Potential Exchange Competition and Best Execution in Mexico

Transcription

1 Potential Exchange Competition and Best Execution in Mexico A Practical Guide to Applying the European Union Regulatory Model, and How It Differs with Those of Other Major Jurisdictions Prepared for Bolsa Institucional de Valores (BIVA) March 21, 2016

2 Contents Section Page # Introduction and Background 3 Notes on Methodology and Scope 4 Executive Summary 7 Best Execution Regulations in the European Union 9 How Market Participants Achieve Best Execution 11 in the EU Changes Coming Under MiFID II 22 Comparison with Other Developed Markets 25 Conclusions and Recommendations 29 Appendix I: Relevant Excerpts from MiFID 30 Pertaining to Best Execution Appendix II: More Information About EU Brokers 33 Order- Execution Policies 2

3 Introduction and Background Central de Corretajes, SA de CV (CENCOR), a company providing brokerage, valuation and technology services in Latin American capital markets, in October 2015 asked the Mexican Ministry of Finance for permission to launch a new stock exchange in Mexico, called Bolsa Institucional de Valores. BIVA would be the first domestic challenger to Bolsa Mexicana de Valores (BMV), currently the country s only stock exchange. Pending regulatory approval, BIVA plans to launch in Q It will use Nasdaq s X- stream trading platform and SMARTS surveillance system. It also plans to offer trade settlement through Grupo BMV s Contraparte Central de Valores clearinghouse. Initially, BIVA will cross- list all BMV- listed company shares but also plains to provide new- listing services, aiming particularly to serve mid- cap companies. Moving from a single- exchange environment to one in which multiple exchanges compete with one another raises several structural, rulemaking and operational issues for the industry and its regulators. Perhaps most important of these is how trading- venue competition affects the concept of best execution for brokers filling customer orders. Specifically, with multiple venues comes the possibility that shares will be available at different prices on separate exchanges, and subject to varying fees, features and service levels that affect outcomes for both end investors and intermediaries. Competition among venues can lead to more- efficient markets that improve outcomes for end investors and listed companies. It also can lead to greater complexity and costs, particularly for intermediaries, and especially when best- execution regulations are highly prescriptive, as in the United States and Canada. Countries moving from monopoly to competitive environments need to ensure that they implement rules and policies that balance these two forces, keeping in mind the overall health of the market and the economy it serves. This is the task Mexican market regulators currently face. BIVA has engaged Rosenblatt Securities to analyze and report on how other major global markets handle the operation and regulation of competing exchanges and trading venues, with a particular emphasis on the best- execution regime in the European Union and how market participants comply with it. The bulk of this report offers a detailed description of the best- execution rules outlined in the EU s Markets in Financial Instruments Directive (MiFID), and provides accounts of how market participants have adapted to the rules. We also examine pending changes to the EU best- execution regime under revisions to MiFID, commonly known 3

4 as MiFID II, which are likely to come into force on January 3, For comparison and contrast, we also provide higher- level information on the rules, policies and procedures in place in other competitive jurisdictions, including the United States, Canada and Australia. Notes on Methodology and Scope To complete this report, we relied on a variety of data and other sources of information. These include public documents and records, such as legislation and related final and draft guidance adopted and provided by national and regional government entities. We also incorporated public disclosures from stock exchanges, multilateral trading facilities and other alternative venues regarding the various fees they charge to members and subscribers. Additionally, we made use of public and proprietary data to help demonstrate and compare the size of various markets across the globe. To supplement this information, we spoke with a range of market participants in Europe. These conversations included telephone and face- to- face meetings with brokers, investment management firms and trading venues. The discussions allowed us to ensure our interpretation of the intent of various regulations was accurate and to give us a deeper understanding of their practical application. These discussions also gave us a richer appreciation of the effects that various best- execution and market- data policies can have on market participants. We also relied on our own knowledge of market practices, gleaned from operating as a broker and member of multiple exchanges and ATSs in the United States, and from longstanding contacts with market participants globally. Our mandate for this project, as defined by BIVA, was to detail the best- execution regime in the European Union, provide details on how European market participants comply with those rules and provide some higher- level information, for comparison s sake, about other jurisdictions that have competing exchanges. We specifically are not weighing in on whether competition among exchanges is beneficial for national economies, investors or issuers. There is substantial evidence, however, from jurisdictions such as the US and the EU, that a multiple- marketplace environment encourages efficiencies that can boost market volumes and result in lower costs for end investors. One such example is the growth of trading volume in NYSE- listed securities following the implementation of Regulation NMS in the US in Alternative trading systems had already been competing vigorously with Nasdaq s fledgling electronic order book and its upstairs dealer community for 4

5 several years following the passage Regulation ATS in Several of these alternative platforms, such as the Island and Archipelago ECNs, charged lower fees and routinely quoted narrower spreads than the Nasdaq order book and dealers, respectively, creating arbitrage opportunities and cost savings that, combined with the reduction of the US market s minimum tick from 12.5 cents to one cent in 2001, helped boost trading volume. In 2004 and 2005, the earliest years for which we were able to source full data, Tape C (Nasdaq- listed) securities, traded more actively, both in terms of share volume and value traded, than did their Tape A (NYSE- listed) counterparts. But following the implementation in 2007 of Regulation NMS, which mandated the same multi- marketplace competition for NYSE- listed stocks, NYSE- listed trading activity grew to eclipse that of the Nasdaq- listed universe and has remained a far more- actively traded segment of the market ever since (see Figure 1, below). The onset of the financial crisis in 2007 and 2008 skew these figures somewhat, with surging volatility and plummeting stock prices temporarily inflating share volume. But comparing trading activity from with the period that followed the worst of the crisis, it s clear that average daily value traded for Nasdaq stocks has been flat while turnover in NYSE- listed shares has increased substantially. Figure 1: Growth of NYSE- Listed Market Following Regulation NMS $18 Average Daily Value Traded, US Equities $16 $14 $12 Billions $10 $8 $6 $4 $2 $ Source: Arcavision Tape A (NYSE) Tape C (Nasdaq) Tape B (NYSE Arca/Regionals) 5

6 All- in transaction costs for end investors also are far lower today in the US than before market structure transformed in ways that encouraged competition with the NYSE floor and Nasdaq dealers. Many market- structure experts attribute this to a reduction of explicit costs, including exchange fees and spreads, as well as greater efficiency that may reduce implicit costs like market impact. Implementation costs for institutional investors in the current environment are far lower than before US market structure began transforming in 1996, even at similar or higher volatility levels (as measured by the average daily closing value of the CBOE s VIX index) than observed before that transformation (see Figure 2, below). Figure 2: All- In Transaction Costs for Institutional Investors in US Equities, vs. Volatility Total Cost (bps) VIX (rt axis) Sources: Abel Noser Corp., CBOE Competition also can help drive down incumbent exchanges fees, which may give brokers more leeway to reduce commission rates without compromising their profits. In the US, for example, alternative trading systems attracted market away from Nasdaq in the late 1990s and early 2000s, in part because of their dramatically lower net fees. Later, in the mid- 2000s, after this first wave of ATSs merged with one another and the two major survivors were acquired by 6

