Global Covered Bond Market RBC MiFID II Execution Survey Commentary and Review. Client Feedback

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1 Covered Bond Market RBC MiFID II Execution Survey 2013 Commentary and Review Client Feedback september 2017

2 table of contents 03 Client Feedback Summary 04 Investment Firms Preparing for Significant Change to Execution Processes Under MiFID II 06 Impact of MiFID II on Trade Cost Analysis 08 Best Execution: Broker Selection & Electronic Focus 14 Liquidity Landscape- Impact on Dark and Block Trading 16 Liquidity Access to Liquidity & Market Fragmentation Concerns 18 Trade Reporting 19 Market Structure 20 Survey Respondent Profile 22 MiFID II Survey Glossary

3 client feedback summary BROKER SELECTION & TCA DARK & BLOCK TRADING 7 of respondents indicated that they will use TCA under MiFID II 65% will utilize 3rd party solutions 1 will utilize in-house expect an increased dependency on dark venues 34% expect a decreased dependency 60% intend to implement a broker execution vote 67% are preparing for a consolidation of execution counterparty lists, up from 47% in our first MiFID II survey conducted in Q anticipate that MiFID II will result in more block trading flow 32% are undecided LIQUIDITY LANDSCAPE REGULATION Anticipated main driver for equity market structure change in Europe over the next 2 years 6 Regulation 1 New Venues & Liquidity Fragmentation Shift to passive trading & consolidation of active managers Dark Pool Caps Brexit ONLY 1 expect the greater transparency provided by MiFID II to improve market liquidity Conditional Order types/sis/ LIT markets are expected to prove the most successful under MIFID II RBC Mi FID EXECUTION SURVEY 3

4 investment firms preparing for significant change to execution processes under mifid ii Following the successful publication of our unbundling & advisory focused client survey in Q1, we once again engaged our client base in Q3 on MiFID II implications, this time with a focus on the impact on execution and market structure. Over 150 buy-side Equity professionals responded to this latest survey 1, which included questions in relation to Transaction Cost Analysis (TCA), best execution, trade reporting and the evolving liquidity landscape. MiFID II has already started reshaping the market landscape, impacting execution processes and liquidity access. Beginning January 3, 2018, execution venues will be required to submit enhanced reports relating to the quality of execution of transactions which will include a number of execution factors including price, size and speed. Investment firms are also expected to provide transparency on their top five execution venues. their execution processes. Meanwhile, 67% of respondents are now planning a consolidation of their broker list, a marked shift since our first MiFID II survey when only 47% expected a consolidation. With January approaching, whilst we are starting to see consensus in a number of topics, a certain degree of uncertainty still exists. Trade Cost Analysis to Accelerate? Survey results indicate that most investment firms are expecting changes in a multitude of areas relating to execution. Most notably the increased use of execution quality tools (e.g. Q: DO YOU EXPECT TO USE TRADE COST ANALYSIS (TCA) UNDER MiFID II? The absence of Broker Crossing Networks (BCNs) is expected to impact the liquidity landscape. Meanwhile, increased regulatory focus on transparency and double volume caps on dark pools will likely force dark liquidity providers to transition to a more LIT market place. RBC has gathered key information from our client base on how regulatory changes will be translated into practice. As an example, more than two thirds of the respondents expect changes to impact Key findings Change to the status quo with only 1 of respondents anticipating no alteration to their execution process under MiFID II. As investment firms look to monitor best execution, 77% said they will increase their usage of Transaction Cost Analysis (TCA). UK & an investment firms are the most likely to increase TCA utilisation given that the majority of their business is likely to be in scope. 65% expect that third party providers will be leveraged to provide TCA solutions. In addition, two thirds of respondents will likely consider the implementation of a broker execution vote in response to the new requirements. Unsurprisingly, a consolidation of execution counterparties is expected in all regions (67%). Additionally, 40% of respondents expect a shift towards increased electronic trading. Investment firms are however not expecting to consider outsourcing execution services, with just anticipating they would do so. There is likely to be an impact on the liquidity landscape, as whilst consensus suggests that more block trading flow (4) is expected, there is significant indecision on the dependency of dark venues. The lack of Broker Crossing Networks is a concern (5) and are still undecided on the implications. There is significant concern (75%) that market fragmentation will be an unwanted consequence of MiFID II regulation and 52% are expecting increased volatility. 5 are also concerned about the inability to access liquidity, with only 1 believing that the market has evolved sufficiently to address this concern. Regulation is still expected to be the main driver of market structure change in Europe over the next 2 years, with few expecting that Brexit, dark pool caps, new venues or a shift to passive trading will be as disruptive. 1 Respondents may consist of multiple members of the same firm. 4 RBC CAPITAL MARKETS

