What Are the Primary Differences between MiFID I and MiFID II Best Execution Standards?

Concept

From a Mandate of Process to a Mandate of Proof

The transition from the Markets in Financial Instruments Directive (MiFID I) to its successor, MiFID II, represents a fundamental re-architecting of the principles governing best execution. This was a shift in regulatory philosophy, moving from a framework that emphasized the establishment of appropriate processes to one that demands demonstrable, data-driven proof of outcomes. MiFID I required firms to take “all reasonable steps” to obtain the best possible result for their clients.

This was a principles-based obligation, focused on ensuring a firm had a coherent and sensible execution policy in place. The systemic objective was to promote competition between venues and establish a baseline for investor protection.

MiFID II elevated this standard significantly by mandating that firms take “all sufficient steps” to achieve the best outcome. This change in language, from “reasonable” to “sufficient,” is the semantic core of the entire reform. It reframes the obligation from one of intent and process to one of empirical validation. A firm’s execution architecture could no longer simply be well-designed in theory; it had to be proven effective in practice.

This necessitated a profound change in how firms approached data capture, analysis, and the governance of their trading operations. The new framework demands a systematic and quantifiable defense of execution choices, transforming best execution from a compliance function into a core operational discipline.

The Expanded Definition of Execution Quality

Concurrent with the heightened evidentiary burden, MiFID II broadened the very definition of what constitutes the “best possible result.” While MiFID I identified key execution factors ▴ price, costs, speed, and likelihood of execution ▴ it allowed firms considerable latitude in how they prioritized these elements. For retail clients, there was a clear emphasis on the “total consideration,” which combines the price of the instrument and all associated execution costs.

MiFID II formalized and expanded this multi-faceted view for all client types. It explicitly codified that the “best possible result” must be determined by taking into account a comprehensive set of factors ▴ price, costs, speed, likelihood of execution and settlement, size, nature of the order, and any other relevant consideration. This created a more complex analytical challenge. A firm’s execution strategy now had to be calibrated based on the specific characteristics of the client, the order itself, the instrument being traded, and the available execution venues.

For instance, for an illiquid, over-the-counter (OTC) derivative, the likelihood of execution and settlement might be a far more critical factor than marginal price improvement, a nuance that the MiFID II framework explicitly requires firms to consider and document. This expansion effectively rendered a simple, price-centric view of best execution obsolete, demanding a more sophisticated, context-aware analytical capability within a firm’s trading infrastructure.

MiFID II fundamentally shifted the best execution obligation from demonstrating reasonable effort to providing sufficient, data-driven evidence of achieving the best possible client outcome.

A Wider Operational Domain

A critical architectural change introduced by MiFID II was the significant expansion of the scope of financial instruments subject to its rigorous standards. MiFID I’s best execution principles were primarily focused on equities traded on regulated markets. While other asset classes were technically included, the lack of price transparency and available market data in non-equity markets made it difficult to apply the standards in a meaningful way.

MiFID II directly addressed this limitation by extending its framework to cover a much broader array of instruments, including bonds, structured finance products, derivatives, and emission allowances. This extension was a direct response to the increasing complexity of financial markets and the need to provide consistent investor protection across all asset classes. Operationally, this presented a substantial challenge. Firms could no longer confine their best execution monitoring systems to the equities domain.

They were now required to develop and implement a robust framework for capturing and analyzing execution data for instruments traded OTC, where liquidity is often fragmented and pre-trade price discovery is less straightforward. This necessitated new data sourcing strategies, analytical models for comparing disparate quotes, and a more holistic view of execution quality that could function across the entire spectrum of a firm’s trading activity.

Strategy

Decoupling Research from Execution

One of the most profound strategic shifts mandated by MiFID II was the unbundling of payments for research from execution commissions. Under the previous regime, it was common practice for asset managers to receive research services from brokers as part of a bundled commission payment for executing trades. This created a potential conflict of interest, where execution decisions could be influenced by the desire to access valuable research rather than the sole objective of achieving the best outcome for the client.

