Concept
The Markets in Financial Instruments Directive II (MiFID II) fundamentally redefines the principle of best execution, elevating it from a procedural obligation to a core tenet of a firm’s fiduciary duty. It mandates a demonstrably effective governance framework designed to ensure that investment firms consistently secure the “best possible result” for their clients. This directive moves the industry beyond the antecedent “all reasonable steps” standard of its predecessor to a more stringent and empirical requirement of “all sufficient steps”. The implication of this semantic shift is profound, demanding a systematic and evidence-based approach to order handling that permeates a firm’s operational structure, from its governance bodies to its execution desks.
At the heart of this framework is a multi-dimensional definition of execution quality. The “best possible result” is a composite outcome, assessed against a range of competing execution factors. These factors include not only the explicit costs, such as price and transaction fees, but also implicit costs and qualitative elements.
Speed of execution, the likelihood of successful execution and settlement, the size and nature of the order, and any other pertinent considerations must be weighed. This holistic view requires firms to develop a sophisticated decision-making matrix, one that is adaptable to the specific needs of the client and the prevailing market conditions for a given financial instrument.
The governance structure under MiFID II compels firms to create and maintain a transparent, data-driven, and continuously optimized system for executing client orders.
The directive compels firms to establish a formal and comprehensive Order Execution Policy. This document is the foundational pillar of the governance process, articulating the firm’s approach to achieving best execution for its clients. It must be a clear, detailed, and accessible explanation of how client orders are handled, including the specific execution venues and the rationale for their selection for each class of financial instrument. The requirement to obtain prior client consent to this policy transforms it from a mere disclosure document into a binding agreement, establishing a clear line of accountability and transparency between the firm and its clients.
Strategy
A compliant strategy for MiFID II best execution governance hinges on the creation of a dynamic and self-correcting operational loop. This system is built upon three strategic pillars ▴ a comprehensive policy framework, a rigorous venue selection and review process, and a nuanced application of the execution factors tailored to client and order types. The objective is to construct a system that not only complies with the letter of the regulation but also embeds a culture of continuous improvement in execution quality.
The Order Execution Policy a Foundational Document
The Order Execution Policy is the central strategic document that governs a firm’s execution practices. Its development and implementation are a primary responsibility of the firm’s management body. The policy must be meticulously detailed and leave no ambiguity about how execution decisions are made.
For each class of financial instrument, the policy must identify the specific execution venues the firm relies on and explain the factors that guide the choice of venue. This requires a granular approach, recognizing that the optimal execution strategy for a large-cap equity will differ significantly from that for an OTC derivative.
The policy must also clearly articulate the relative importance of the execution factors. For instance, for retail clients, the total consideration, representing the price of the financial instrument and the costs related to execution, is generally the most important factor. For institutional clients executing large orders, the likelihood of execution and minimizing market impact might take precedence over speed or even marginal price differences. This strategic calibration must be documented within the policy and consistently applied.
Venue Selection a Continuous Analytical Process
MiFID II requires that firms’ execution policies include venues that enable them to obtain the best possible result on a consistent basis. This necessitates a strategic and ongoing assessment of all potential execution venues. Firms cannot simply rely on historical relationships or convenience. They must perform due diligence and monitor the execution quality offered by various venues, including regulated markets, multilateral trading facilities (MTFs), organised trading facilities (OTFs), systematic internalisers (SIs), and third-country venues.
The selection process involves a multi-faceted analysis of each venue’s capabilities. The following table outlines some of the key criteria that a firm’s strategic venue selection process should incorporate:
| Assessment Criterion | Strategic Consideration |
|---|---|
| Liquidity Profile | Analysis of available liquidity for specific instruments and order sizes, including depth of order book and potential for market impact. |
| Cost Structure | Evaluation of explicit costs, including execution fees, clearing and settlement charges, and any applicable taxes. |
| Execution Quality Data | Systematic review of the venue’s public execution quality reports (e.g. RTS 27 reports) to assess metrics like speed and likelihood of execution. |
| Clearing and Settlement | Assessment of the efficiency and reliability of the venue’s clearing and settlement arrangements to minimize settlement risk. |
| Technological Resilience | Evaluation of the venue’s system uptime, latency characteristics, and resilience to market volatility. |
The Interplay of Execution Factors
The strategic core of best execution is the intelligent balancing of the execution factors. A firm’s governance framework must empower its traders to make these nuanced judgments while providing a clear structure for accountability. The relative importance of each factor is not static; it shifts based on the client’s categorization, the client’s specific instructions, the characteristics of the financial instrument, and the characteristics of the execution venues.
Effective best execution strategy involves a dynamic weighting of multiple factors to align with specific client needs and order characteristics.
The following list details the primary execution factors and their strategic application:
- Price ▴ The price at which the transaction is executed. For many scenarios, particularly for retail clients, this is a dominant factor.
- Costs ▴ All expenses incurred by the client that are directly related to the execution of the order, including execution venue fees, clearing and settlement fees, and any other fees paid to third parties.
- Speed ▴ The elapsed time from order receipt to execution. High speed can be critical in fast-moving markets but may be less important for limit orders.
- Likelihood of Execution and Settlement ▴ The probability that the trade will be successfully executed and settled. This is paramount for illiquid instruments or large orders where certainty of execution is a primary goal.
