What Are the Key Differences between MiFID I and MiFID II regarding Best Execution?

Concept

The transition from the Markets in Financial Instruments Directive (MiFID I) to its second iteration, MiFID II, represented a fundamental recalibration of the European Union’s financial markets. Within this sweeping reform, the principle of best execution underwent a profound transformation. The initial framework, established under MiFID I, introduced a harmonized standard for investment firms, mandating them to take all “reasonable steps” to obtain the best possible result for their clients. This was a foundational move away from disparate national regulations, establishing a common language for execution quality centered on factors like price, costs, speed, and likelihood of execution.

It created a baseline expectation of diligence, compelling firms to formalize their execution policies and demonstrate a structured approach to fulfilling their client duties. This initial directive laid the groundwork for a more transparent and competitive execution landscape across the European Union.

However, the 2008 financial crisis and the subsequent evolution of market structure exposed the limitations of the “reasonable steps” standard. The proliferation of trading venues, the rise of high-frequency trading, and the increasing complexity of financial instruments created a far more fragmented and opaque environment than the one MiFID I was designed to govern. Regulators perceived that the flexibility inherent in the term “reasonable” could allow for inconsistent application and, in some cases, a failure to secure the optimal outcome for end investors.

The directive’s application was also heavily concentrated on equity markets, leaving significant gaps in other asset classes where robust execution data was less readily available. A consensus emerged that a more stringent, evidence-based standard was necessary to restore investor confidence and ensure that the duty of best execution was a demonstrably fulfilled obligation rather than a procedural checklist.

The shift from “reasonable steps” under MiFID I to “sufficient steps” under MiFID II marked a pivotal change from a process-oriented obligation to a results-driven, evidence-based mandate.

MiFID II, therefore, was not merely an update but a systemic overhaul of this principle. It replaced the “reasonable steps” clause with a requirement for firms to take all “sufficient steps.” This seemingly subtle semantic shift carried immense weight, signaling a move from a standard of conduct to a standard of result. Sufficiency implies a higher, more demanding burden of proof. Under this new regime, a firm must be able to demonstrate, with quantifiable data and rigorous analysis, that its execution arrangements consistently deliver the best possible outcome for clients.

This change necessitated a complete re-engineering of internal processes, from front-office execution protocols to back-office data analysis and governance. The directive’s reach was also explicitly extended to encompass a much wider array of financial instruments, including over-the-counter (OTC) derivatives, bonds, and structured products, forcing firms to apply the same rigorous standards to markets that had historically operated with greater opacity. The era of best execution as a statement of policy was over; the era of best execution as a demonstrable, data-driven discipline had begun.

Strategy

Adapting to the best execution framework of MiFID II required investment firms to move beyond procedural compliance and embed a new strategic discipline into their operating models. The core challenge was transforming the firm’s execution philosophy from a passive fulfillment of obligations to an active, data-centric pursuit of optimal client outcomes. This strategic realignment was driven by several key pillars of the new directive, each demanding a fundamental rethink of existing practices and the development of new institutional capabilities.

From a General Duty to a Granular Mandate

Under MiFID I, firms were required to establish a single, overarching execution policy. While this policy needed to outline the factors considered for achieving best execution, its application could be relatively uniform across different asset classes. MiFID II dismantled this approach, mandating that execution policies be tailored to each specific class of financial instrument. This requirement recognized that the factors determining the best outcome for a liquid equity trade are fundamentally different from those for an illiquid corporate bond or a complex OTC derivative.

A firm’s strategy could no longer be monolithic. Instead, it had to become a mosaic of specialized approaches.

This necessitated a deep, strategic analysis of each market’s microstructure. For instance:

• For Equities ▴ The strategy would continue to focus on the interplay between lit venues, dark pools, and systematic internalisers, but with a greater emphasis on quantitatively measuring the execution quality provided by each.
• For Fixed Income ▴ The strategy had to address the challenges of a quote-driven, often illiquid market. This involved developing systems to capture and compare quotes from multiple counterparties and building a framework to justify execution decisions in the absence of a centralized, public tape.
• For Derivatives ▴ The focus shifted to assessing not just price, but also counterparty risk, clearing arrangements, and the total cost of the transaction over its lifecycle.

The Primacy of Cost and Price

While MiFID I listed several execution factors ▴ price, costs, speed, likelihood of execution, etc. ▴ it allowed firms considerable discretion in prioritizing them based on the client’s objectives. MiFID II strategically re-architected this hierarchy. For retail clients, the directive established total consideration, representing the combination of the instrument’s price and all associated costs, as the paramount factor. This strategic shift forced firms to deconstruct their entire cost structure, from explicit execution fees and clearing charges to implicit costs like market impact and spread.

