Can a Firm Justify Choosing a Higher-Priced Quote in an RFQ under MiFID II Rules?

Concept

The architecture of the Markets in Financial Instruments Directive II (MiFID II) codifies a principle that seasoned capital markets professionals have long understood ▴ the optimal execution of a client order is a complex, multi-variable equation. The question of whether a firm can justify selecting a higher-priced quote within a Request for Quote (RFQ) protocol moves directly to the core of this regulation. The answer is an unequivocal yes. The framework of MiFID II provides the necessary latitude for such a decision, contingent upon a robust, documented, and defensible rationale.

This is not a loophole. It is a structural acknowledgment that in institutional finance, price is an incomplete metric of value. The directive mandates that firms take all “sufficient steps” to obtain the best possible result for their clients. This phrasing represents a deliberate elevation from the previous “reasonable steps” standard. It compels a firm to construct and adhere to a systemic process that evaluates a range of execution factors in their totality.

The regulation’s design is a direct reflection of the operational realities of trading, particularly for large, illiquid, or complex financial instruments. In these scenarios, the certainty of execution, the minimization of information leakage, and the stability of the counterparty can collectively outweigh a marginal price advantage. A lower price from an unreliable counterparty that fails to settle, or a price that is only available for a small size and creates significant market impact when trying to execute a larger block, delivers a profoundly negative outcome for the client. MiFID II provides the regulatory rails for a firm to apply its professional judgment, moving the definition of “best execution” from a simplistic, price-centric view to a holistic, outcome-oriented one.

The entire system is built upon the premise that the firm, acting as a fiduciary, possesses the expertise to navigate these complexities. The burden of proof, therefore, lies in the firm’s ability to articulate its decision-making process through clear policies and meticulous record-keeping. The justification for a higher price is found within the disciplined application of this comprehensive evaluation framework.

A firm’s duty under MiFID II is to secure the best overall trading outcome for a client, a process where the headline price is just one of several critical execution factors.

Understanding this concept requires a shift in perspective. The RFQ is a form of bilateral price discovery. The quotes received are data points, not definitive commands. Each quote carries with it an implicit set of characteristics related to the counterparty providing it.

These include the counterparty’s creditworthiness, its settlement history, and its potential to absorb a large trade without signaling the firm’s intent to the wider market. MiFID II empowers firms to quantify and qualify these characteristics as part of the execution calculus. The directive is built for a market where liquidity is fragmented and risk is multi-dimensional. It implicitly trusts the firm to build an internal operating system for execution that is sophisticated enough to account for these variables. The ability to justify a higher-priced quote is a direct function of the quality and rigor of that internal system.

Strategy

A compliant strategy for justifying a higher-priced RFQ response under MiFID II is rooted in the systematic application of a Total Cost Analysis (TCA) framework that extends beyond explicit costs. The regulation itself, specifically in RTS 28, provides the core components for this analysis by listing the execution factors that must be considered. The strategic imperative for any firm is to translate these regulatory factors into a concrete, repeatable, and auditable internal process. The primary execution factors are price and costs.

However, for professional clients, the directive allows for the prioritization of other factors, including speed, likelihood of execution, likelihood of settlement, and the size and nature of the order. A successful strategy depends on the firm’s ability to pre-define the relative importance of these factors for different instrument classes, order types, and client categories within its formal execution policy.

This policy becomes the foundational document upon which all subsequent execution decisions are built. For example, for a large block trade in an illiquid corporate bond, the policy might explicitly state that “likelihood of execution” and “minimization of market impact” are of higher importance than achieving the absolute best price from a pool of quotes. This is because the signaling risk associated with shopping a large, illiquid order can move the market against the client, resulting in a far worse effective price than the one initially quoted. The strategy involves creating a clear hierarchy of decision-making.

The trading desk must be empowered to make judgments based on these weighted factors, but their decisions must be recorded against the pre-defined policy. This creates a feedback loop where the firm’s strategic approach to execution is consistently applied and documented at the individual trade level.

How Do Execution Factors Interact in Practice?

The interaction between execution factors is where the strategic depth of the firm is demonstrated. A lower price may be offered by a counterparty with a slower, less reliable settlement process. This introduces settlement risk, which has a quantifiable cost in terms of operational resources and potential market movements while the trade is unsettled. Similarly, a counterparty might offer a keen price but only for a fraction of the required order size.