5 Transaction Cost Analysis) is likely to be a top priority, with 7 of all respondents expecting to use such tools in some capacity. UK & an investment firms almost unanimously agree that an increase is to be expected under MiFID II. Whilst investment firms have been debating the value of leveraging third party TCA providers versus implementing more bespoke in-house solutions, our survey indicates a consensus is emerging: 65% of all respondents are likely to opt for a third party solution with just 1 expecting to build in-house. Despite the lack of clarity on liquidity, from a venue & order type perspective, respondents noted Conditional Orders types, Systematic Internalisers and LIT markets are expected to be the most successful under MiFID II, according to the results of the survey. Q: DO YOU EXPECT THE CHANGING MARKET STRUCTURE AND REGULATION TO IMPACT THE AMOUNT OF FLOW YOU ROUTE TO THE DARK Broker Selection & Electronic Focus There appears to be a consensus that the best execution regulations are likely to cause a consolidation of execution counterparty lists. n respondents in particular have adjusted their expectations, with 69% now anticipating a reduction compared to just 3 in the original survey. The survey also suggests regulation is likely to shift respondents execution preferences towards electronic trading, possibly due to the increased scrutiny on trade costs. 40% of respondents expect an increased electronic trading bias, and only 14% anticipate a decrease in flow sent to electronic providers. Investment firms with European exposure, in particular UK & an respondents, indicate they are also likely to implement an execution broker vote as an additional method of measuring execution performance. Q: CONSOLIDATION OF EXECUTION COUNTERPARTIES Liquidity & Market Fragmentation a Concern? Market Fragmentation is of concern globally with 75% of all respondents highlighting it as a potential issue. Whilst MiFID II is expected to improve transparency, just 1 believe that this will result in improved liquidity. Q: ARE ANY OF THE FOLLOWING OF CONCERN UNDER MIFID II? MARKET FRAGMENTATION Impact to Dark & Block Trading The effect of regulation on the amount of flow routed to the dark remains unclear. Whilst almost half of all respondents are anticipating no change, the remaining 5 are split between expectations on increased () and a decreased dark dependency (34%). Changes to block trading are slightly clearer, with almost half of all respondents indicating that they anticipate increased block trading flow as a result of MiFID II. That said, 32% of respondents indicated that they are undecided on the topic, underscoring that while a consensus is emerging, an element of uncertainty remains surrounding liquidity under MiFID II. RBC Mi FID EXECUTION SURVEY 5

6 impact of mifid ii on trade cost analysis DO YOU EXPECT THE NEW BEST EXECUTION OBLIGATIONS UNDER MIFID II TO HAVE ANY IMPACT ON YOUR TRADING PRACTICES? Algo trading practices (e.g. introduction of an algo trading wheel) 47% 47% % 5 40% 42% 41% 59% Increased focus on execution quality tools (e.g. Transaction Cost Analysis) 77% % 94% 92% 54% 4 Consolidation of execution counterparties 67% 3 61% 39% 75% 7 27% 69% 31% Implementation of a broker execution vote 60% 40% 65% 35% 67% 75% 3 41% 59% 6 RBC CAPITAL MARKETS

