What Are the Core Components of a Defensible Best Execution Policy after the Repeal of RTS 28?

Concept

The Enduring Principle of Best Execution

The repeal of the Regulatory Technical Standard 28 (RTS 28) has been misinterpreted by some as a relaxation of a firm’s duty to its clients. This perspective is flawed. The removal of the prescriptive reporting framework of RTS 28 does not in any way diminish the fundamental, overarching obligation under the Markets in Financial Instruments Directive (MiFID II) to achieve the best possible result for clients.

The core principle of best execution, therefore, remains a critical pillar of market integrity and investor protection. The focus has simply shifted from a box-ticking reporting exercise to a more principles-based approach that demands a robust and demonstrable commitment to achieving the best possible outcomes for clients.

A defensible best execution policy in this new environment is one that is deeply embedded in a firm’s culture and operational DNA. It is a dynamic, living framework that is constantly monitored, reviewed, and adapted to changing market conditions and client needs. The core components of such a policy are not a static checklist but a set of interconnected systems and processes that work together to ensure that every client order is handled with the utmost care and diligence. This requires a sophisticated understanding of market microstructure, a commitment to data-driven decision-making, and a culture of continuous improvement.

A defensible best execution policy is a dynamic framework that demonstrates a firm’s commitment to achieving the best possible outcomes for its clients, even without the prescriptive reporting requirements of RTS 28.

From Compliance to Competitive Advantage

The repeal of RTS 28 presents an opportunity for firms to move beyond a compliance-driven mindset and embrace best execution as a source of competitive advantage. A firm that can consistently demonstrate superior execution quality will be better placed to attract and retain clients, particularly in the institutional space where execution costs can have a significant impact on portfolio performance. This requires a move away from a one-size-fits-all approach to a more nuanced and client-centric model that takes into account the specific needs and objectives of each client.

A truly defensible best execution policy is one that is not only compliant with the letter of the law but also with its spirit. It is a policy that is designed to deliver real, tangible benefits to clients, and that is supported by a culture of transparency and accountability. This requires a significant investment in technology, data, and expertise, but the returns, in terms of client trust and loyalty, can be substantial.

Strategy

The Four Pillars of a Defensible Policy

A defensible best execution policy in the post-RTS 28 world must be built on four key pillars ▴ a comprehensive order execution policy, a robust process for selecting and monitoring execution venues, a sophisticated approach to transaction cost analysis (TCA), and a clear governance and oversight framework.

1. Order Execution Policy ▴ This is the foundational document that sets out the firm’s approach to best execution. It should be a clear, concise, and comprehensive document that is easily understood by clients and regulators alike. It should detail the relative importance of the various execution factors, such as price, costs, speed, and likelihood of execution, and how these factors are taken into account for different types of financial instruments and client categories.
2. Execution Venue Selection and Monitoring ▴ The policy must outline a rigorous and objective process for selecting the execution venues that the firm will use to execute client orders. This process should be based on a thorough due diligence of the venues’ execution quality, liquidity, and costs. The firm must also have a system in place to monitor the performance of its chosen venues on an ongoing basis and to make changes as necessary.
3. Transaction Cost Analysis (TCA) ▴ TCA is a critical tool for monitoring the effectiveness of a firm’s execution arrangements. A sophisticated TCA framework will go beyond simple measures of price improvement and will analyze a wide range of metrics, including slippage, market impact, and opportunity cost. The insights from TCA should be used to identify areas for improvement in the firm’s execution processes and to demonstrate to clients and regulators that the firm is taking all sufficient steps to achieve the best possible results.
4. Governance and Oversight ▴ A clear governance and oversight framework is essential to ensure that the best execution policy is effectively implemented and monitored. This should include the establishment of a best execution committee with responsibility for overseeing the firm’s execution arrangements, as well as clear lines of accountability for best execution within the firm.

Execution Factors and Their Application

The relative importance of the execution factors will vary depending on the specific circumstances of each order. For example, for a large, illiquid order, the likelihood of execution may be the most important factor, while for a small, liquid order, price may be the primary consideration. A defensible best execution policy will recognize this and will provide a framework for determining the appropriate prioritization of the execution factors in different scenarios. The table below provides an illustrative example of how the execution factors might be prioritized for different types of orders.

Execution

Demonstrating Compliance in a Post-RTS 28 World

In the absence of the prescriptive reporting requirements of RTS 28, firms must find new ways to demonstrate to clients and regulators that they are meeting their best execution obligations. This requires a move away from a “one-size-fits-all” approach to a more tailored and data-driven approach that is focused on providing meaningful and relevant information to clients. A key element of this is the ability to provide clients with detailed, post-trade analysis that shows how their orders have been executed and how the firm has taken into account the various execution factors.

This post-trade analysis should be more than just a simple confirmation of the execution price. It should provide a detailed breakdown of all the costs associated with the trade, including explicit costs such as commissions and fees, as well as implicit costs such as market impact and slippage. It should also provide a clear explanation of why the firm chose a particular execution venue and how this choice contributed to achieving the best possible result for the client. The table below provides an example of the kind of data that a firm might provide to a client as part of its post-trade analysis.

A defensible best execution policy requires a sophisticated approach to post-trade analysis that provides clients with a detailed and transparent view of how their orders have been executed.

The Role of Technology

Technology plays a critical role in enabling firms to meet their best execution obligations in a post-RTS 28 world. A sophisticated execution management system (EMS) can help firms to automate many of the tasks involved in the best execution process, from order routing and execution to post-trade analysis and reporting. An EMS can also provide firms with access to a wide range of liquidity sources, including dark pools and other alternative trading systems, which can help them to achieve better execution outcomes for their clients.

• Smart Order Routing ▴ A smart order router (SOR) is an automated system that can be used to route orders to the execution venue that is most likely to provide the best possible outcome for the client. An SOR will take into account a wide range of factors, including the price, liquidity, and costs of the various venues, as well as the specific characteristics of the order.
• Algorithmic Trading ▴ Algorithmic trading strategies can be used to execute large or complex orders in a way that minimizes market impact and achieves a better average price. There are a wide variety of different algorithmic trading strategies available, each of which is designed to be used in a different market environment.
• Transaction Cost Analysis (TCA) ▴ As discussed above, TCA is a critical tool for monitoring the effectiveness of a firm’s execution arrangements. A sophisticated TCA system will be able to analyze a wide range of data, including market data, order data, and execution data, to provide a detailed and comprehensive picture of the firm’s execution quality.

Reflection

A Continuous Journey

The repeal of RTS 28 should not be seen as an endpoint, but rather as a new beginning. It is an opportunity for firms to re-examine their approach to best execution and to build a framework that is truly fit for purpose in the 21st century. This will require a significant investment in technology, data, and expertise, but the rewards, in terms of client trust, loyalty, and competitive advantage, will be well worth the effort.

Ultimately, a defensible best execution policy is not just about compliance; it is about culture. It is about creating an environment in which everyone in the firm, from the front-line traders to the back-office staff, is committed to achieving the best possible outcomes for clients. This is a journey, not a destination, and it is a journey that every firm must embark on if it is to succeed in the new, post-RTS 28 world.