MiFID II sought to dismantle this arrangement by requiring firms to pay for research and execution services separately. This forced a complete strategic reassessment of how firms source, value, and pay for investment research.

From a systems perspective, this required a fundamental re-engineering of internal cost allocation and vendor management processes. Firms had to establish clear budgets for research, distinct from their trading commissions. They needed to implement mechanisms to assess the quality and value of the research they consumed, creating a more disciplined and accountable procurement process.

This regulatory intervention had a direct and lasting impact on the market for investment research, leading to more transparent pricing and forcing firms to make explicit strategic decisions about what information was essential to their investment process. The result was a clearer, more defensible link between the costs incurred and the services received, reinforcing the core MiFID II principle of acting in the client’s best interest.

The Evolution of the Execution Policy

MiFID II transformed the order execution policy from a static, high-level compliance document into a dynamic and detailed strategic disclosure. Under MiFID I, the requirement was to establish a policy and make it available to clients. MiFID II elevated this, demanding that the policy be customized for each class of financial instrument and provide clients with clear, detailed, and easily understandable information about how their orders would be executed.

This strategic shift required firms to move beyond generic statements and articulate the specific methodologies used to achieve best execution for different asset types. For example, the policy for executing liquid equities on a continuous auction order book would look very different from the policy for sourcing liquidity for an illiquid corporate bond via competing quotes. The policy had to name the specific execution venues the firm relied upon and explain the factors that guided the choice of venue for a given order. This level of detail serves two strategic purposes ▴ it provides clients with unprecedented transparency into the firm’s execution practices, and it forces the firm itself to codify and justify its strategic choices, creating a stronger internal governance framework.

The mandate to unbundle research payments and create detailed, instrument-specific execution policies forced firms to adopt a more transparent and deliberate strategic posture.

The following table illustrates the strategic evolution of the best execution framework from MiFID I to MiFID II, highlighting the systemic changes firms were required to implement.

Enhanced Governance and Monitoring

A cornerstone of the MiFID II strategy is the requirement for firms to establish a more robust and continuous system of monitoring and governance. It was no longer sufficient to simply have a policy; firms had to demonstrate that they were actively monitoring the effectiveness of their execution arrangements and policies to identify and remedy any deficiencies. This involves both ex-ante and ex-post analysis.

This continuous oversight loop represents a significant strategic undertaking. It requires the integration of data feeds, analytical tools, and a formal governance process capable of reviewing the outputs and enacting change. The strategic objective is to create a self-correcting system where execution quality is constantly measured, evaluated against benchmarks, and optimized. This proactive stance on governance is a defining feature of the MiFID II era, embedding the discipline of best execution into the firm’s operational DNA.

• Ex-ante controls involve pre-trade checks to ensure that orders are being routed according to the firm’s execution policy. This could include checks on venue eligibility, algorithm selection, and cost estimates.
• Ex-post analysis involves a post-trade review of execution quality, typically through Transaction Cost Analysis (TCA). This analysis compares the execution achieved against various benchmarks to measure performance and identify areas for improvement.
• Formal governance requires the establishment of a committee or function with the responsibility and authority to review monitoring reports, challenge poor outcomes, and approve changes to the firm’s execution policy and arrangements.

Execution

The Operational Playbook for Public Transparency

The execution of MiFID II’s best execution mandate crystalized into a set of highly specific, data-intensive reporting requirements known as Regulatory Technical Standards (RTS). Two of these standards, RTS 27 and RTS 28, formed the operational bedrock of the new transparency regime, translating the directive’s principles into concrete data outputs. Although the requirement to produce these specific reports has since been suspended or deprioritized by regulators in both the UK and EU, understanding their architecture is essential to grasping the level of detail and operational capability that MiFID II originally envisioned.

RTS 27 was a report on execution quality published quarterly by the execution venues themselves (including stock exchanges, multilateral trading facilities, and systematic internalisers). Its purpose was to provide the public with standardized data to compare the quality of execution across different venues. RTS 28 was an annual report published by the investment firms executing client orders.

It required firms to disclose their top five execution venues for each class of financial instrument and provide a qualitative summary of the execution quality achieved. Together, these reports created a two-way flow of information designed to make the entire execution chain transparent and accountable.

