How Does MiFID II Specifically Address RFQ Protocols in Its Best Execution Framework? ▴ Question

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Concept

The Markets in Financial Instruments Directive II (MiFID II) fundamentally re-architected the European financial landscape, imposing a systemic, evidence-based discipline upon previously opaque market practices. For the Request for Quote (RFQ) protocol, this represented a profound operational shift. The regulation did not prohibit this vital method for sourcing liquidity, particularly in less liquid, over-the-counter (OTC) markets.

Instead, it integrated the RFQ process into a rigorous, auditable best execution framework, compelling firms to justify its use and prove its efficacy through data. This moved the RFQ from a relationship-driven convenience to a component of a quantifiable execution strategy.

Before the directive’s implementation, a firm’s reliance on an RFQ was often implicit, based on established counterparty relationships and accepted market conventions. MiFID II challenged this status quo by codifying the “best execution” obligation. This requires investment firms to take “all sufficient steps” to obtain the best possible result for their clients. This mandate extends across all financial instruments, including those complex or illiquid products frequently traded via RFQ.

The core of the directive’s intervention is the demand for proof. A firm must be able to demonstrate, with clear data and a documented policy, why an RFQ was the optimal execution method for a specific order at a specific moment in time, considering a range of execution factors.

The directive compels firms to treat RFQ not as an exception to market structure, but as an integral part of a deliberate and defensible execution system.

This systemic integration is most evident in the requirement for a detailed Order Execution Policy. This policy must explicitly state the circumstances under which an RFQ is appropriate and outline the factors affecting the choice of execution venue or counterparty. It forces a firm to move from a subjective assessment of “a good price” to an objective, multi-faceted analysis that considers price, costs, speed, likelihood of execution and settlement, size, and any other relevant consideration.

For OTC products, this includes a specific requirement to check the fairness of the price proposed by gathering market data and comparing it with similar or comparable products where possible. The best execution obligation applies to RFQs directed at professional clients, establishing a clear line of accountability that was previously ambiguous.

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Strategy

Adapting to MiFID II’s treatment of RFQ protocols required a complete strategic overhaul of execution workflows. Firms had to transition from a qualitative, relationship-based model to a quantitative, evidence-based framework. The central pillar of this new strategy is the firm’s Order Execution Policy, which acts as the constitutional document governing all execution decisions, including the deployment of RFQs. This policy must be a dynamic, detailed, and defensible guide that clearly articulates how the firm achieves best execution for its clients across different asset classes and order types.

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What Constitutes a Compliant Execution Policy?

A MiFID II-compliant execution policy must be granular and specific. It is insufficient to simply state that the firm will seek the “best price.” The policy must detail the relative importance of the various execution factors for different types of clients and financial instruments. For a highly liquid equity, price might be the dominant factor.

For a complex, illiquid OTC derivative traded via RFQ, the likelihood of execution and settlement, or minimizing market impact, might justifiably take precedence over the headline price. The policy must explain this logic clearly.

The key strategic shift is from a passive to an active state of compliance. Firms must continuously monitor the effectiveness of their execution arrangements and policies to identify and correct any deficiencies. This involves a regular assessment of whether the counterparties and venues included in the policy consistently provide the best possible results. This “ex-ante” and “ex-post” monitoring requirement means that the selection of counterparties for an RFQ can no longer be static; it must be a dynamic process informed by ongoing performance analysis.

Under MiFID II, the choice to use an RFQ is a strategic decision that initiates a documented, data-driven process, not merely a message sent to a trusted counterparty.

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Data Capture and the Burden of Proof

The most significant strategic challenge introduced by MiFID II for RFQ workflows is the burden of proof. Every execution decision must be auditable and justifiable. This necessitates a robust technological infrastructure capable of capturing and storing a vast amount of data related to each RFQ. The following table illustrates the strategic pivot from the pre-MiFID II environment to the current state.

Table 1 ▴ Strategic Shift in RFQ Workflow Post-MiFID II
Process Component	Pre-MiFID II Approach	MiFID II Mandated Strategy
Counterparty Selection	Based on established relationships and perceived reliability. Often informal and undocumented.	Systematic and evidence-based. Counterparties are selected based on documented performance against execution factors. Regular reviews are mandatory.
Justification for RFQ	Implicit, based on the instrument type (e.g. OTC bond, swap). Rarely documented on a per-trade basis.	Explicit and documented. The Order Execution Policy must define when RFQ is used. For each trade, the firm must be able to justify why RFQ was chosen over other methods (e.g. lit market, systematic internaliser).
Price Verification	Relied on the counterparty’s quote, with informal checks against general market levels.	Formal process required. Firms must gather market data to check the “fairness” of the price for OTC products, comparing against similar instruments where possible.
Data Recording	Minimal. Typically limited to the final trade details. Timestamps of requests and quotes were often not captured systematically.	Comprehensive. Requires capturing timestamps for the entire lifecycle of the order, including the request, all quotes received (winning and losing), and the final execution.
Monitoring & Review	Ad-hoc and qualitative. Based on trader feedback.	Systematic and quantitative. Requires regular, formal reviews of execution quality from counterparties and publication of reports on the top five execution venues/brokers used.

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The Role of Systematic Internalisers

MiFID II also introduced the concept of the Systematic Internaliser (SI), a firm that deals on its own account by executing client orders outside a regulated market or MTF. When a firm sends an RFQ to a counterparty that is operating as an SI, the best execution obligation is clearly engaged. The SI regime provides a formal structure for bilateral trading, bringing a significant portion of what was once purely OTC activity into a more transparent framework. A firm’s strategy must therefore include a clear process for identifying which counterparties are SIs and understanding the specific obligations that apply when interacting with them.