7 DO YOU EXPECT TO USE TRANSACTION COST ANALYSIS (TCA) UNDER MIFID II? 1 65% 14% 7, we will build our own TCA in-house 1 70% 12%, we will leverage 3rd party providers We do not plan on using TCA 84% Still to be decided 49% 11% 34% RBC Mi FID EXECUTION SURVEY 7

8 best execution: broker selection & electronic focus DO YOU EXPECT THE CHANGES UNDER MIFID II TO IMPACT YOUR EXECUTION PROCESSES? % % 7 17% 5% 85% 15% Unsure 4 14% 4 HOW DO YOU CURRENTLY MEASURE BEST EXECUTION? 80% 70% 6 60% 59% 59% 55% 5 50% 40% 30% 44% 40% 41% 3 35% 35% 27% % 3 32% 29% 27% 24% 24% 24% 1 0% Cost of trading Likelihood of execution and settlement Price Size Speed 8 RBC CAPITAL MARKETS

9 DO YOU EXPECT THAT ANY OF THE BELOW QUALITATIVE VARIABLES WILL FEED INTO YOUR BEST EXECUTION DECISION-MAKING PROCESS? Quality of IOI s 7 24% 71% 29% 81% 100% 67% 3 Execution consultancy 6 32% 81% 5 77% 47% % Market structure analysis 6 34% 80% 47% 62% % 39% Qualitative variables will be part of our best execution process 79% 21% 77% 2 69% 80% 31% 82% 1 Sales trading ideas and market colour 7 24% 75% 69% 69% 31% 31% 81% RBC Mi FID EXECUTION SURVEY 9

10 HAS MIFID II PROMPTED YOU TO CONSIDER OUTSOURCING YOUR EXECUTION SERVICES? 90% 7% 94% 94% I'd rather not say 84% 94% 10 RBC CAPITAL MARKETS

11 DO YOU EXPECT MIFID II TO CHANGE YOUR EXECUTION BIAS? Electronic / e-trading 40% 14% 4 41% 35% 42% % 47% Increase Decrease Change 4 11% 4 High touch or voice trading 2 29% 44% 31% % 47% 44% Increase Decrease Change 17% 37% 4 Program trading 87% 9% 11% 91% 89% 67% Increase Decrease Change 11% 89% RBC Mi FID EXECUTION SURVEY 11

12 WHAT PERCENTAGE OF YOUR EQUITIES TRADING FLOW IS CURRENTLY EXECUTED ELECTRONICALLY? 1 12% 11% 15% 21% <5% 11% 24% 11% % % 9% 9% 1 37% 27% 40-60% >60% 9% 9% 15% 12% 15% Prefer not to say DO YOU EXPECT THIS TO CHANGE POST MIFID II? 3 49% 3 5% 54% Increase Decrease 31% 27% % change Prefer not to say 29% 50% 15% WHAT IS YOUR CURRENT BENCHMARK? (MULTIPLE ANSWERS) What is your current benchmark? (multiple answers) 45% 40% 35% 30% 42% 15% 5% 0% IS (Implementation shortfall) VWAP (Volume weighted average price) 12% TWAP (Time weighted average price) 7% 5% PWP (Participation weighted performance) Target MOC (Target market on close) POV (Percentage of volume) 21% I d rather not say 12 RBC CAPITAL MARKETS

13 DO YOU EXPECT TO CHANGE YOUR CURRENT BENCHMARK(S) UNDER MIFID II? 90% 80% 70% 60% 50% 40% 30% 0% 7 71% 1 5% 24% 7 62% 6 27% 29% Undecided HOW WILL YOU SELECT YOUR EXECUTION COUNTERPARTIES YOU TRADE WITH POST MIFID II? 8 1% 11% 97% Trade with either based on opportunity to trade 79% 21% Trade with nonsystematic internalisers for illiquid instruments 67% 3 Utilise systematic internalisers for liquid instruments 87% RBC Mi FID EXECUTION SURVEY 13