- Size and Nature of the Order ▴ The specific characteristics of the order, such as its size relative to average daily volume, can influence the choice of execution method (e.g. using an algorithmic trade or a block trading facility) to minimize market impact.
Execution
The execution of a MiFID II-compliant best execution governance framework translates strategy into a set of robust, repeatable, and auditable operational processes. This involves the continuous monitoring of execution quality, transparent public reporting on execution practices, and a closed-loop governance process for review and remediation. These operational mechanics are data-intensive and require a significant commitment to technology and quantitative analysis.
The Monitoring Mandate from Data to Action
Firms are required to monitor the effectiveness of their order execution arrangements and policy on an ongoing basis. This is an active, not passive, requirement. It involves systematically collecting and analyzing execution data to determine whether the outcomes achieved are consistent with the firm’s policy and whether the selected venues continue to provide the best possible results. This process must be able to detect and identify any deficiencies in the firm’s execution performance.
The monitoring process typically involves comparing the firm’s execution results against relevant benchmarks. This can include:
- Internal Benchmarks ▴ Comparing execution quality across the different venues the firm uses.
- External Benchmarks ▴ Using consolidated market data to compare the execution price against the prevailing market price at the time of execution.
- Third-Party Analysis ▴ Employing Transaction Cost Analysis (TCA) providers to perform detailed, independent assessments of execution performance against a variety of metrics.
This quantitative analysis allows the firm to objectively assess its performance and demonstrate to regulators that it is taking sufficient steps to achieve best execution.
RTS 28 the Public Disclosure Requirement
A cornerstone of the MiFID II best execution framework is the annual publication of a report, under Regulatory Technical Standard 28 (RTS 28), detailing the top five execution venues used for each class of financial instrument. This report provides transparency to clients and the public about where their orders are being executed. For each of the top five venues, the firm must report the volume of client orders and the percentage of orders executed on that venue. It must also provide a summary of the analysis and conclusions from its detailed monitoring of execution quality.
The following table provides a simplified example of what a portion of an RTS 28 report might look like for a specific class of financial instruments:
| Execution Venue | Proportion of Volume | Proportion of Orders | Percentage of Passive Orders | Percentage of Aggressive Orders |
|---|---|---|---|---|
| Venue A (Regulated Market) | 45% | 35% | 60% | 40% |
| Venue B (MTF) | 25% | 30% | 55% | 45% |
| SG Systematic Internaliser | 15% | 20% | N/A | N/A |
| Venue C (MTF) | 10% | 10% | 50% | 50% |
| Broker D | 5% | 5% | N/A | N/A |
Public reporting under RTS 28 creates an empirical basis for clients to evaluate a firm’s execution practices and holds the firm accountable for its strategic choices.
The Governance Loop Review, Challenge, and Rectification
The data generated from monitoring and reporting is not an end in itself. It is an input into a formal governance process. The management body of the firm has ultimate responsibility for the best execution policy.
This body, or a designated committee, must review the monitoring reports at least annually. This review should assess whether the firm’s execution arrangements are delivering the best possible results for clients or if changes are needed.
An essential part of this process is an independent challenge. The individuals responsible for day-to-day execution should not be the only ones assessing their own performance. The compliance function, risk management, or an internal audit function should provide a critical review of the results, questioning the assumptions and conclusions of the monitoring reports. If this review process identifies any deficiencies ▴ for example, a particular venue is consistently providing poor execution quality, or a specific trading algorithm is underperforming ▴ the firm must take prompt and appropriate remedial action.
This could involve changing the execution policy, removing a venue from the approved list, or recalibrating a trading algorithm. Crucially, this entire process ▴ the review, the challenge, and the corrective actions taken ▴ must be documented to create a complete audit trail for regulatory scrutiny.
References
- European Securities and Markets Authority. “Final Report on the Technical Standards specifying the criteria for establishing and assessing the effectiveness of investment firms’ order execution policies.” ESMA, 2024.
- HSBC Private Bank. “MiFID II ▴ Best Execution.” 2018.
- Planet Compliance. “In a nutshell ▴ Best Execution under MiFID II/MiFIR.” 2024.
- Société Générale. “Best Execution and Client Order Handling Policy for Professional and Retail Clients.” 2022.
- Association Française des Marchés Financiers. “Consultation paper on draft RTS on the content and format of order execution policy.” AMAFI, 2024.
Reflection
From Mandate to Mechanism
The intricate web of governance requirements under MiFID II transforms the concept of best execution from a passive compliance duty into an active, data-driven discipline. The regulation compels firms to construct a perpetual motion machine of analysis, execution, monitoring, and refinement. The true test of a firm’s commitment lies not in the elegance of its written policy, but in the robustness of its monitoring systems and the integrity of its review and remediation loop. The framework demands a cultural shift, where execution quality is viewed as a quantifiable and optimizable metric, central to the firm’s value proposition.
It challenges firms to look beyond their established practices and continuously question whether their execution architecture is truly engineered to deliver the best possible outcome for every client, on every trade. The ultimate measure of success is a system that is not only compliant by design but also superior in its performance.
Glossary
Governance Framework
Sufficient Steps
Execution Quality
Execution Factors
Financial Instrument
Order Execution Policy
Execution Venues
Best Execution Governance
Venue Selection
Execution Policy
Mifid Ii
Best Execution
Clearing and Settlement
Order Execution
Transaction Cost Analysis