The objective was to provide the client with the best possible net result. For professional clients, while other factors could be prioritized, firms were now required to provide robust justification for why they delivered a superior outcome even if the headline price was not the most competitive. This placed the burden of proof squarely on the investment firm.

The strategic imperative of MiFID II was to make execution quality a tangible, measurable, and comparable metric across the industry.

A Comparative Framework MiFID I Vs MiFID II

The strategic adjustments required by MiFID II become clearest when viewed in direct comparison to its predecessor. The following table illustrates the fundamental shift in regulatory expectation and the resulting strategic imperatives for investment firms.

Execution

The execution of a MiFID II-compliant best execution framework is a complex operational undertaking, transforming the abstract principles of the directive into a concrete, auditable, and data-driven system. It moves beyond policy statements into the realm of quantitative analysis, technological integration, and rigorous governance. The core of this operational challenge lies in two key areas ▴ the implementation of a robust monitoring and evidence-gathering process, and the fulfillment of the new public disclosure requirements mandated by Regulatory Technical Standards (RTS) 27 and 28.

The Four-Fold Test an Operational Checklist

To operationalize the “sufficient steps” standard, regulators have informally established what is known as the “four-fold test.” This provides a practical framework for firms to build their internal controls and demonstrate compliance. An effective execution framework must be able to answer these four questions at any given time:

1. Is there an execution policy? This is the foundational layer. The policy must be detailed, instrument-specific, and readily available to clients.
2. Is the firm following that policy? This requires robust pre-trade controls and post-trade surveillance to ensure that trading activity aligns with the documented procedures. Any deviation must be logged and justified.
3. Does the policy deliver the best possible result for the client? This is the most challenging component. It requires a systematic process of Transaction Cost Analysis (TCA) and comparison against relevant benchmarks to quantitatively assess execution quality.
4. Can the firm prove it? This is the evidentiary layer. It requires the collection, storage, and analysis of vast amounts of data to produce the reports and documentation necessary to satisfy regulators and clients.

The Data-Driven Mandate RTS 27 and RTS 28

The most significant operational change introduced by MiFID II was the creation of a public, data-driven feedback loop through RTS 27 and RTS 28 reports. These disclosures were designed to increase transparency and create competitive pressure on both execution venues and investment firms to improve their performance.

RTS 27 the Venue’s Report Card

Execution venues, including stock exchanges, multilateral trading facilities (MTFs), and systematic internalisers (SIs), are required to publish quarterly reports (RTS 27) detailing the quality of execution achieved on their platforms. These reports are highly granular and provide the raw data that investment firms need to conduct their own analysis and justify their venue selection. The operational challenge for venues is immense, requiring them to capture and process every single order and transaction.

A simplified representation of a portion of an RTS 27 table for a specific equity might look as follows:

RTS 28 the Firm’s Disclosure

Building on the data provided by venues, investment firms must produce their own annual report (RTS 28). This report summarizes, for each class of financial instrument, the top five execution venues to which they routed client orders. Crucially, it must also include a qualitative summary of the execution quality achieved.

This forces firms to publicly declare their execution strategy and defend its effectiveness. The operational process involves aggregating all client order data for the year, ranking venues by volume for each instrument class, and then drafting a clear, evidence-based summary of the results.

The operational reality of MiFID II is that best execution is no longer a matter of opinion; it is a matter of data.

This requirement to “show your work” fundamentally changed the relationship between firms, venues, and clients. It created a system where execution performance is constantly measured, compared, and scrutinized, driving a continuous cycle of analysis and improvement. Firms must now operate a sophisticated data infrastructure capable of ingesting venue data, combining it with their own internal order data, performing complex TCA, and generating these detailed public reports. This is the operational core of the MiFID II best execution regime.

Reflection

From Mandate to Mechanism

The evolution from MiFID I to MiFID II reframed best execution from a regulatory mandate into an operational mechanism. The true impact of the directive was not simply in changing the rules, but in altering the very flow of information within the market ecosystem. By mandating the public disclosure of execution quality data, MiFID II created a system of accountability that operates continuously and transparently.

It forces a perpetual dialogue, grounded in quantitative evidence, between a firm and its clients about the quality of service delivered. Considering this new reality, the essential question for any investment firm is no longer “Are we compliant?” but rather “Is our execution data telling the story we want it to tell?” The answer to that question reveals the true quality of the firm’s operational framework and its ultimate commitment to the principle of acting in its clients’ best interests.