Buyside, Buyside, Watcha Gonna Do?

A recent headline in The Trade caught our attention: “Buy-side brace for further regulatory scrutiny.” While the article focuses on the European Union, and MiFID II, we believe that the buyside should take this under consideration in the European Union, the United States and elsewhere.

Why is this the case? In Europe, Best Execution is coming under a regulatory microscope after foundational regulatory changes with MiFID II. In the UK, the FCA is already paying close attention, and has come out to say that the buyside is failing to ensure appropriate oversight of best execution and failing to meet the FCA’s expectations with commission sharing and soft dollars. European authorities will likely examine these same issues once MiFID II is in force (still scheduled for January 2018).

In the United States, we have seen a clear trend of enforcement from regulators. This has entailed significant enforcement actions in the past few years targeted at: exchanges, ATSs and broker-dealers. All of these enforcement actions have had a common theme - they’ve either involved technology and data, or accurate disclosures.

These trends have also included substantive regulatory rule proposals increasing transparency and disclosure requirements (which we have championed for years), including for ATSs and institutional order routing. It should be clear what the next step of the process will be - a deeper examination of buyside firms. We expect regulators will be asking the following questions, demanding far more depth and expertise than in the past:

Do asset managers have comprehensive and sufficient best execution policies and procedures in place? Are past bast execution procedures still sufficient given new technology and data?
Are asset managers accurately representing what these policies and procedures are?
How are asset managers using current public disclosures?
How will asset managers incorporate enhanced public disclosures into their best execution procedures?
How are asset managers handling the conflict-of-interest that soft dollars and commission sharing present?

Unfortunately, there is significant informational asymmetry with regards to best execution. Regulators have not been clear about their expectations of asset managers, likely because they want flexibility for future enforcement.

Asset managers don’t like to discuss it with each other because it can be a sore subject. Within firms, trading teams can see it as a way for management to second-guess their trading decisions. Compliance groups can have trouble making the business case for more robust execution decision analysis and procedures. Portfolio management and research teams are concerned about ensuring their favorite research and deal flow sources receive enough trading commissions.

Trading, portfolio management, legal and compliance can all see it as a big waste of time and money. It doesn’t have to be.

There are distinct advantages to adopting a best practices approach to best execution that go beyond covering one’s regulatory exposure. This includes cost savings across multiple departments and alpha creation from optimizing the trading process. It can enhance existing broker relationships, and ensure a holistic approach to these relationships that is customized to an individual asset manager’s needs through broker scorecards. It can make it easy to assuage concerns of potential investors that are raised in the questionnaire / due diligence process, and to be sure you are representing yourself accurately. It can help to set apart an asset manager from others who have not done the necessary work, potentially winning investments that are becoming increasingly competed over.

At Mile 59, we’ve helped dozens of asset managers, of all sizes (from $1B to $1T of AUM), adopt a Modern Approach to Best Execution. This is a forward-looking, future-proof approach that ensures these firms have adopted the absolute best possible practices given their size and trading activity. It means understanding what your peers are doing, and leveraging our expertise and exposure to many different firms in the industry to understand how to adapt peer best practices to a firm’s unique trading style and strategy. It means leveraging quantitative analysis of order routing data, which is often much harder than just buying some TCA software. It means realizing significant cost savings from optimizing order routing decisions and broker relationships. It means ensuring soft dollars and commission sharing is managed appropriately and consistently across geographic regions.

Are you concerned that your best execution practices may not measure up? Are you unsure of the implications of MiFID II on your firm? Are you struggling to figure out how to measure algorithmic trading performance? Have you been disappointed by the results of your TCA efforts, or feel that there must be a better way to analyze the results? Has it been years since you’ve revisited your best execution policies and practices? Do you know how firms of similar size and trading style are managing these issues?

Dave LauerAugust 2, 2018