How Do MiFID II and FINRA Define the Factors for Best Execution Differently?

Concept

In the complex global financial landscape, the principle of “best execution” serves as a critical safeguard for investors. This principle mandates that financial firms execute client orders to maximize value for the client. However, the application of this principle varies significantly across jurisdictions, particularly between the European Union’s Markets in Financial Instruments Directive II (MiFID II) and the United States’ Financial Industry Regulatory Authority (FINRA) rules. Understanding these differences is paramount for any firm operating in both markets.

The Philosophical Divide a Shared Goal with Distinct Approaches

At their core, both MiFID II and FINRA’s Rule 5310 aim to ensure that firms act in their clients’ best interests during trade execution. Both frameworks require a holistic view of execution, extending beyond the headline price of a security. Yet, their foundational philosophies and priorities diverge in subtle but impactful ways.

MiFID II employs a prescriptive, principles-based approach, compelling firms to take “all sufficient steps” to secure the best possible outcome for their clients. This standard is a notable escalation from the “all reasonable steps” required by its predecessor, MiFID I, imposing a more demanding compliance burden on firms. This change necessitates a proactive and transparent approach to best execution.

Conversely, FINRA’s best execution rule is centered on the concept of “reasonable diligence.” This standard requires firms to use their professional judgment to identify the best market for a security and to execute trades at the most favorable price under prevailing market conditions. While this may seem less stringent than MiFID II’s “all sufficient steps,” it is far from a lenient standard. FINRA mandates that firms perform “regular and rigorous” reviews of their execution quality to ensure consistent compliance.

Strategy

The strategic implications of the differences between MiFID II and FINRA’s best execution frameworks are far-reaching, influencing everything from a firm’s operational structure to its client relationships. A successful strategy for navigating these two regimes requires a deep understanding of their nuances and a proactive approach to compliance.

A Tale of Two Frameworks Deconstructing the Factors

The divergence between the two frameworks becomes even more pronounced when we dissect the specific factors firms must consider when executing client orders. Although there is significant overlap, the emphasis and scope of these factors differ in crucial respects.

MiFID II a Comprehensive and Granular Approach

MiFID II provides an explicit and detailed list of execution factors that firms must take into account:

• Price The price at which the trade is executed.
• Costs All costs associated with the execution, including fees, commissions, and any other charges.
• Speed The speed at which the trade is executed.
• Likelihood of execution and settlement The probability that the trade will be successfully executed and settled.
• Size and nature of the order The size and complexity of the order, which may influence the choice of execution venue.
• Any other consideration relevant to the execution of the order A catch-all provision that allows firms to consider any other factors that may be relevant to the specific circumstances of the trade.

MiFID II also introduces a critical distinction between retail and professional clients. For retail clients, the best possible result must be determined in terms of the total consideration, representing the price of the financial instrument and the costs related to execution. This places a strong emphasis on achieving the best possible net price for retail investors. For professional clients, firms have more discretion to prioritize other factors, such as speed or likelihood of execution, depending on the client’s specific instructions and objectives.

FINRA a Focus on “reasonable Diligence” and Market Dynamics

FINRA’s Rule 5310, while less prescriptive than MiFID II, outlines a similar set of factors that firms must consider in their pursuit of best execution:

• The character of the market for the security This includes factors such as the price, volatility, relative liquidity, and pressure on available communications.
• The size and type of transaction The size and complexity of the order.
• The number of markets checked The extent to which the firm has explored different execution venues to find the best possible price.
• The accessibility of the quotation The ease with which the firm can access and execute at a quoted price.
• The terms and conditions of the order Any specific instructions provided by the client.

In addition to these factors, FINRA places a strong emphasis on the concept of “price improvement,” which refers to the opportunity to obtain a better price than the publicly quoted price at the time of the order. This reflects the unique market structure of the United States, where multiple competing market centers and liquidity providers create opportunities for price improvement.

Execution

The execution of a best execution strategy in a dual-jurisdictional environment requires a meticulous and well-documented approach. Global financial firms must build a compliance framework that satisfies the stringent requirements of both MiFID II and FINRA, a task that demands careful planning and ongoing vigilance.

Key Differences at a Glance

The Impact on Firms a Global Challenge

The differences between the MiFID II and FINRA frameworks present a significant challenge for global financial firms that operate in both jurisdictions. These firms must develop and implement compliance programs that are robust enough to meet the requirements of both regimes. This often involves a “highest common denominator” approach, where firms adopt the most stringent requirements of both frameworks to ensure compliance across all of their operations.

For example, a global firm may choose to apply MiFID II’s more prescriptive approach to all of its clients, regardless of their location, to ensure a consistent and demonstrable approach to best execution. Similarly, a firm may choose to adopt FINRA’s emphasis on price improvement across all of its operations, even in jurisdictions where it is not explicitly required.

Conclusion a Shared Goal, a Divergent Path

While MiFID II and FINRA may take different paths to achieving the same goal, they both share a fundamental commitment to protecting investors and ensuring the integrity of financial markets. The differences in their approaches reflect the unique legal, regulatory, and market structures of their respective jurisdictions. For global financial firms, navigating these differences requires a deep understanding of both frameworks and a commitment to developing a compliance program that is both robust and flexible enough to meet the challenges of a constantly evolving regulatory landscape.

The core difference lies in the stringency of the overarching standard ▴ MiFID II’s “all sufficient steps” versus FINRA’s “reasonable diligence.”

This seemingly subtle distinction has significant implications for how firms approach their best execution obligations, from the level of detail required in their policies and procedures to the way they demonstrate compliance to regulators.

MiFID II’s explicit distinction between retail and professional clients adds another layer of complexity, requiring firms to tailor their execution strategies to the specific needs of each client type.

This is a key difference from the FINRA framework, which, while expecting firms to consider client needs, does not have the same explicit categorization.

Ultimately, both frameworks are driving the industry towards a more data-driven and transparent approach to best execution, which can only be a positive development for investors.

As technology continues to evolve and markets become more complex, the importance of a robust and well-defined best execution framework will only continue to grow.

Reflection

The journey through the intricacies of MiFID II and FINRA’s best execution requirements reveals a shared commitment to investor protection, albeit through different regulatory lenses. As a firm, the key takeaway is not simply to comply with a set of rules, but to cultivate a culture of best execution that permeates every aspect of your operations. This requires a proactive and dynamic approach, one that is constantly evolving to meet the challenges of a changing market landscape.

The question is not merely “are we compliant?” but rather, “are we truly acting in the best interests of our clients at all times?” This is a question that cannot be answered by a simple checklist or a one-time review. It requires a continuous process of self-assessment, data analysis, and a willingness to challenge the status quo. The ultimate goal is to build a best execution framework that is not just a regulatory requirement, but a competitive advantage.