How Did MiFID II Impact the Use of Last Look in RFQ Workflows?

Concept

The implementation of the Markets in Financial Instruments Directive II (MiFID II) represented a fundamental recalibration of the European financial markets’ operating system. For participants in Request for Quote (RFQ) workflows, particularly within the vast and decentralized foreign exchange market, the directive’s influence was not a peripheral adjustment but a core systemic change. It directly confronted the established, and often opaque, practice of “last look,” forcing a structural evolution in how liquidity is provisioned and consumed.

Understanding this impact requires setting aside a simplistic view of regulation as a mere set of constraints. Instead, MiFID II should be viewed as a set of new protocols that altered the very physics of information exchange and trust between buy-side firms and liquidity providers.

At its heart, an RFQ is a bilateral communication protocol ▴ a client requests a price for a specific transaction from a select group of liquidity providers. Before MiFID II, the quoting process was frequently governed by the principle of “last look.” This mechanism granted the liquidity provider a final, brief window of time after receiving the client’s trade request to accept or reject the trade at the quoted price. From the perspective of the market maker, this was a critical risk management tool. It served as a final check against latency arbitrage and protected them from being filled on a stale price during moments of high market volatility.

The practice, however, created a significant information asymmetry. The client committed to the trade, while the provider retained a final, unilateral option to withdraw. This imbalance was the central point of friction that MiFID II’s principles sought to address.

MiFID II fundamentally altered RFQ workflows by imposing stringent best execution and transparency obligations, which directly challenged the opaque nature of traditional last look practices.

The directive did not explicitly outlaw last look. Its impact was more nuanced and systemic. MiFID II introduced an uncompromising mandate for investment firms to take all “sufficient steps” to achieve “best execution” for their clients. This was a significant elevation from the previous “all reasonable steps” standard.

The new framework demanded that firms not only consider price but also costs, speed, likelihood of execution, and any other relevant consideration. Crucially, it required them to create and enforce a formal execution policy and to be able to demonstrate, with clear data and evidence, how they fulfilled this duty for every client order. This evidentiary requirement was the lever that forced a change. A firm could no longer simply state it had achieved a good outcome; it had to prove it through a rigorous, data-driven process. This created a direct conflict with the opacity of traditional last look, where rejections were frequent, often unexplained, and created unpredictable execution outcomes that were difficult to quantify and justify in a best execution report.

Strategy

The strategic response to MiFID II’s impact on last look practices was divergent, cleaving the market into distinct operational philosophies. For both buy-side and sell-side participants, the directive acted as a forcing function, compelling a move away from relationship-based assumptions toward a more quantitative and defensible approach to execution. The core of this strategic shift revolved around the new, non-negotiable requirement for demonstrable best execution, which in turn placed the concepts of transparency and execution certainty at the forefront of all trading decisions.

The Buy-Side’s Strategic Realignment

For institutional investors, the primary strategic adaptation was the institutionalization of Transaction Cost Analysis (TCA) as a central component of the execution workflow. Before MiFID II, TCA was often a post-trade, backward-looking exercise. The directive elevated it to a pre-trade and at-trade strategic tool. The goal was no longer simply to solicit a tight spread via RFQ but to achieve the highest possible probability of a successful fill at the quoted price, with minimal information leakage.

This led to a number of strategic adjustments:

• Liquidity Provider Segmentation ▴ Buy-side desks began to systematically analyze and segment their liquidity providers based on empirical data. This went far beyond just the quoted price. Key metrics included fill ratios, rejection rates, and the “hold time” ▴ the duration of the last look window. LPs with high rejection rates or long hold times, which could signal adverse selection or the use of client information for the LP’s own hedging activities, were systematically down-tiered or removed from RFQ panels.
• Protocol Preference Shift ▴ There was a marked shift in preference toward RFQ protocols that offered greater certainty. This included “firm” or “no last look” streams, where the quoted price was binding. While these streams might sometimes feature slightly wider spreads to compensate the LP for taking on more risk, the certainty of execution was often deemed a worthwhile trade-off, as it eliminated the negative market impact associated with a rejected trade that had to be re-quoted in the market.
• TCA as a Negotiation Tool ▴ Armed with detailed data mandated by MiFID II’s reporting standards (like RTS 28), buy-side firms could engage with their LPs from a position of strength. They could present evidence of poor fill quality or excessive rejections and demand changes in the LP’s behavior or pricing model, turning the best execution requirement from a compliance burden into a tool for improving execution outcomes.

The Sell-Side’s Bifurcated Response

Liquidity providers faced a more complex strategic dilemma. They had to balance the risk management benefits of last look with the commercial imperative of remaining a preferred counterparty for their clients. This led to a split in strategic direction:

1. The Path of Transparency ▴ A significant portion of the market moved toward greater transparency. These LPs invested in technology and compliance frameworks to make their last look practices defensible under MiFID II. This involved creating clear, consistent, and auditable policies for when a trade would be rejected. Rejections were typically limited to instances of genuine price moves in the underlying market during the hold window, and could not be used for the LP’s own commercial benefit. They offered shorter hold times and provided clients with detailed data on why a trade was rejected, aligning with the principles later codified in the FX Global Code.
2. The Path of Firm Pricing ▴ Other LPs chose to compete by eliminating last look entirely for certain clients or on specific platforms. This “firm pricing” model became a key differentiator. By offering guaranteed execution at the quoted price, these providers attracted buy-side flow that prioritized certainty and sought to minimize TCA complexity. This strategy required more sophisticated internal risk management and pricing engines on the part of the LP to manage the risk of being hit on stale quotes, but it aligned perfectly with the buy-side’s need for demonstrable best execution.