14 liquidity landscape impact on dark and block trading DO YOU EXPECT THE CHANGING MARKET STRUCTURE AND REGULATION TO IMPACT THE AMOUNT OF FLOW YOU ROUTE TO THE DARK? 80% 70% 60% 50% 40% 30% 0% 70% 5 44% 4 40% 42% 34% 29% 29% 2 17% - Increased dependence on dark venues - Decreased dependence on dark venues change DO YOU EXPECT TO SEE MORE BLOCK TRADING FLOW UNDER MIFID II? 100% Do you expect to see more block trading flow under MiFID II? 90% 80% 70% 60% 50% 40% 30% 0% 67% 54% 4 50% 49% 32% 32% 3 32% 14% 14% 11% Undecided 14 RBC CAPITAL MARKETS

15 DO YOU EXPECT THE REMOVAL OF BROKER CROSSING NETWORKS UNDER MIFID II TO IMPACT THE WAY YOU ACCESS BLOCK LIQUIDITY? 90% 80% 70% 60% 50% 40% 30% 0% 80% % 44% 29% 17% 31% 12% Undecided RBC Mi FID EXECUTION SURVEY 15

16 liquidity access to liquidity & market fragmentation concerns ARE ANY OF THE FOLLOWING OF CONCERN UNDER MIFID II? Inability to access liquidity 5 42% 50% 50% 75% 75% 5 44% Increased Volatility 52% 4 44% 5 40% 5 60% 47% 62% 3 Market fragmentation 75% 81% 67% % 74% 2 DO YOU EXPECT THAT GREATER TRANSPARENCY UNDER MIFID II WILL HELP IMPROVE LIQUIDITY? % 1 49% 64% 32% 1 17% 50% 3 Unsure RBC CAPITAL MARKETS

17 DO YOU EXPECT NEW ORDER TYPES AND VENUES UNDER MIFID II TO PROVIDE AN ADEQUATE SUBSTITUTE IN THE CHANGING MARKET LANDSCAPE? 1 31% 1 27% - the market has evolved sufficiently to provide adequate liquidity 29% 2 - we are concerned about accessing liquidity 30% 3 50% we are concerned about information leakage 1 35% 39% - we expect that other venues/order types will offer the same access to liquidity Undecided WHICH OF THE FOLLOWING LARGE IN SCALE (LIS) VENUE AND ORDER TYPES DO YOU EXPECT TO BE THE MOST SUCCESSFUL UNDER MIFID II? Conditional Order Types 37% 29% 1 LIT 24% 24% 2 Continuous Auctions % 5% Intra-Day Auctions 30% First Choice Second Choice Third Choice Fourth Choice Fifth Choice WHICH OF THE FOLLOWING VENUES DO YOU EXPECT TO BE THE MOST SUCCESSFUL UNDER MIFID II? 50% 45% 40% 35% 30% 47% 41% 39% 15% 5% 1 15% 1 11% 0% Conditional Systematic internalisers Lit markets MTFs On exchange LIS hidden orders Rather not say Intraday Auctions Iceberg orders Periodic auctions ne of the above RBC Mi FID EXECUTION SURVEY 17

18 trade reporting HOW DO YOU INTEND TO MEET YOUR TRADE REPORTING OBLIGATIONS? All Respondents United Kingdom 1 21% 1 15% 15% 2 47% 17% 2 21% 1 7% Build in-house t in scope Outsource Mainland Europe 11% 44% Utilise broker assisted trade reporting rth America 2 29% 1 2 Undecided WILL YOU USE PRE-TRADE TOOLS TO OPTIMISE YOUR TRADING PERFORMANCE? 47% 29% 24% 5, this will be a valuable tool for us 47% 5 29% 24% 17%, this is not applicable for our style of trading Undecided 35% 3 27% DO YOU EXPECT YOUR DUE DILIGENCE OF ALGO PROVIDERS TO CHANGE UNDER MIFID II? 39% % 27% 5%, we will be looking to enhance our diligence over external algos 5, we have adequate due diligence in place already 3 42% 17% Unsure 29% 2 39% I d rather not say 18 RBC CAPITAL MARKETS