Executing the remainder of the order could lead to significant slippage, making the all-in cost of the trade higher than accepting a single, slightly higher-priced quote for the full size from a different dealer. The strategy is to model these trade-offs explicitly.

The following table illustrates the strategic considerations when evaluating RFQ responses, moving beyond the simple price metric.

The strategic framework must also account for qualitative factors. The nature of the relationship with a counterparty, their willingness to commit capital in volatile conditions, and their ability to provide valuable market color are all relevant considerations under MiFID II. While harder to quantify, these qualitative aspects can be documented in the trade rationale as contributing to the overall quality of the execution. The key is to have a consistent methodology for assessing and recording these factors, ensuring that the decision-making process is transparent and defensible.

Execution

The execution of a decision to accept a higher-priced quote requires a disciplined and robust operational workflow. This workflow must be designed to capture the decision-making process in real-time and produce an auditable record that stands up to regulatory scrutiny. The core of this process is the creation of a contemporaneous justification narrative. This cannot be an afterthought; it must be an integral part of the trade lifecycle.

The moment a trader decides to deviate from the best-priced quote, the system must prompt for a structured justification based on the firm’s execution policy. This ensures that the rationale is recorded with the trade details, preventing any post-trade rationalization.

The operational execution of a higher-priced trade hinges on the firm’s ability to produce a contemporaneous, evidence-based record justifying the decision.

This process begins with the firm’s Order and Execution Management System (OMS/EMS). The system should be configured to automatically flag any RFQ execution that does not align with the top-ranked quote based on price. This flag then triggers a mandatory workflow for the trader. This workflow should present the trader with a pre-defined list of justification reasons derived directly from the MiFID II execution factors and the firm’s own execution policy.

The trader must select the relevant factors and provide a concise, clear narrative explaining their reasoning. This structured approach ensures consistency and makes the data easier to aggregate and review for compliance and oversight functions.

The Justification Protocol in Action

To illustrate the protocol, consider a portfolio manager needing to sell a €20 million block of an illiquid corporate bond. The trading desk sends out an RFQ to three dealers. The responses are as follows:

• Dealer A ▴ Price 99.50, firm for the full €20m size.
• Dealer B ▴ Price 99.60, firm for only €5m.
• Dealer C ▴ Price 99.55, indication only, subject to final confirmation.

In this scenario, the highest price is from Dealer B, but it is for a fraction of the required size. Attempting to sell the remaining €15m after showing the order to the market could result in significant price degradation (market impact). Dealer C’s price is better than Dealer A’s, but it is not firm, introducing uncertainty.

The trader, therefore, chooses to execute with Dealer A at 99.50, securing a clean exit from the entire position at a guaranteed price. This decision, while at a lower headline price, achieves a better overall result for the client by prioritizing certainty of execution and avoiding negative market impact.

What Does a Compliant Justification Record Contain?

The record of this trade must contain all the necessary data to reconstruct the decision. The following table outlines the key components of a robust justification record, which would be stored electronically alongside the other trade data.

This systematic approach to execution and record-keeping is the ultimate fulfillment of the MiFID II mandate. It transforms the abstract requirement to take “all sufficient steps” into a tangible, data-driven process. It provides the firm with a defensible audit trail and demonstrates to both clients and regulators that its execution strategy is designed to achieve the best possible outcome, even when that means selecting a quote that is not the highest price.

A firm’s compliance with best execution is ultimately demonstrated through the quality and completeness of its trade documentation.

The final layer of execution involves periodic review. The compliance function must regularly analyze the data generated by these justification records. This analysis can identify patterns, such as a particular trader consistently overriding the best price, or a counterparty frequently providing non-firm quotes. This review process allows the firm to refine its execution policy, improve its counterparty management, and ensure that the discretion afforded by MiFID II is being used appropriately and in the best interests of its clients.

Reflection

The architecture of MiFID II compels a firm to look inward, to examine the very core of its execution philosophy and operational design. The ability to justify a higher price is less a specific action and more the output of a highly calibrated system. It requires an honest assessment of your firm’s technological capabilities, the clarity of its internal policies, and the culture of accountability on the trading desk. How does your current workflow capture intent at the moment of execution?

Is your data architecture robust enough to provide a complete picture of each trade, not just the price but the context surrounding it? The regulation provides the framework, but the competitive edge is found in the quality of your implementation. It is an opportunity to build a superior execution engine, one that consistently translates complex market data into the best possible client outcomes.