The regulation forced a strategic pivot, transforming RFQ from a simple price discovery tool into a sophisticated mechanism for managing execution certainty and information leakage.

The table below illustrates the strategic trade-offs that a buy-side desk would need to consider when choosing between different liquidity provider quoting models in the post-MiFID II environment.

Execution

The execution-level changes mandated by MiFID II’s principles-based regulation were profound, requiring a complete re-engineering of the technological and procedural architecture of RFQ workflows. Firms could no longer rely on informal practices; they needed to build systems capable of capturing, analyzing, and reporting on every stage of the order lifecycle to satisfy the directive’s stringent evidentiary requirements. This operational overhaul was centered on data, transparency, and control.

The New Operational Playbook for RFQ Execution

The practical execution of an RFQ changed from a simple, quote-driven process to a data-intensive, multi-stage workflow. The following steps outline the new operational playbook for a MiFID II-compliant buy-side desk:

1. Pre-Trade Analysis ▴ Before an RFQ is even initiated, the system must perform a snapshot of market conditions. This includes capturing the prevailing bid/ask spread from a composite feed, assessing market volatility, and consulting internal analytics on historical LP performance for the specific instrument and trade size.
2. Intelligent LP Selection ▴ The choice of which LPs to include in the RFQ is no longer static. The Execution Management System (EMS) must dynamically filter and rank potential LPs based on TCA metrics. An LP with a historically high rejection rate for that currency pair during volatile periods might be automatically excluded from the request.
3. Standardized Data Transmission ▴ The RFQ sent to LPs must contain standardized data fields. The FIX protocol, the electronic messaging standard for financial markets, became even more critical. Specific FIX tags were used to indicate whether the request was for a firm price or would be subject to last look, ensuring clarity from the outset.
4. Quote Response Monitoring ▴ Upon receiving quotes, the system must log not only the price but also the precise timestamp of receipt and the duration of the last look window specified by each LP. This “hold time” became a critical data point for TCA.
5. Execution and Data Capture ▴ When the client chooses a quote and sends the trade request, the clock starts. The system must record the exact time the request is sent (t4) and the time the LP’s final acceptance or rejection is received (t5). If a trade is rejected, the system must be capable of capturing the rejection reason code provided by the LP.
6. Post-Trade Reporting and Analysis ▴ The captured data feeds directly into the firm’s TCA and best execution reporting systems (e.g. RTS 27/28 reports, though their format has evolved). This allows for the systematic evaluation of LPs and continuous refinement of the pre-trade and at-trade logic within the EMS.

Quantitative Modeling and Data Analysis

The core of MiFID II compliance lies in quantitative proof. Buy-side firms had to build or integrate systems capable of performing sophisticated analysis on execution data. The goal was to move beyond simple spread comparison to a holistic view of execution quality. The following table provides a hypothetical example of a quarterly TCA report a firm might use to evaluate its liquidity providers, directly addressing the demands of MiFID II.

In this model, the Composite TCA Score would be a weighted average calculated based on the firm’s execution policy. A firm prioritizing certainty might weight the Fill Ratio and Rejection Rate heavily, while a firm focused purely on cost might give more weight to Price Improvement. MiFID II forced firms to have such a policy and to be able to demonstrate how their execution choices, as reflected in this data, adhered to it.

System Integration and Technological Architecture

The operational changes required significant technological investment. The entire trading infrastructure, from the front-office EMS to the back-office reporting systems, needed to be upgraded.

• Execution Management Systems (EMS) ▴ An EMS could no longer be a simple order routing tool. It needed to become an analytical engine, equipped with pre-trade TCA, smart order routing logic that could differentiate between last look and firm liquidity, and the ability to capture granular timestamp and rejection data.
• FIX Protocol Integration ▴ Deeper integration with the FIX protocol was necessary. Custom tags might be used to communicate specific client requirements or to receive enhanced data from LPs. For example, a standardized set of rejection reason codes (e.g. ‘Price stale’, ‘Risk limit exceeded’) became essential for meaningful TCA.
• Data Warehousing and Analytics ▴ Firms had to build robust data warehouses to store the vast amounts of execution data now being generated. This data needed to be structured in a way that allowed for complex queries and analysis by TCA systems, compliance departments, and regulators. The ability to reconstruct the full lifecycle of any trade upon request became a baseline requirement.

Ultimately, MiFID II acted as a catalyst for an industrial-scale upgrade of the RFQ execution process. It transformed a practice once defined by opacity and information asymmetry into a transparent, data-driven, and highly controlled workflow, where execution quality could be measured, managed, and, most importantly, proven.

Reflection

From Mandate to Mechanism

The integration of MiFID II’s principles into the market’s infrastructure illustrates a core truth of financial systems ▴ regulation is a form of architectural specification. The directive did not merely impose rules; it provided the blueprints for a new operational reality. The focus on demonstrable best execution and transparency effectively deprecated protocols built on information asymmetry. This systemic evolution presents a clear imperative.

The question is no longer how to comply with the regulation, but how to leverage the new architecture it created. The data streams and analytical requirements mandated by MiFID II are not simply compliance artifacts; they are the raw materials for building a superior execution framework. The strategic advantage now lies with those who can most effectively analyze this data, refine their liquidity provider relationships, and tune their execution algorithms to navigate the transparent, yet still complex, landscape that has emerged. The ultimate impact of the directive is the codification of transparency, transforming what was once a source of friction into a fundamental component of the market’s operating system.