7 NYSE and Nasdaq, the BATS and Direct Edge ATSs emerged as new competitors that took market share by undercutting the incumbents on fees. This forced Nasdaq and NYSE to slash their own rates to remain relevant. A similar scenario played out in Europe following the imposition of MiFID in 2007, with multilateral trading facilities including Chi- X Europe and Turquoise offering far cheaper tariffs than Europe s national exchanges. By September 2008, for example, Chi- X Europe and Turquoise had taken 23% of the trading in FTSE 100 issues from the London Stock Exchange, which responded by reducing its net trading fees. One year later the LSE adopted a volume- discount model that favored its biggest customers. Other incumbent exchanges including Euronext and Deutsche Börse also lowered trading fees in the wake of MiFID, as they lost market share to the likes of Chi- X Europe and Turquoise. Executive Summary As we mentioned in the Introduction and Background section above, it is important for regulators to consider how to achieve the appropriate balance between best- execution rules that encourage competition and efficiency but also do not impose excessive costs and complexity on market participants. When brokers can choose between multiple exchanges for buying and selling the same securities, the venues they select can play a critical role in whether clients receive the best possible outcomes. Multiple factors must be taken into consideration here. The prices quoted on each exchange are extremely important, but so are the fees brokers must pay for connecting to exchange matching engines, consuming their market data, executing, clearing and settling transactions. Rules that impose a strict, best- quoted- price test or routing obligation such as those in place in Canada and the United States, where brokers generally cannot trade at prices inferior to the best advertised bids or offers tend to encourage complexity and fragmentation, and impose higher absolute costs on intermediaries. A principles- based approach such as that adopted by the European Union can give brokers flexibility to consider not just the best quoted prices across all market centers, but also the costs of connecting to and routinely transacting on multiple venues, and tends to result in less fragmentation and complexity, as well as lower absolute costs for intermediaries. Hybrid systems like Australia s, in which retail orders are subject to a best- price- based rule but an EU- style, principles- based system governs institutional trading, can attempt to balance these two extremes. 7

8 Considering the strong linkage between the prescriptiveness of best- execution regulations and the level of complexity, fragmentation and intermediary costs, it is important to consider a market s size when determining which best- execution regime may be most appropriate. For bigger markets such as the United States and Europe, a more- prescriptive approach may work because the level of trading and the size of the participants may be large enough to justify the added complexity and cost of strict best- execution rules. In smaller markets, however, turnover and participant size may be too small to warrant a prescriptive regime that leads to high intermediary costs and greater structural complexity. In the EU, legislators and regulators have settled on a principles- based best- execution regime. Brokers are not required to obtain the best quoted prices for customers or route orders to the exchanges displaying the best bids or offers. Instead, brokers are free to establish best- execution policies that can consider a number of factors, including the costs associated with connecting to multiple venues. As a result, brokers have flexibility to adopt a wide array of approaches to achieving best execution. Some big banks and agency brokers particularly those that have significant operations in the US or Canadian equity markets connect to all major trading venues and deploy sophisticated technological systems to evaluate prices, fees and features across those market centers and automatically route customer orders accordingly. Smaller or more- regionally focused firms may simply execute all orders on the major listing market in their country. Others choose a middle ground, sometimes contracting with bigger firms or specialty vendors to handle collecting data from and routing to multiple markets. Mexico s equity market is less than 1/5 the size of Australia s, which is the smallest of the major national stock markets featuring exchange competition (see Table 1, page 9). Considering market size, as well as the dominant role institutional investors play there, we believe a principles- based approach is appropriate for Mexico. There are risks associated with such a liberal best- execution policy, however. Brokers may, for example, seek to minimize costs and fail to utilize exchanges that routinely offer the most- attractive prices for Mexican securities, thereby placing their own interests ahead of their customers. The free market may allow investors to penalize brokers that systematically achieve inferior outcomes by simply directing their business elsewhere. Rules requiring brokers to disclose routing and execution data could help investors make such decisions. Access to accurate, affordable consolidated market data and fungible post- trade services are also important in a principles- based regime. Accordingly, 8

9 Mexican regulators should weigh whether steps are necessary to encourage both of these outcomes. Table 1: Average Daily Value Traded in Mexico vs. Major Markets with Exchange Competition YEAR US EU Canada Australia Mexico 2008 $322,459 $106,550 $7,664 $4,193 $ $220,510 $66,181 $6,934 $3,119 $ $234,447 $78,361 $8,365 $4,190 $ $252,707 $90,798 $9,479 $4,229 $ $211,274 $69,531 $7,810 $9,704 $ $222,480 $70,689 $7,772 $4,784 $ $259,707 $81,641 $9,019 $4,439 $ $276,745 $86,265 $9,040 $4,331 $811 All figures in USD, millions Sources: Thomson Reuters, Fidessa, World Federation of Exchanges, Australian Securities Exchange, BMV Best Execution Regulations in the European Union Broadly speaking, EU rules require brokers to exercise their judgment to obtain the best possible result for clients. Firms can take into account the differing needs of clients for example, retail compared with institutional as well as both implicit and explicit transaction costs. Such a regime became necessary with the November 2007 implementation of the EU s Markets in Financial Instruments Directive (MiFID). This legislation abolished the so- called concentration rules that long had required trades to be executed on national stock exchanges, effectively granting markets like the London Stock Exchange, Deutsche Börse and Euronext monopolies on the trading of their own listed securities. MiFID ended this dynamic by allowing competitors to national stock exchanges, known as multilateral trading facilities (MTFs). Under Article 21 of MiFID 1, titled Obligation to execute orders on terms most favorable to the client, national regulators need to ensure that brokers take all reasonable steps to obtain the 1 See Appendix 1 for full text of MiFID Article 21 9

10 best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order. However, brokers can override these considerations if they receive specific instructions from a client. To ensure compliance with these principles, the legislation requires brokers to establish order- execution policies that are regularly monitored and reviewed annually. Each policy needs to include information on the venues a broker uses and the factors that affect when specific venues are chosen. If a broker does not use a stock exchange or multilateral trading facility to execute an order (i.e. executes a trade over- the- counter), it needs express consent from the client beforehand. Further details about how market participants can achieve the broad goal laid out in the legislation are provided in MiFID s level- two rules. Article 44 of the level- two rules 2 explains that the relative importance of the factors contributing to best execution (price, costs, speed, likelihood of execution and settlement, size, nature) should be based on whether a client is classed as retail or professional, the characteristics of a specific order, the characteristics of the instruments being traded and the features of the execution venue to which an order can be directed. Article 44 also defines the best possible result for retail orders as the total consideration, representing the price of the financial instrument and the costs related to execution, including clearing and settlement fees. Where there is a choice of execution venues, brokers own commissions and costs should also be taken into account. This system recognizes the costs accrued by brokers when transacting in a multi- venue environment and gives them flexibility in deciding how to achieve best execution. EU authorities built into the MiFID legislation a review process, which began in That process has resulted in substantial revisions to MiFID, set to take effect in January 2018, commonly known as MiFID II. Best- execution regulations won t change dramatically under MiFID II, but there will be significant new disclosure requirements that should help investors better scrutinize and understand broker conduct under the EU s flexible, principles- based approach. 2 See Appendix 1 for full text of MiFID Implementing Measures Article 44 10