The RTS 27 and RTS 28 reports operationalized MiFID II’s transparency goals, requiring a sophisticated data infrastructure to capture, format, and publish granular execution metrics.

Quantitative Modeling for Venue Reporting under RTS 27

The operational challenge of RTS 27 was immense, requiring venues to capture and publish a vast array of data points for each financial instrument they traded. The report was structured to provide granular detail on price, costs, and speed of execution. The data had to be published quarterly and made available to the public free of charge in a machine-readable format, facilitating large-scale analysis by market participants and data vendors. Constructing these reports required a robust data warehousing and processing infrastructure capable of handling massive volumes of tick-level data.

The table below provides a simplified, illustrative example of the kind of data a trading venue would have been required to publish under RTS 27 for a single, highly liquid equity. This demonstrates the level of granularity required, covering everything from average spreads to the number of orders executed at different price points relative to the prevailing market quote.

System Integration for Firm Reporting under RTS 28

While RTS 27 focused on venues, RTS 28 placed the reporting burden on investment firms, requiring them to provide a public accounting of their execution practices. This annual report had two primary components ▴ a quantitative disclosure of the top five execution venues used for each class of financial instruments, and a qualitative summary of how the firm had monitored and achieved best execution. This required a sophisticated integration of the firm’s Order Management System (OMS), Execution Management System (EMS), and its post-trade TCA systems.

The following steps outline the system integration and technological architecture required to produce an RTS 28 report:

1. Data Aggregation ▴ The system must first pull all client order and execution data for the preceding year from the firm’s OMS. This data includes the instrument traded, venue of execution, timestamp, volume, and client categorization.
2. Venue and Instrument Classification ▴ The raw data must be cleaned and categorized. All trades need to be classified according to the MiFID II instrument classes (e.g. Equities ▴ Tick Size Liquidity Band 5 & 6, Debt Instruments ▴ Bonds, etc.). Execution venues must be identified by their unique Market Identifier Code (MIC).
3. Volume Calculation ▴ The system then calculates the total trading volume for each instrument class and determines the percentage of that volume executed on each venue. This analysis identifies the top five venues for each class.
4. Qualitative Analysis Integration ▴ The quantitative data is then combined with the outputs of the firm’s TCA and monitoring program. This involves preparing a summary that explains how the firm’s venue and algorithm choices delivered high-quality results for clients, referencing the execution factors of price, cost, speed, and likelihood of execution.
5. Report Generation ▴ Finally, the system must generate the report in the prescribed format, including the detailed tables of the top five venues and the accompanying qualitative summary, ready for public disclosure.

This process demonstrates that MiFID II compliance was a significant technological undertaking, demanding a cohesive architecture that could connect front-office trading activity with back-office data analysis and reporting functions.

Reflection

Beyond Compliance a System of Intelligence

The architectural evolution from MiFID I to MiFID II provides a critical lesson in regulatory trajectory. The initial framework established a principle, while the successor demanded a system of proof. The extensive data capture, analysis, and reporting infrastructure built to satisfy the RTS 27 and RTS 28 requirements, while no longer mandatory in its original form, should not be dismantled.

Viewing this infrastructure as a sunk cost of compliance is a strategic error. Instead, it must be recognized as the foundational chassis for a modern execution intelligence system.

The capacity to systematically measure execution quality across multiple dimensions, venues, and asset classes is a powerful competitive asset. This data-driven framework allows a firm to move beyond simply meeting a regulatory standard and toward actively optimizing every aspect of its trading function. It provides the quantitative basis for refining algorithmic strategies, negotiating more effectively with liquidity providers, and demonstrating superior performance to clients in a clear and empirical manner. The questions that a firm’s leadership should now ask are not about how to reduce the cost of this infrastructure, but about how to leverage its full potential.

How can this data be used to predict liquidity, minimize information leakage, and ultimately generate superior risk-adjusted returns? The legacy of MiFID II is the recognition that in modern finance, the quality of your execution is a direct function of the quality of your data architecture.