Best execution U-Turn in Europe: What does the industry think?

Biggest white elephant in history: ESMA gives up as the political lobying against the FX industry did not work, we prospered, they ended up with expensive administration. FinanceFeeds speaks to key FX industry executives to get their perspective on why ESMA backtracked


Good news or bad news?

Could it be that the bungling European regulators are so disorganized that they would waste an absolute fortune in designing and implementing an incredibly bureaucratic and vague framework aimed at costing OTC derivatives and regulated exchanges an equally absolute fortune in redesigning their entire trading topography and technological infrastructure and then abandon some important key tenets of said bureaucratic and vague framework?

Or could it be that after a fraught start, some aspects of MiFID II have become a millstone around everyone’s neck including the bogged-down European Securities and Markets Authority (ESMA) that it’s own orchestrator is looking to hang parts of it up forever?

Either way, the bizarre potential U-turn that is being considered by ESMA – namely the possible cancellation of MiFID II’s ‘Best Execution’ policies and retraction of RTS27 and RTS28 reporting procedure, all of which are little understood by regulator and brokerage alike.

The Brussels bureaucrats, many of whom do not understand the operational methodology of electronic trading, and cannot tell their matching engines from their trade repositories, committed several years of planning toward separating the different type of execution facility and platform into several categories, including Market Maker (b-book brokerage), Regulated Marketplace (derivatives exchange with central counterparty), and OTF (organized trading facility) and then stipulating how these entities should report their trades, using LEIs and specialist trade reporting mechanisms.

From a technological perspective, this was a major undertaking and most brokerages went to huge extents to listen carefully to specialist consultancy firms such as Point9, Cappitech and TRAction FinTech, who in turn went to great lengths to explain to the entire industry how these rulings should be adhered to, and who came up with very important solutions for meeting the deadline to implement these requirements.

In 2017, FinanceFeeds held a conference in London for brokerages to be able to speak to knowledgeable regulatory technology specialists and prepare their brokerages for the impending huge change in modus operandi.

This was followed up by the regulatory technology specialists themselves.

ESMA and the European Parliament had stuck firmly to the line that customer protection was vital and that many complaints against OTC FX firms had related to ‘poor execution’ practices, slippage and not acting in the best interest of customers, so why now the sudden backtracking?

Surely this is akin to installing streetlamps, then insisting all cars have no headlamps, and then removing the streetlamps? That may well sound banal, but looking at the same thing in a different context shows up the odd nature of this decision.

The capital I in MiFID stands for Infrastructure, and indeed the requirements for brokerages to stick rigidly to very structured infrastructure categories and ensure that best execution  is carried out, as well as be able to demonstrate exactly how a price was decided and trace the entire order trail, is vast and very clear.

Dissenting voices in Western regions have several times displayed their concern about this, however – perhaps their lobbying didn’t work , OTC derivatives companies are still prospering despite having had to be coerced into complying with intentionally expensive, bureaucratic and technologically complex rules aimed at befuddling and wearing them down, so perhaps the exchange lobby has had to give up, the only result being an expensive white elephant now left in the hands of the government.

Many have that whilst companies in the world’s largest financial center – London – and branches of those firms in Europe along with native European firms, will have to organize themselves as specific entity types and make massive attempts to keep themselves that way and report specifically, others do not.

FinanceFeeds today spoke to senior executives in the FX industry on their position on this matter, as it is very much a moot point at the moment.

Husam Al Kurdi, CEO of SquaredFinancial in Cyprus, an industry leader who places a very significant emphasis on the use of technology to further the security, user experience and versatility of the FX industry via various initiatives including artificial intelligence solutions and the will to acquire a bank in order to provide dedicated secure custodian services for client funds to brokerages, was quite optimistic and looked at the future should ESMA ditch these rules.

“ESMA has made these changes in light of the pressures placed on European financial markets by the Covid pandemic, but the real question is whether they still have concerns over their approach to best execution.  We have always argued for fair execution rather than best execution which would protect the broker, the clients and the price providers behind them” he said.