11 How Market Participants Achieve Best Execution in the EU The first step for any broker seeking to comply with the EU best- execution regime is to develop an order- execution policy. As stated in the previous section, these policies must be regularly monitored and reviewed annually. They also must be shared with and approved by clients when opening accounts with the broker. Under MiFID, order- execution policies must show which exchanges and other trading venues a broker accesses when filling client orders, and explain the reasoning behind venue selection. The market participants we interviewed differ about whether MiFID obligates brokers to publicly disclose their policies. Some insist they must be publicized, and many firms do make them available on their websites. 3 Others, however, only share their policies privately with clients. The details of any particular broker s order- execution policy will vary based upon the firm s size and client profile. Small firms particularly those that deal primarily with retail investors or focus on just one or a small group of EU member states, for example, may find it sufficient to connect only to the national listing exchanges. These firms can cite MiFID best- execution criteria other than best price, such as cost and certainty of execution, to validate sole use of the incumbent exchange. Consider as an extreme example a firm whose clients primarily buy and sell small quantities of highly liquid German- listed shares, with long holding periods. Such a firm may judge that the cost of connecting to alternative venues outweighs the benefits it could deliver to clients by doing so. In that case, the firm could simply route all orders to the local listing market, Deutsche Börse, bypassing major Multilateral Trading Facilities, such as Bats Europe and Turquoise, that also match trades in German equities. Bigger firms, particularly those that deal primarily with institutional investors and serve clients across the entire EU region, often take a different approach. They may have the resources to bear the cost of connecting to, buying market data from and transacting regularly on multiple marketplaces. And their more- sophisticated clients may see significant benefits, in the form of improved performance, from consistently having large orders filled at the best advertised prices across a number of venues. Institutional clients also are likelier to be aware that alternatives exist to the national listing exchanges in various EU member states, and ask brokers for detailed explanations of how their orders are routed among those market centers. These larger brokers 3 See Appendix 2 for links to the order execution policies of a variety of brokers 11

12 can thus afford to place a heavier weight on accessing the best quoted prices and pay less attention to other factors such as cost and certainty of execution. The biggest global investment banks and agency brokers, for example, already comply with far more- prescriptive best- execution regimes in the United States and, in some cases, Canada. These jurisdictions prohibit trading at prices worse than the best displayed quotes. This strict order protection effectively requires all brokers to connect to and take market data from all quoting venues (for more on this, please see the Comparisons With Other Developed Markets section on page 23). Firms like these are able to apply to EU trading the systems they ve developed for monitoring prices and routing customer orders in price- protected markets, even though EU rules provide them with far more flexibility. Many of their institutional customers also trade in price- protected markets like the US and Canada, and therefore expect similar treatment when trading European stocks. An additional benefit for these big banks and brokers is that alternative venues tend to offer cheaper explicit execution fees than national listing markets. The Turquoise MTF, for example, was started by a consortium of nine investment banks 4 who committed to sending a portion of their proprietary trading activity to the venue to help build initial activity and foster fee competition with the London Stock Exchange, Deutsche Börse, Euronext and other incumbent exchanges, many of which subsequently reduced their own trading fees. Most big banks and brokers also maintain best- execution committees that examine new and existing venues and consider changes to market structure and regulation. These committees form part of brokers obligation to continually monitor and review their order- execution policies. For firms that judge connecting to alternative markets as prudent, monitoring these markets for the best prices and being able to quickly access those quotes becomes very important. To determine the best prices across competing venues, brokers need to receive pre- trade and post- trade market- data feeds from competing venues, so that they may effectively create a consolidated view of the market and determine the best bid and offer available on a pan- EU basis. This is often called the European best bid and offer (EBBO). Because there is no securities information processor providing consolidated market data in Europe (contrary to what exists in the US and Canada, for example), firms must pay for direct data from multiple sources. Then, 4 Turquoise was acquired by the London Stock Exchange in December

13 once a broker identifies where the best prices reside, it must be able to access those quotes, which requires order- entry connectivity to the various exchanges and alternative platforms. In Table 2 (below) we list costs for connecting to and receiving market data from major EU exchanges. For market data, we have provided the fees for so- called Level 2 data, which includes quotes on both sides of the market for the full depth of the order book. Having this data is useful for firms seeking to consider best price as foremost among the various factors they can take into account when routing customer orders. Table 2: Market- Data and Connectivity Fees on Major European Markets Exchange Level 2 Annual Data Fee Annual Connectivity Fee Bats Europe 44,741 44,674 5 London Stock Exchange 67,858 Variable Deutsche Börse 42,000 54,000 Euronext 43,800 Variable BME (Spain) 14,000 21,600 SIX Swiss Exchange 46,010 49,691 Nasdaq Nordic 36,000 Variable Sources: Bats Europe, London Stock Exchange, Deutsche Börse, Euronext, Bolsa Madrid, Six Swiss Group, Nasdaq Connectivity fees can vary widely, depending on the type of connection a broker requires and the exchange involved. These range from co- location housing a firm s trading servers in the same data center as the exchange matching engine, ensuring minimum roundtrip latency and maximizing certainty of execution to slower, indirect connections and managed- service packages. Many global investment banks and big agency brokers run their European equity trading businesses from London, where a number of key data centers are located. For example, the London Stock Exchange supplies technology to its Turquoise and Borsa Italiana subsidiaries as well as Oslo Børs, and lets firms to connect to all four markets from its London data center. Some markets only make their connectivity fees available under non- disclosure agreements that do not allow for making the fees public. For these reasons, it is difficult to arrive at accurate comparisons of connectivity fees. But for the purposes of compiling a table that gives Mexican 5 Includes access to BXE and CXE order books 13