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Execution

The execution of an RFQ under MiFID II is a precise, multi-stage process governed by data-driven protocols. It transforms the simple act of asking for a price into a detailed operational workflow that must be meticulously documented and auditable. Success in this environment depends on the seamless integration of technology, compliance procedures, and trader expertise to satisfy the “all sufficient steps” mandate.

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A Procedural Blueprint for Compliant RFQ Execution

Executing a trade via RFQ in a compliant manner involves a series of distinct, non-negotiable steps. Each stage generates critical data points that form the audit trail, demonstrating that the firm has adhered to its own execution policy and the regulator’s requirements.

Order Inception and Pre-Trade Analysis
- Order Characteristics Review ▴ The trader first assesses the order against the firm’s execution policy. Key characteristics include the instrument’s liquidity profile, the order size relative to average market volume, and the client’s specific instructions.
- Method Selection Justification ▴ Based on the review, the trader makes a formal decision to use the RFQ protocol. The rationale must be recorded. For example, for a large, illiquid corporate bond order, the justification might be “To minimize market impact and access specialized liquidity pools, in line with Section 4.2 of the Order Execution Policy.”
- Counterparty Shortlisting ▴ The trader selects a list of counterparties to include in the RFQ. This selection must be drawn from the firm’s approved list, which is maintained based on ongoing quantitative performance monitoring (TCA).
The Quote Solicitation Process
- RFQ Dissemination ▴ The RFQ is sent to the selected counterparties, typically through an Execution Management System (EMS). The system must log the precise timestamp of this request for each counterparty.
- Quote Reception and Capture ▴ As counterparties respond, the EMS must capture every quote received, including the price, quantity, and the timestamp of its arrival. Crucially, all quotes ▴ both winning and losing ▴ must be recorded to provide a complete picture of the available liquidity at that moment.
- Pre-Trade Price Fairness Check ▴ For OTC products, the trader must perform a “price fairness” check. This involves comparing the received quotes against available market data, such as composite pricing feeds (e.g. from Bloomberg or Reuters) or prices of comparable instruments. This check and the data used must be documented.
Execution and Post-Trade Documentation
- Execution Decision ▴ The trader executes the order against the chosen quote. The decision is based on the firm’s defined execution factors ▴ while price is often primary, factors like the likelihood of settlement or counterparty reliability may influence the final choice, and this must be justifiable.
- Post-Trade Data Consolidation ▴ All data points are consolidated into a final trade record. This includes the full audit trail of timestamps, all quotes, the price fairness check, and the final execution details.
- Reporting and Surveillance ▴ The trade data feeds into the firm’s broader compliance systems for transaction reporting (where applicable) and for inclusion in the periodic best execution monitoring reports (e.g. RTS 28 reports on top-five venues).

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How Is Total Cost Analysis Applied to RFQ?

A significant operational challenge is applying Total Cost Analysis (TCA) to RFQ-based trades. Unlike trades on a lit exchange where a public benchmark price (like the arrival price) is readily available, RFQ trades are bilateral. Effective TCA for RFQs requires a more sophisticated approach.

Table 2 ▴ TCA Metrics for RFQ Execution Quality
Metric	Description	Operational Implementation
Quote Spread Analysis	Measures the difference between the best quote received and the other quotes. A consistently wide spread from a single provider may indicate non-competitive pricing.	Requires systematic capture of all quotes. Analysis is performed periodically to rank counterparties on pricing competitiveness.
Price Drift / Slippage	Measures the difference between the price of the winning quote and a relevant market benchmark at the time of execution.	The benchmark must be defined in the execution policy (e.g. a composite price feed). The EMS must calculate and log this slippage for each trade.
Quote Rejection/Hold Time Analysis	Monitors how often counterparties provide quotes that are quickly withdrawn or how long they “hold” a request before responding. This can be an indicator of “last look” practices.	The EMS must track the time from RFQ to quote and flag rejections. High rejection rates or long hold times can lead to a counterparty being downgraded.
Hit/Fill Ratio	Calculates the percentage of times a counterparty’s quote is selected for execution out of the total number of times they were sent an RFQ.	A very low ratio may suggest the counterparty is not a genuine source of liquidity for that instrument, prompting a review of their inclusion in future RFQs.

The execution of RFQs under MiFID II is therefore an exercise in systemic discipline. It demands a robust technological architecture to capture the necessary data, a clear and detailed policy to guide decisions, and a commitment to ongoing quantitative analysis to prove that the firm is consistently acting in its clients’ best interests.

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References

Dechert LLP. “MiFID II ▴ Best execution.” Dechert, 2014.
Hogan Lovells. “Achieving best execution under MiFID II.” Hogan Lovells, 31 Aug. 2017.
Swedish Investment Fund Association. “Guide for drafting/review of Execution Policy under MiFID II.” 2018.
BofA Securities. “Order Execution Policy.” Bank of America, 2023.
“Best Execution Under MiFID II.” Finextra, 2018.

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Reflection

The integration of RFQ protocols into the MiFID II best execution framework provides a powerful case study in the systemization of market conduct. The regulation did not eliminate a necessary tool; it elevated the standard for its use. This prompts a critical self-assessment for any trading entity. Is your execution policy a living document that guides strategy, or a static compliance artifact?

Does your technology serve merely to transact, or does it function as a data-capture architecture, building the evidence base for every decision? The principles embedded within the directive ▴ transparency, accountability, and evidence-based decision-making ▴ are universal. Viewing your own operational framework through this lens reveals whether it is truly engineered for optimal performance or simply reliant on legacy convention.