“The issue has always been that not all clients are the same, so for certain aggressive client’s best execution can lead to loss on the broker side and disrupt the relationships with the market makers.  For us, fair execution to protects clients and at the same time liquidity providers” – Husam Al Kurdi, CEO, SquaredFinancial

“We will have to wait and see whether this will be a short-term amendment or if, after so much work in this area, they will come back with a different option” concluded Mr Al Kurdi.

Michael Buchbinder, Managing Director at Swedish specialist brokerage Scandinavian Capital Markets has always been an advocate of brokerages taking responsibility and operating technologically advanced, high-touch client-facing brokerages rather than being slack in their approach and ending up being herded around by inept regulators had a pragmatic view on the matter.

“I read about that Andrew” said Mr Buchbinder. “Apparently the reasoning is that not many clients are clicking the reports to view the information” he said.

“I think it is interesting what that move says or doesn’t say. Measures like these were brought in to help bring in a better playing field for clients and trading environment. These were a direct result of all of the client complaints within the industry” – Michael Buchbinder, Managing Director, Scandinavian Capital Markets
“Does this mean client complaints are going down?” asked Mr Buchbinder. “If so I think it is something to celebrate. The industry is moving in the right direction” he said.
Ron Finberg, an expert in regulatory technology and esteemed long term prominent voice of reason within the FX industry, has tremendous experience in this area. At Cappitech, Mr Finberg has seen the entire preparation for ‘best execution’, RTS27 and RTS28 regulations in their advent and post-implementation state, and has been a voice in many global conferences on the matter.
Mr Finberg explained to FinanceFeeds ““Best execution standards are an important part of MIFID II regulation. However, with so many different types of products and company types covered by the regulation, the RTS 27 format isn’t ‘one size fits all’.”
“Therefore it has been difficult for buyside firms and consumers to review the data and benefit the reports. I would support any initiative from ESMA to gather feedback from industry participants of both what data is points are desired and what can be reasonably provided by venues” – Ron Finberg, Compliance and RegTech Specialist, Cappitech
Indeed so.

Implementation of MiFID II was not without its initial hurdles.

Back in January 2018, it tripped up on its first day.

FinanceFeeds took a look at this in London, and found that nderlining the complexity of the MiFID II reforms that touch on everything from the cost of analysts’ research to the trading of equities, London’s Liffe derivatives exchange and the London Metal Exchange were given an extra 30 months to comply with rules related to clearing on the very day they were due to come into force.

Eurex, the Frankfurt-based futures exchange owned by Deutsche Börse, was given a similar late reprieve on Tuesday by BaFin, Germany’s national regulator.

The UK’s Financial Conduct Authority said just a day after MiFID II implementation that it had granted the extension to ensure the “orderly function” of a clearing market that the reforms are designed to open up.

Banks and brokers had at the time sought to upgrade their IT systems in advance of MiFID II, which will require far more detailed reporting of trades. Mifid II is expected to cost the finance industry more than €2.5bn to implement, with the largest banks spending more than €40m each on compliance, according to estimates by Opimas, the consultancy.

In securing its late delay, Eurex argued that the exit of the UK — Europe’s largest market for clearing derivatives — from the EU introduced too much uncertainty given that Britain may not be bound by the rules once it leaves, but that is hogwash.

Some said that the proposed changes would have also potentially increase the links between clearing houses at a time when the shape of the UK’s relationship with the EU is unclear, also hogwash.

Many City institutions had lobbied for the changes, especially the London Stock Exchange Group, which owns the LCH clearing house, which is not surprising giving the anti-OTC lobbying activities of the exchange giants.

In terms of complexity, Pavel Khizhnyak, CEO of Tradefora, detailed how brokerages should navigate these rules at a meeting in Cyprus.

“A lot of columns in the RTS27 procedure report end up being filled out as NA by brokers, and quite often when generating a report about execution price vs reference price, the two are the same because many reporting officers within brokerages enter their own prices because they don’t access to quality reference pricing data. Some input reference feed from institutional vendors, which is again not correct, because we should not be comparing retail broker pricing to an institutional one. We should be comparing apples to apples” Mr. Khizhnyak told FinanceFeeds, and yes indeed he is quite right.

Now that most brokers have benefited from this, and are all aligned, ESMA looks to retract. The question is, who and what is really behind this?

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