14 market participants an idea of the costs that can be incurred by European brokers, we have selected, where available, the fastest, most robust connectivity options. It s important to note here that for stock- trading purposes the EU is not a single region as much as it is a collection of national markets, each with a dominant listing exchange, a small group of rival quoting markets and various dark or OTC venues. The London Stock Exchange, for example, faces competition for matching transactions in LSE- listed stocks from Bats Europe s two displayed markets (CXE and BXE), dark Multilateral Trading Facilities like UBS MTF and ITG s POSIT and an array of OTC venues. But other European listing markets, such as Deutsche Börse in Germany or the Euronext exchanges in France, the Netherlands, Belgium and Portugal, do not compete head- to- head with LSE, and vice- versa. Those other listing markets typically do also face competition from the same array of rival lit markets, dark MTFs and OTC venues. The Bats order books, for example, also operate in Germany, the Euronext markets, Spain and elsewhere in the EU, as does the LSE s Turquoise subsidiary. So although the biggest firms serving clients throughout the EU often feel compelled to connect to all the national exchanges and rival venues throughout the region, some smaller brokers may focus only on one or a small group of countries and don t need to absorb the full range of costs that would come with accessing all markets on a pan- EU basis. Once brokers obtain market data from, and set up order- entry connectivity to, a range of exchanges, they must be able to process this market data and intelligently route customer orders among multiple markets. This requires various technological systems that firms must either build, buy or rent from third parties, including feed handlers, risk- management and surveillance systems, as well as smart order routers and algorithms that govern order entry. Most firms also find themselves committing significant human resources to maintaining and operating these systems. Feed- handling systems process the various exchange market- data streams and provide pricing information to a firm s smart order router, or SOR, which often works hand- in- glove with execution algorithms that are programmed to direct trades among various markets showing the best price for a stock. The SOR and algorithms typically divide big institutional orders into many smaller pieces, and can take into account many factors when deciding among potential execution venues for these child orders. Often, more than one market is displaying the best bid or offer for a given security. Broker routers and algos typically are programmed to follow a 14

15 routing priority, which considers fees, fill rates and other features, when multiple markets are displaying the best price. For example, consider a situation in which Euronext Paris, Bats CXE and Turquoise are all showing the same number of shares offered at the best price for Total SA shares, and a broker is in the midst of executing a large buy order in Total for an institutional investor. The broker may program its router to consider the relative market shares of the three venues, as well as their fees and the router s recent experience when executing buy orders in Total SA, when deciding to which exchange it will send a child order first at that moment. It may also decide not to send the order to an exchange at all, but rather make use of dark MTFs that offer midpoint pricing or other off- exchange venues. Smaller firms that do not have the technical infrastructure or resources to pull in multiple market data feeds and build and maintain a smart order router may instead rely on a vendor- supplied router or offer their clients white- label access to algorithmic trading strategies developed by bulge- bracket brokers. Such white- labelling agreements are generally kept confidential. Many brokers, both large and small, will not connect to a market or obtain its pre- trade data until it has reached a certain level of market share. The specific amount of market share varies by broker, but typically sits between 2-5% of pan- European trading activity. The market- share cutoff is related to firms flexibility to consider factors other than best price specifically, certainty of execution when routing customer orders. For example, if a broker sends an order to a new venue with a low market share via its smart router, the order may not be filled and the broker may miss out on liquidity available at other markets. The decision to add a new market to a broker s routing logic is typically made during best- execution committee meetings. Consequently, it can be more difficult for upstarts to challenge incumbent listing exchanges in Europe than in markets, like the US and Canada, with stricter best- execution regulations. 6. In Europe, there are currently only three alternative markets (Bats Europe s BXE and CXE, and the London Stock Exchange s Turquoise) that have more than 5% pan- European market share. Figure 3 and Figure 4 (page 16) show the combined share of trading executed at multilateral 6 Europe, however, has many national stock exchanges, including the London Stock Exchange, Deutsche Börse, Euronext (comprising national markets in Paris, Amsterdam, Lisbon and Brussels), Borsa Italiana, Bolsas y Mercados Españolas, SIX Swiss Exchange, the Irish Stock Exchange, Nasdaq OMX Nordic Markets (Stockholm, Helsinki, Copenhagen), the Vienna Stock Exchange and Oslo Børs 15

16 trading facilities compared with domestic stock exchanges 7 and the market shares of the various venues. Figure 3: Exchange vs MTF Market Share 60 45% Billions % 35% 30% 25% 20% 15% 10% 5% % Exchange ADVT MTF ADVT MTF Market Share Sources: Thomson Reuters, Fidessa Figure 4: ADVT of MTFs Billions BATS Chi- X CXE Turquoise BATS Chi- X BXE OTHER Sources: Thomson Reuters, Fidessa 7 Bats Europe made the transition from a multilateral trading facility to an exchange in 2011 but is categorised as an MTF for the entirety of this chart 16

17 The most recent example of a new venue finding it difficult to gain critical mass in Europe is Aquis Exchange, which launched in November 2013 and offered a new subscription- based pricing model that differs from the maker- taker fee schedules that are popular among alternative markets. However, Aquis has so far failed to reach the initial threshold that would lead brokers to add it to their smart order routers and its market share has stayed at sub- 1% since its launch (see Figure 5 below). Figure 5: Aquis Average Daily Value Traded (ADVT) and Market Share Millions % 0.70% 0.60% 0.50% 0.40% 0.30% 0.20% 0.10% % Aquis ADVT Aquis Market Share Source: Fidessa The fragmented nature of clearing and settlement in Europe also influences best- execution compliance. This disjointed post- trade structure stems in large part from the pre- EU legacy of separate national stock markets that did not cross- list each others shares, each supported by unique, sometimes vertically integrated, post- trade platforms. This landscape became more complex with the launch, following MiFID, of Chi- X Europe and Turquoise and the creation of new clearinghouses the European Multilateral Clearing Facility (EMCF) and EuroCCP, 8 respectively to support them. Before MiFID, each stock could only be cleared at a single central counterparty such as LCH.Clearnet (for the London Stock Exchange) or Eurex Clearing (for Deutsche Börse). The introduction of EMCF and EuroCCP required brokers to hold margin for trades in the same stock at different clearinghouses, which raised costs for both large and small brokers. Under the MiFID best- execution principles, higher clearing and settlement costs can be used as a justification for not connecting to a new market. Small and medium- sized firms have been more 8 EMCF and EuroCCP merged in December 2013, retaining the EuroCCP brand 17

