DANISH BANKERS ASSOCIATION CESR Best execution and Pre- and post trade transparency requirements for regulated markets and MTFs CESR consultation paper The Danish Bankers Association appreciates this opportunity to provide comments on CESR s consultation paper regarding advice for level 2- regulation on MiFID. This is the second part of our responses to CESR s 17th June 2004 consultation paper and it relates to best execution and pre- and post trade transparency. The Danish Bankers Association - Finansrådet - is the trade organisation for Danish banks, covering the entire banking sector. Members include banks, savings banks and Danish branches of foreign banks. The Association has 161 members, which covers member banks with only handful employees to larger bank groups. We would like to express the following general and specific remarks to the consultation paper. General remarks 1. We find that the consultation paper proposes far too detailed and prescriptive measures and we urge CESR to reconsider the level of details. The consultation paper and the Commission s mandate seek to codify into EU law some matters that should not be dealt with at level 2 but in a more flexible way in order for the European financial markets to continue to adapt to meet the ever-changing needs of investors and issuers and retain their global competitiveness. Furthermore, the proposal appears in some respects to go beyond the Level 1 text. 4 October 2004 Finansrådets Hus Amaliegade 7 DK-1256 Copenhagen K Phone +45 3370 1000 Fax +45 3393 0260 mail@finansraadet.dk www.finansraadet.dk 2. Level 2 measures should recognise and distinguish between different market structures and business models. Consideration should be taken to differences in scale, nature and complexity of business. 3. It is a fact that the proposed measures will lead to increased cost for investment firms due to IT-development, training of staff and changing of documentation. Such increased cost will inevitably lead to a rise in the price of investment services to the disadvantage of the investors/clients. Hence, consideration should be given to whether an imposed measure in the end will result in a net benefit for the investors in the form of increased transparency and a better service without substantial rise in price. We believe, that the draft
proposal in some situations does not provide for such benefits. Page 2 4. The consultation paper envisages heavy disclosure requirements that are unnecessary, burdensome and not obviously have any benefit to customers. Instead, they should meet the points raised by the Post-FSAP Securities Expert Group, which underlined that regulation should be justified and shown to be needed and beneficial before it is imposed. 5. We fear that the load of information that CESR propose to be provided to clients would damage the clients ability to form a general view of how the market functions and how to invest rather than provide the necessary transparency and general view. In addition, we see it as outermost importance to ensure that information provided to clients can be standardised. 6. We would like to stress the need for transitional measures for various aspects of the consultation paper that will require the industry to make organisational and technological changes. 7. Finally, when a firm has provided existing clients with the material required under the existing ISD, MiFID should not require new documentation to be provided until changes in a firm s business relationship with its existing clients make it appropriate to modify terms of business. Grandfathering clauses are needed. Specific remarks Best execution 1. Initially, we would like to draw the attention to the fact that due to Danish regulation on best execution we have a different starting point than foreseen by article 21. In Denmark investment firms are obliged (trade by trade) to agree with a retail client what specific type of order the client wishes. Hence, the retail client will have made a specific instruction in accordance with article 21.1. In general there are three different types of orders for retail clients and the characteristics of these orders automatically implies whether the order is to be executed on or outside a regulated market. Thereby, it is the client that to some extent chooses the venue for instance a regulated market or internalisation. 2. The level 1 obligation to obtain best execution imposes detailed requirements on firms expressed in relatively straightforward language, which requires little elaboration though further directives or regulations at Level 2. Most of the issues that CESR discusses in the consultation paper would be better suited to guidance at Level 3, and are not suitable for EU-level legislative requirements. 3. Regulators should see obtaining best execution for a client as a process that firms must follow, not an outcome to be assessed on a