19 market structure WHAT DO YOU EXPECT WILL BE THE MAIN DRIVER FOR EQUITY MARKET STRUCTURE CHANGE IN EUROPE OVER THE NEXT 2 YEARS? All Respondent 1 6 2% Brexit United Kingdom 9% 7% 7% 71% 5 11% 7% Dark pool caps New venues and liquidity fragmentation Regulation Mainland Europe 45% 3 Shift to passive trading and consolidation of active managers 7% 7 4% Other RBC Mi FID EXECUTION SURVEY 19

20 survey respondent profile Number of respondents: 156 WHAT IS THE APPROXIMATE VALUE OF YOUR FIRM S ASSETS UNDER MANAGEMENT (USD AUM)? 9% 14% $10-25bn 15% 1 $1-5bn $25-50bn $500m-1bn 3 9% 2% $50bn+ $5-10bn <$500m WHICH OF THE FOLLOWING BEST DESCRIBES YOUR INSTITUTION? 1% 1% 4% 1% 1 Central Bank Hedge Fund Institutional asset manager Insurance Company Other (please specify) Pension Fund Wealth Management 74% 20 RBC CAPITAL MARKETS

21 RBC Mi FID EXECUTION SURVEY 21

22 glossary Transaction Cost Analysis (TCA) A method to measure trading performance against benchmarks by evaluating the prices at which trades are executed. Broker Crossing Network (BCN) Broker owned electronic platform that facilitates matching of third-party orders anonymously and uses selected LIT markets reference prices. Large in Scale (LIS) An order that is equal to or larger than the minimum size of orders. Trade Reporting The real time reporting of trade data. Benchmarks: Volume weighted average price (VWAP) Comparison of the average execution price against historical volume weighted average price. Implementation shortfall (IS) Comparison of the average execution price against arrival price. Time weighted average price (TWAP) Comparison of the average execution price against time weighted average price. Target market on close (Target MOC) Comparison of the average execution price against price at market close. Percentage of volume (POV) Comparison of the order participation rate against a specified percentage of volume. Participation weighted performance (PWP) Comparison of the average execution price to a specified percentage participation weighted price. 22 RBC CAPITAL MARKETS

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24 contact Ines Fernandez RBC Capital Markets James Damen RBC Capital Markets Jordan Lorch RBC Capital Markets Mathew Szeto RBC Capital Markets The information contained in this brochure has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made by Royal Bank of Canada, RBC Capital Markets, its affiliates or any other person as to its accuracy, completeness or correctness. thing in this brochure constitutes legal, accounting or tax advice or individually tailored investment advice. This brochure is prepared for general circulation to clients and has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The investments or services contained in this brochure may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. This brochure is not an offer to sell or a solicitation of an offer to buy any securities or to take any deposits or provide any financing. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, every state in the US, and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, the products and services discussed in this brochure may not be eligible for sale or otherwise in some jurisdictions. This brochure is not, and under no circumstances should be construed as, a solicitation to act as securities broker or dealer or otherwise in that jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer or otherwise in that jurisdiction. To the full extent permitted by law neither RBC Capital Markets nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this brochure or the information contained herein. RBC Capital Markets is the global brand name for the capital markets business of Royal Bank of Canada and its affiliates, including RBC Capital Markets, LLC (member CFTC, FINRA, NFA, NYSE, and SIPC); RBC Dominion Securities, Inc. (member IIROC and CIPF); RBC Europe Limited (authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority); Royal Bank of Canada Sydney Branch (ABN ) ; Royal Bank of Canada Hong Kong Branch and RBC Capital Markets (Hong Kong) Limited (both entities are regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission of Hong Kong). Registered trademark of Royal Bank of Canada. Used under license. Copyright All rights reserved. 09/ A rbccm.com