18 likely to cite this reason for not connecting to alternative venues. Big investment banks, on the other hand, often had equity stakes in upstart MTFs and stood to benefit from their growth. They also were better positioned than smaller firms to spread the cost of separate margin deposits across their larger- scale operations. In recent years, the industry has worked toward ameliorating this situation by implementing so- called clearing interoperability arrangements, which foster multilateral relationships between exchanges and clearinghouses. Interoperability pacts allow brokers to direct all trades to the CCP of their choice, regardless of on which venue the trades are executed. As a result, brokers can net clients buy and sell trades in each stock, across multiple venues. This lets them reduce the total margin they pay to clearinghouses. It also encourages competition on fees and service between central counterparties, in much the same way that MiFID s repeal of concentration rules triggered competition among trading venues that cut fees and improved service. Institutional investors also play an important role in the best- execution process in Europe. Because most brokers express their order- execution policies in mostly generic terms, investors often request supplementary information. This can include qualitative information about order- handling practices, such as how internal crossing networks and execution algorithms function, as well as trading data. Some investors assess execution quality using transaction cost analysis (TCA) tools that measure trade performance against pre- determined benchmarks such as volume- weighted average price or implementation shortfall (also known as slippage against the arrival price of an order). Investors can use this data to question brokers about trades with outcomes outside the norm, such as those executed at prices far away from the prevailing EBBO. Buy- side firms often will combine broker- supplied TCA with analysis from third- party, independent providers to ensure they have an objective view of trade performance. TCA data supplied by top- tier brokers includes metrics such as: Percentage of flow crossed internally and in dark pools Proportion of flow sent to different venues Spread capture Performance versus arrival price Percentage of volume and price movements while an order is in the market. 18

19 Several of the institutional investors we interviewed for this report noted that brokers rarely deliver TCA results that show poor performance. Consequently, some buy- side firms attempt to take the analysis further, by comparing their executions with consolidated post- trade data. But the lack of a consolidated post- trade reporting system in Europe means these investors either have to build their own at great cost (similar to the way bigger executing brokers do, as described earlier in this section) or rely on brokers or data vendors like Bloomberg or Thomson Reuters to create one for them. MiFID envisaged an industry- led solution to a European consolidated tape, but these efforts have failed because of the commercial interests of the different market participants involved. The exchange data fees cited earlier in this section are often seen as an impediment to creating an affordable consolidated tape. Exchanges garner substantial revenues from equity- market data and are reluctant to reduce fees in the interest of fostering a consolidated tape. MiFID II attempts to solve this issue (see Changes Coming Under MiFID II section, page 22). Another method for using data to assess best execution involves investors asking brokers for a more- limited data set, potentially including the total number of shares routed to and executed on each venue accessed by a broker on that client s behalf during a given time period, such as one calendar quarter or year. Sometimes this data can also include basic execution- quality metrics, such as the number of shares executed at or near the near side, midpoint and far side of the EBBO. Investors, sometimes working with third parties that have market- structure expertise, can use this data to measure fill rates and price improvement on a venue- by- venue basis. Such analysis can reveal questionable patterns of behavior, such as brokers prioritizing their own execution venues, despite low fill rates and price improvement, over bigger exchanges that have more liquidity. To address qualitative questions, some buy- side firms conduct regular face- to- face meetings with brokers to ask deeper questions about their execution policies. These meetings can cover a range of topics, including: The decision process for connecting to new trading venues How venue priority is determined when multiple markets are displaying the best prices Who in the firm sits on the best- execution committee and the substance of its meetings The structure, rules and operating procedures of any execution venues (such as dark MTFs or broker crossing networks) the brokers own and operate 19

20 Potential conflicts of interest, such as venue ownership and proprietary trading, and how they are managed Another form of qualitative engagement is the use of questionnaires sent by buy- side firms to their brokers asking for specific, detailed answers on aspects related to execution. These could include, for example, questions on the technology used to access markets, internal controls for protecting confidential client information, onward routing practices, ability for the broker to match client orders against proprietary flow, as well as clearing and settlement practices. These questionnaires have become more common as market- structure issues have gained increasing attention and come under the regulatory spotlight. For example, fines given to various broker- owned dark trading venues in the US, which also have EU operations including UBS 9, Barclays, Credit Suisse 10 and ITG 11 have led European investors to reinforce their understanding of broker practices. However, the quality of broker responses to questionnaires varies, and follow- up discussions are often required to clarify vague answers. Some institutional investors also are starting to take more initiative and push their brokers to connect to markets that they believe would improve execution quality. As a result of these commercial pressures, some brokers may connect to smaller venues and offer them to clients on an opt- in basis, rather than as an automatic destination included in smart- order- routing logic. Some of the brokers with whom we spoke for this report are taking this approach with Aquis Exchange, for example. The additional work that buy- side firms must undertake to understand order execution policies has led various regulatory bodies to conclude that brokers are not adequately fulfilling their best- execution obligations under MiFID. The UK s Financial Conduct Authority (FCA), the European Securities and Markets Authority (ESMA) and the European Commission all have acknowledged failings in the implementation of the best- execution rules. The FCA in July conducted a thematic review of best- execution practices, which identified a significant risk that best execution is not being delivered to all clients on a consistent basis. Many of the firms the FCA visited appeared to rely on the assumption that buy- side clients would switch to a competing broker if they were dissatisfied with execution quality. The FCA detailed examples of poor broker practices in its review. These included: 9 Link to SEC release on UBS charges: 10 Link to SEC release on Barclays and Credit Suisse charges: 11 Link to SEC release on ITG charges: 12 Link to FCA thematic review: Best execution and payment for order flow : fca/documents/thematic- reviews/tr

21 Brokers being unable to demonstrate that front- office staff understood the scope of best execution Inadequate order- execution policies Failure to indicate the relative importance attached to the factors contributing to best execution Excluding algorithmic trading from best- execution compliance. The FCA s report on this review used strong language to summarize its conclusions: Our findings not only highlight that a failure to obtain best execution on a consistent basis presents a risk of detriment to individual clients, but that it also presents risks to trust and confidence in the integrity of our markets as well as potentially undermining competition between trading venues. ESMA, a pan- European regulatory agency, undertook a peer review 13 among national regulators to assess how the best- execution rules were being enforced across Europe. It found that the majority of authorities still consider the execution of trades on a single market (typically the national stock exchange of each country) as a good proxy for the assessment of best execution and that best execution of orders invariably seems to be interpreted in terms of best price and not with regard to the analysis of the other execution factors, even in markets for which there is a certain level of dispersion and where several execution venues exist. The ESMA review attributed these failings in part to the lack of a consolidated tape that would offer buy- side firms an easily available source of information they could use to determine prices across various execution venues. It added that the number of complaints related to best execution is low, which it attributed to a poor understanding of execution quality among investors as well as a certain opacity of best- execution practices. ESMA said that MiFID II may solve some of the shortcomings it identified. But it also recommended that national regulators be more proactive in their supervision of best execution, by assessing the adequacy of resources devoted to best- execution compliance, ensuring there is clear guidance on how best execution should be monitored and creating a deterrent against future breaches by considering high financial penalties for firms that break the rules. 13 Link to ESMA peer review report: Best execution under MiFID : 21

