Best execution failures: there’s blame on both sides
The FCA has warned that best execution is often not being achieved
A Financial Conduct Authority investigation that found banks and brokers are failing to provide best execution highlights the need for more responsibility and education among their buy-side customers.
Under the European Markets in Financial Instruments Directive, financial services firms that execute trades on behalf of clients are obliged to achieve “best execution” – a hard-to-define combination of the security price and the cost of the overall trade . Brokers don’t always have to achieve this, but they must be able to demonstrate that they took appropriate steps to get the best possible result.
The FCA found that in many cases, banks and brokers do not understand their obligations under the rules and are not adequately controlling client costs when executing orders. The failures were compounded by insufficient managerial oversight or engagement from front office staff, according to the regulator, which ordered all firms to review their best execution arrangements and take immediate action to ensure compliance.
But the focus on the responsibilities of the sell-side is only half the picture, says Howard Tai, senior analyst at Aite. “The best way to resolve this is for the client to be diligent and show they understand and care a lot about best execution,” he said. “A lot of buy-side firms may have a best execution policy but they don’t follow up with the due diligence to check what the broker is doing on their behalf. If you leave it strictly to the sell-side without proper due diligence, you may not get the best result. Responsibility lies on both sides.”
The FCA noted in its findings that there were frequent attempts on the sell-side to limit obligations to clients, with four firms actively attempting to evade FCA rules by changing the description of services they offered to clients so they could continue to receive payment for order flow, despite FCA guidance issued in 2012. The FCA has warned that it will take action against any firm that continues to do this.
The regulator also noted that most firms lacked the ability to effectively monitor order execution or identify poor client outcomes, and that they were often unable to demonstrate how they managed conflicts of interest. It was often unclear who was responsible for best execution, the investigation found, and reviews often focused on process rather than client outcomes.
“I’m not surprised this has happened,” said Tai. “Sometimes a conflict of interest emerges between the executing broker and the client. At the end of the day, the broker needs to make money, thus their actions will incorporate a great deal of self-interests, and then the interest of the client.”
The review comes ahead of new EU-wide rules on best execution expected as part of MiFID II and is linked to the FCA’s work on firms’ use of client dealing commission and how they discharge their duty to act as good agents.
“Firms told us that best execution is a simple commercial imperative – yet our review shows many firms unacceptably fail to put their clients’ interests first, undermining market integrity and inhibiting competition,” said David Lawton, director of markets at the FCA. “The FCA expects to see firms act as good agents, placing equal focus on controlling client costs as delivering returns, and will take action where firms fall short of our standards.”
