of the books in SMI securities[1]:

• Greater than 70% market share in SMI and 90% presence of the best bid/offer in order books
• Average spreads at the touch of 3.55bps, 0.4bps tighter than the nearest lit rivals
• Average book depths of greater than EUR 1.5mm 10bps from the top of book which means five times greater depth than the nearest competitor, and greater depth than the next four largest MTFs combined 
• To trade EUR 25,000 of an SMI security, the average spread will be 3.73bps at the Swiss stock exchange, vs. 4.99bps at CHIX.

Graphic 1: Continued strong liquidity profile of SIX orders books measured by spreads and depth of the liquidity.[2]

Innovative solutions keep markets fair and accessible

The Swiss stock exchange run by SIX remains the preferred destination by evolving and responding to the needs of its members. This is evidenced by the growing use of SwissAtMid (mid-point execution on Swiss equity instruments) to obtain price improvement. In the course of H1 2018, SwissAtMid became the largest non-displayed pool of liquidity for Swiss equities, offering clients an average 4bps price improvement that translated into direct savings of over CHF 2 million in the first six months of 2018.

Graphic 2: Members achieve considerable price improvement when trading at the mid-price in SwissAtMid. Blue Chips ~3bps, Mid/ Small Caps shares ~10bps.

?Sustained partnerships to remain at the forefront

SIX partners with technology providers to bring fair and affordable technology solutions to its members. This allows the most current technology to be available to its members, and not just those who can afford to build it themselves. As an example:

SIX is the first stock exchange worldwide to own and operate an international microwave network in Europe. The network connects Zurich to London, Frankfurt and Milan as well as Milan to London and Frankfurt. It enables trading participants of the Swiss stock exchange to execute their trading strategies faster (99.97% of the speed of light) and enhances their risk management. It also improves liquidity and tightens spreads, which results in better execution conditions for all stakeholders of the Swiss stock exchange. This service is offered through 12H AG.

[1] Source: IFS LiquidMetrix – May 2018 data.

[2] Source: IFS Liquidmetrix, July 2018 for SMI shares. From the left: spread in bps for 25k EUR order, liquidity within 50bps point from the mid-price, unique best bid and ask prices for 25k EUR order.