22 The brokers we interviewed for this report told us they expect greater scrutiny of how they define, monitor and deliver best execution as a result of the ESMA and FCA reviews. Indeed, many brokers have used the FCA review as the impetus to begin improving their best- execution practices ahead of the introduction of MiFID II. Changes Coming Under MiFID II MiFID II, which is likely to be introduced in January , largely retains the principles- based approach laid out in the first version of the directive, but includes some important changes that reflect the evolution of the trading environment in Europe and regulators desire to make markets more transparent. The revised legislation includes the rationale behind the enhancements being made to best execution rules in recitals (notes that accompany the rules). Recital 97, for example, states: Information provided by investment firms to clients in relation to their execution policy often are generic and standard and do not allow clients to understand how an order will be executed and to verify firms compliance with their obligation to execute orders on term most favourable to their clients. One notable change under the revised legislation is a subtle adjustment to the wording of brokers core best- execution obligation. MiFID II states that (emphasis added) Member States shall require that investment firms take all sufficient steps to obtain, when executing orders, the best possible result for their client. The original MiFID used all reasonable steps instead. Many market participants view the use of sufficient in MiFID II as a statement of intent that EU regulators are seeking stricter enforcement of best execution. To improve investor protection and help clients understand execution policies, MiFID II also proposes bolstering the best- execution rules by requiring brokers and trading venues to publish data pertaining to execution quality. The specific data brokers will need to publish haven t been determined yet, as the technical rules that underpin the core MiFID II legislation have yet to be finalized. But based on drafts we have reviewed, it appears that trading venues will bear the brunt of these rules and need to publish data including: Number and average duration of any outages, as well as the reasons they occurred Number of failed transactions 14 At the time of writing, the European Commission was in the process of extending the start date for MiFID II from January 2017 to January The European Commission s delay proposal needs to be approved by the European Parliament and the Council of the European Union. 22

23 Average price and total value of all transactions executed within two- minute windows occurring at 09.30, 11.30, and Daily average and volume- weighted average transaction price and the highest and lowest executed price (if more than two transactions occurred) Execution fees Fees for the submission, modification or cancellation of orders or quote withdrawals Market- data and terminal fees Clearing and settlement fees, and any other fees paid to third parties involved in the execution of the order A description of rebates, discounts or other payments offered to customers Number of orders of requests for quotes received, executed, cancelled and modified Median transaction size and median size of all orders Number of designated market makers BBO and corresponding volumes Average effective spread Average volume and spread at BBO Number of cancels and modifications at BBO Average depth for three price levels Mean and median time between an aggressive order/quote acceptance by the venue and the subsequent execution amount Average execution speed for unmodified passive orders at the BBO Number of failed fill- or- kill orders Number of IOC orders with zero fills Number of orders qualifying for large- in- scale waiver to pre- trade price transparency Number and average duration of trading interruptions caused by volatility auctions or circuit breakers Although the list of data points is extensive and in many cases applicable to each individual security traded, many venues already collect this information and would simply need to ensure it can be consolidated and delivered in the appropriate format. By comparison, brokers would 23

24 need to show the top five venues, measured by trading volumes, that they used to execute client orders on an annual basis and have an obligation to take account of the execution- quality data published by trading venues. Many brokers already have the systems in place to consume and analyze the data that trading venues will need to publish under MiFID II. However, it should be noted that some brokers also run trading venues and internal crossing networks called systematic internalizers (SIs), which would be required to publish the execution- quality data listed above. Additionally, some market participants, including buy- side firms, are questioning whether the data that is likely to be supplied under MiFID II will be useful in helping to refine best execution. Smaller brokers, for example, may not have the technical resources to analyze the data and draw meaningful conclusions. Moreover, under the current rule drafting, trading venues have three months after the end of each quarter to publish the data. This means that some data could be six months old when it is released, by which time the venue may have made changes to key features like fee schedules and matching- engine operation that materially affect execution quality. MiFID II also recognizes the need for a standardized source of post- trade data that market participants can use to measure execution quality. Given the lack of progress under MiFID I, the revised legislation includes a commitment to reduce market- data fees and imposes a deadline by which the industry needs to create a standardized consolidated tape. According to the legislation: Now that a market structure is in place which allows for competition between multiple trading venues it is essential that an effective and comprehensive consolidated tape is in operation as soon as possible it is appropriate to make provision now for a consolidated tape to be put in place through a public procurement process if the mechanism envisaged does not lead to the timely delivery of an effective and comprehensive consolidated tape for equities and equity- like financial instruments. Two aspects of MiFID II aim to make it easier to create a consolidated tape. Firstly, MiFID II introduces the concept of Approved Publication Arrangements, entities that are responsible for ensuring data quality and transparency. Currently, post- trade data, particularly for over- the- counter trades, is difficult to decipher. It is currently not possible to easily determine whether an OTC trade is price forming or merely a technical trade, such as a give- up between two brokers. It is also not possible to see which trades were executed in broker crossing networks. APAs will be responsible for cleaning up post- trade data so that it can be easily aggregated by a consolidated tape provider. Another significant development is that the Markets in Financial 24

25 Instruments Regulation (MiFIR), which accompanies MiFID II, introduces the concept of a reasonable, commercial basis for the provision of market data. This is designed to compel stock exchanges to reduce their fees and allow for more- affordable aggregation of pan- EU data. The method by which this will be achieved is still being decided, but may include greater transparency of exchanges market- data fees or cost controls. The European Commission, with assistance from ESMA, needs to report on the progress of an industry- led consolidated tape by September If there has been insufficient progress, ESMA will launch a public procurement process to choose a commercial entity to run a consolidated tape. Many market participants believe that although MiFID II is a step in the right direction, regulatory intervention will be required before the industry coalesces around a standardized consolidated tape provider. Many point to the failure of the COBA Project, an independent initiative to create a consolidated tape, as an example of the vested interests that have hampered progress. The creation of an affordable consolidated tape may remove an obstacle to certain firms, particularly smaller brokers, adopting order- execution policies that go beyond simply routing all customer orders to the national listing market for the stock in question. To be sure, these firms would also face the substantial connectivity fees at multiple market centers, but may be able to contract with third parties for comprehensive routing services at lower cost than directly connecting to all venues. And greater adoption of multiple- marketplace connectivity and routing could result in better outcomes for end investors, making them more likely to receive the best available prices on all trades. Comparisons with Other Developed Markets (USA, Canada, Australia) Our primary mandate on this project has been to provide a detailed look at the EU best- execution regime and how brokers comply with it. But it also can be instructive for regulators and market participants in a country contemplating exchange competition to consider how other major markets globally approach best execution in a multiple- venue environment. In this section we offer a high- level comparison of the EU model with three other developed markets: the United States, Canada and Australia. Each of these other developed markets has stricter best- execution rules than the EU. In the US and Canada, for instance, regulators have imposed so- called order- protection rules, giving special status to displayed price quotations, which cannot be traded through. In other words, brokers cannot execute trades at prices inferior to the best quoted prices. The US version of this order- protection regime is codified in Rule 611 of Regulation National Market System 25

26 (commonly known as Reg NMS), and protects only the top level of each exchange order book against trade- throughs. The Canadian order- protection rule, goes even further, providing protection against trade- throughs to every quotation at all levels of each marketplace s order book. Both of these systems date back several years, with Reg NMS being implemented in 2007 and amendments to Canada s National Instrument that established full- depth- of- book protection being introduced in Australia, on the other hand, has taken a hybrid approach to best- execution regulation. Its best- execution policy is set out in Chapter 3 of the Australian Securities and Investments Commission s 2011 Market Integrity Rules and bears a strong similarity to the EU approach under MiFID. The rules state that when handling and executing an order for a client a Participant must take reasonable steps to obtain the best outcome for that client. The rules define best outcome more specifically and establish different definitions for retail and wholesale orders. For retail orders, best execution is defined as best total consideration. This gives a heavy weight to the quoted price, but also can include brokerage commissions, venue and post- trade fees as well as stock prices. For wholesale orders, brokers can consider a wider array of factors, including price, costs, total consideration, speed, likelihood of execution or any other relevant outcome, or any combination of those outcomes. And ASIC guidance specifically states that brokers need only connect to competing venues when they have judged that the benefits outweigh the costs. For retail brokers, where best execution is defined as best total consideration, connections to alternative venues appear more critical. The only displayed- market rival to the ASX, Australia s national listing exchange, is Chi- X Australia. We understand that most Australian retail brokers connect and route orders to Chi- X Australia. But brokers handling primarily institutional flow have been less willing to connect to the rival market, and have greater flexibility to maintain that stance under Australia s hybrid best- execution rules. Generally speaking, strict price- protection regimes tend to result in greater market- structure complexity, including large numbers of quoting market centers, and higher intermediary costs. In the US and Canada for example, rules prohibiting trade- throughs effectively require all brokers to access the market data and matching engines of every quoting marketplace, regardless of how big or small those venues may be. Consider, for example, a scenario in which the Chicago Stock Exchange (CHX) is alone in displaying the best offer for a particular US- listed equity security, and a broker receives a customer order to buy that security. Under Reg NMS, the broker cannot buy the shares for its customer at a price higher than the CHX offer. The broker is 26

27 free to search off- exchange markets for the same or a better price, but if none is available, the firm must send the order to CHX. Unlike in Europe, whose principles- based regime gives brokers flexibility to consider factors beyond best price when deciding whether to connect to smaller venues, the US broker must pay for a connection to and market data from CHX, even though it only executes approximately 0.3% of consolidated US equity volume. Price- based order protection, then, constitutes a subsidy of sorts for exchanges and other execution venues that display quotes. Even single operating companies can find it valuable, in price- protected markets, to operate more than one exchange. This is especially true in jurisdictions that combine trade- through protection with so- called fair- access rules, which prevent exchanges from providing services on a discriminatory basis to some customers but not others. US exchanges and Canadian marketplaces (the Canadian regulatory classification for any execution venue, regardless of whether it is an exchange or alternative trading system, or whether or not it displays price quotations), for example, have fair- access requirements. Consider how this applies to accessing the liquidity that resides on an exchange order book. Exchanges often charge a fee to those who remove liquidity from the book, and pay a slightly smaller rebate to the customer that posted the quote. This so- called maker- taker system can be appealing to firms that primarily add liquidity, as it provides a subsidy to their P&L in the form of the liquidity- provider rebate. But brokers that primarily remove liquidity including most investment banks and agency brokers serving institutional investors often prefer inverted fee schedules, which pay rebates to the liquidity taker while charging the maker. A single fair- access exchange cannot fully satisfy both of these customer groups. But a company operating a maker- taker venue could launch a second exchange with an inverted fee schedule to attract liquidity- removing brokers. This is one reason why several exchange groups operate multiple markets in the US and Canada, and why even when exchange companies merge they do not necessarily consolidate the number of exchanges they run. US exchange operators BATS and Direct Edge, for example, kept all four of their exchanges operating separately when they merged in The tendency of strict, price- based order protection regimes to support market- structure complexity and venue fragmentation can be seen in the number of lit venues operating in the US, Canada and Australia, particularly when taking into consideration the size of each country s equity market (see Table 3, page 28). Indeed, the proliferation of venues in Canada, with its full- depth- of- book order protection, has been greater than one might expect for a market of its size. 27

28 Canada s average daily turnover is more than twice that of Australia s, but it has five times as many lit marketplaces. Conversely, the United States dwarfs Canada in turnover terms by a ratio of more than 30:1, but in terms of protected, quoting markets by a measure of just 1.2:1. The EU equity market, in comparison, is about one- third the size of the US and 10 times larger than Canada s but typically features just four to six quoting venues per country and listed security even though the total number of venues across the region is far higher, owing primarily to the large number of national exchanges that don t compete head- to- head with one another. Table 3: Comparison of Average Daily Turnover and # of Lit Venues in US, Canada and Australia Country # of Lit Venues USA $234,447 $252,707 $211,274 $222,480 $259,707 $276, CAD $8,365 $9,479 $7,810 $7,772 $9,019 $9, AUS $4,190 $4,229 $9,704 $4,784 $4,439 $4,331 2 Strict trade- through protection, combined with high fees for removing liquidity from trading- venue order books 15, also gives dealers a powerful incentive to divert customer order flow to the venues charging the lowest fees for removing liquidity on behalf of customers, all other things (namely, best price) being equal. This, at least in the short term, can result in further fragmentation, as brokers starting their own trading venues in many cases so- called dark pools that do not post bids or offers and therefore contribute less to price discovery than do displayed markets primarily to avoid exchange fees and thereby fatten their profit margins. This occurred in Canada, with several major dealers banding together in November 2008 to start the Alpha ATS. Alpha originally served as a printing venue for block trades but later became the country s second- biggest dark pool, through its Intraspread facility, which began trading in June 2011 and specifically allowed dealers to internalize retail order flow. The growth of dark trading, prompted Canadian regulators to introduce new rules, on October 15, 2012, requiring either block size or significant price improvement for dark trades. Dark market share in Canada stood at 3.65% in January 2016, down from a high of around 5.7% before the new rules were introduced in late Unlike in the United States, there is no cap on lit- market access fees in Canada 28

29 Conclusions and Recommendations Considering that Mexico s equity market is less than 1/5 the size of Australia s, the smallest major market that allows exchange competition today, and that a vast majority of its volume comes from institutional investors (as opposed to retail), we believe that a EU- style, principles- based best- execution regime is most appropriate for ensuring investor orders receive proper treatment in a multiple- exchange environment. Such a regime would offer brokers the flexibility to consider a range of factors, including which exchange is displaying the best price, when deciding how to handle orders. A principles- based approach also would guard against the tendency for strict price- based order protection to maximize market fragmentation and structural complexity. We believe such safeguards are important considering that Mexican brokers operate in a market that is far smaller than others featuring exchange competition, and may not be able to absorb the costs of such complexity as much as counterparts operating in bigger markets like the US and Canada (and, indeed, even the EU, despite its reliance on a principles- based regime). Mexican regulators, however, may also want to consider supplementary measures that could offset some of the risks of offering brokers best- execution flexibility. These include disclosure requirements for trading venues and brokers similar to those being introduced in the EU under MiFID II (though it should be noted that the effective date of these revisions have been delayed at least one year, to January 2018). Additionally, ensuring that competing exchanges share a common post- trade infrastructure, similar to the systems in the US, Canada and Australia, is important, as fragmentation among clearing and settlement providers can add costs that may act as a deterrent for brokers to connect to a full range of execution venues. Given that the existing post- trade infrastructure is owned by the national listing exchange, BMV, regulators should consider requiring that BMV provide access for any rival exchanges subject to reasonable commercial terms, similar to the arrangement in Australia through which ASX provides clearing services to Chi- X Australia. Finally, regulators may want to consider taking steps that ensure an affordable, accurate stream of consolidated market data from all exchanges is available for market participants seeking to comply with best- execution principles. The European experience has shown that without a standard view of post- trade prices, it is extremely difficult to measure and monitor best execution in a meaningful way. 29

30 Appendix 1: Relevant Excerpts from MiFID Pertaining to Best Execution (Source: lex.europa.eu/legal- content/en/txt/?qid= &uri=celex:02004l ) Article 21 Obligation to execute orders on terms most favourable to the client 1. Member States shall require that investment firms take all reasonable steps to obtain, when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order. Nevertheless, whenever there is a specific instruction from the client the investment firm shall execute the order following the specific instruction. 2. Member States shall require investment firms to establish and implement effective arrangements for complying with paragraph 1. In particular Member States shall require investment firms to establish and implement an order execution policy to allow them to obtain, for their client orders, the best possible result in accordance with paragraph The order execution policy shall include, in respect of each class of instruments, information on the different venues where the investment firm executes its client orders and the factors affecting the choice of execution venue. It shall at least include those venues that enable the investment firm to obtain on a consistent basis the best possible result for the execution of client orders. Member States shall require that investment firms provide appropriate information to their clients on their order execution policy. Member States shall require that investment firms obtain the prior consent of their clients to the execution policy. Member States shall require that, where the order execution policy provides for the possibility that client orders may be executed outside a regulated market or an MTF, the investment firm shall, in particular, inform its clients about this possibility. Member States shall require that investment firms obtain the prior express consent of their clients before proceeding to execute their orders outside a regulated market or an MTF. Investment firms may obtain this consent either in the form of a general agreement or in respect of individual transactions. 4. Member States shall require investment firms to monitor the effectiveness of their order execution arrangements and execution policy in order to identify and, where appropriate, correct any deficiencies. In particular, they shall assess, on a regular basis, whether the execution venues included in the order execution policy provide for the best possible result for the client or whether they need to make changes to their execution arrangements. Member States shall require investment firms to notify clients of any material changes to their order execution arrangements or execution policy. 5. Member States shall require investment firms to be able to demonstrate to their clients, at their request, that they have executed their orders in accordance with the firm's execution policy. 6. In order to ensure the protection necessary for investors, the fair and orderly functioning of markets, and to ensure the uniform application of paragraphs 1, 3 and 4, the Commission shall M3 adopt implementing measures concerning: 30

31 (a) the criteria for determining the relative importance of the different factors that, pursuant to paragraph 1, may be taken into account for determining the best possible result taking into account the size and type of order and the retail or professional nature of the client; (b) factors that may be taken into account by an investment firm when reviewing its execution arrangements and the circumstances under which changes to such arrangements may be appropriate. In particular, the factors for determining which venues enable investment firms to obtain on a consistent basis the best possible result for executing the client orders; (c) the nature and extent of the information to be provided to clients on their execution policies, pursuant to paragraph 3. The measures referred to in the first subparagraph, designed to amend non- essential elements of this Directive by supplementing it, shall be adopted in accordance with the regulatory procedure with scrutiny referred to in Article 64(2). Extract from MiFID Implementing Directive (Source: lex.europa.eu/legal- content/en/txt/?qid= &uri=celex:32006l0073) Article 44 (Articles 21(1) and 19(1) of Directive 2004/39/EC) Best execution criteria 1. Member States shall ensure that, when executing client orders, investment firms take into account the following criteria for determining the relative importance of the factors referred to in Article 21(1) of Directive 2004/39/EC: (a) the characteristics of the client including the categorisation of the client as retail or professional; (b) the characteristics of the client order; (c) the characteristics of financial instruments that are the subject of that order; (d) the characteristics of the execution venues to which that order can be directed. For the purposes of this Article and Article 46, execution venue means a regulated market, an MTF, a systematic internaliser, or a market maker or other liquidity provider or an entity that performs a similar function in a third country to the functions performed by any of the foregoing. 31

32 2. An investment firm satisfies its obligation under Article 21(1) of Directive 2004/39/EC to take all reasonable steps to obtain the best possible result for a client to the extent that it executes an order or a specific aspect of an order following specific instructions from the client relating to the order or the specific aspect of the order. 3. Where an investment firm executes an order on behalf of a retail client, the best possible result shall be determined in terms of the total consideration, representing the price of the financial instrument and the costs related to execution, which shall include all expenses incurred by the client which 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 involved in the execution of the order. For the purposes of delivering best execution where there is more than one competing venue to execute an order for a financial instrument, in order to assess and compare the results for the client that would be achieved by executing the order on each of the execution venues listed in the firm's order execution policy that is capable of executing that order, the firm's own commissions and costs for executing the order on each of the eligible execution venues shall be taken into account in that assessment. 4. Member States shall require that investment firms do not structure or charge their commissions in such a way as to discriminate unfairly between execution venues. 5. Before 1 November 2008 the Commission shall present a report to the European Parliament and to the Council on the availability, comparability and consolidation of information concerning the quality of execution of various execution venues. 32

33 Appendix 2: More Information on EU Brokers Order- Execution Policies Links to Order Execution Policies Citi: Instinet: Investment Technology Group Limited: Execution- Policy- for- ITG- in- Europe1.pdf J.P. Morgan: Jefferies: 20Policy%20Version%202_1.pdf KCG: performance/execution- quality Kepler Cheuvreux: 20KC%202015%2004%2013.html Saxo Bank: terms- and- policies/best_execution_policy_en.pdf Société Générale Group: al_best_execution_policy_eng_final_ pdf UBS: bank/termsinvestmentbusiness/_jcr_content/par/linklist_0/link file/bgluay9wyxr ops9jb250zw50l2rhbs9jbnzlc3rtzw50qmfuay9kb2n1bwvudhmvdwjzlwlilw9yzgvylw V4ZWN1dGlvbi1wb2xpY3kucGRm/ubs- ib- order- execution- policy.pdf Links to information on Order Execution Policies Bank of America: Net_v2.pdf Goldman Sachs: prof- clients.pdf 33