trade-by-trade basis. The discussion in the explanatory text (page 72) usefully sets out the complexity of the best execution assessment: speed, price, market impact, etc. Page 3 4. The framework should leave sufficient flexibility for choosing venues, and not become a straitjacket; the choice must be commercial, and allow room for differentiation by product. CESR s objective of encouraging competition between execution venues has to be balanced against the costs of mandating expensive search and direct or indirect access requirements on firms cost that would be ultimately borne by investors. CESR has established that in 95% of cases the most liquid market is least five times the size of the second biggest market (page 107 of CESR s consultation paper). For instance regarding Danish shares Copenhagen Stock Exchange will be the most liquid market. Hence, an investment firm that typically executes orders regarding Danish shares should not be obliged to be a direct or indirect member of Oslo Stock Exchange. Many smaller Danish investment firms are not direct or indirect member of a venue at all. They typically execute orders through another broker. This should still be possible since the cost of being direct member of a venue will raise the cost of a smaller investment firm s ability to provide investment service to its clients significantly. According to Danish regulation on best execution an investment firm, who do not direct an order to a regulated market, is obliged to provide the same or a better price for the execution of an order as the price on a regulated market. Therefore, costs are an essential parameter for competition among investment firms. Smaller firms should not be excluded from providing investment services to its clients due to the huge cost of access to venues and reviewing and monitoring requirements. 5. An obligation to mount extensive searches of multiple venues (which may include exchanges, MTFs and dealers) will take time that would frustrate clients need for immediacy. Lack of immediacy can in turn mean that the price changes to the detriment of the client. Furthermore, many investment firms normally have their core knowledge regarding certain (national or neighbouring) markets and will typically use a domestic broker when trading a financial instrument that they do not have full knowledge about. In such cases the investment firm usually allows the domestic broker flexibility in execution of orders. The determination of whether best execution has been obtained or not is generally present through post trade information. It would therefore be an unnecessary and costly burden to require a huge amount of information flow between the involved parties.
6. Extensive disclosures to clients about firms execution policy of the sort that CESR seems to be envisaging would not only be costly, but also overload clients (particularly retail clients) with information of little or no use to them. The best balance is to allow firms to choose the venues they access, in a way which is tailored to clients characteristics and needs, and to require appropriate, but not excessive, disclosure of the firm s execution policy, so that investors can choose the service they demand and the costs they wish to incur. Page 4 Best execution factors Q1: Are the criteria described above relevant in determining the relative importance of the factors in Article 21(1)? How do you think the advice should determine the relative importance of the factors included under Article 21(1)? Q2: Are there other criteria that firms might wish to consider in determining the relative importance of the factors? Do you think that the explanatory text clearly explains the meaning of all the different factors in respect of the different financial instruments? Q3: How might appropriate criteria for determining the relative importance of the factors in Article 21(1) differ depending on the services, clients, instruments and markets in question? Please provide specific examples. Q.4: Please provide specific examples of how firms apply the factors in Article 21(1) to determine the best possible result for their clients. Ad. Q1: Yes, they are the relevant criteria though, the statement that Price is the first consideration in executing client orders is wrong. One cannot determine the relative importance of these factors. In fact, Q1 contradicts the statement in the CP, which we support: It is important to emphasis that Mandate 3.4.1 does not invite CESR to determine the relative importance of the factors. That job is left to investment firms, Rather, CESR is asked to provide criteria that firms may use to assess the relative importance of the factors. (page 73 of the CP). We support this approach, and believe that it would be impossible to pre-determine the relative importance of these factors, as there would be an endless number of different situations to take into account. The relative importance will not vary among different client segments but also within a given client segment, depending on the specifics of a transaction. Ad. Q2: No there are no other criteria. Ad. Q3: One must keep in mind that best execution is not an exact science. As noted above, the relative importance of these factors will not vary among different client segments but also within a given client segment, depending on the specifics of a transaction. Review requirements : What investment services does your firm provide?
Q.2: How many venues does your firm access now? Does your firm expect to access more venues after the Directive become effective? Q.3: What factors does your firm consider in selecting and reviewing venues? Q.4: Please provide specific examples of costs you consider in evaluating venues. Q.5: How do costs affect your decisions about venue selection? Q.6: Do you take account of implicit costs such as market impact? Is the question of implicit costs only relevant to firms that act as portfolio managers? Q.7: What specific events have led your firm to re-evaluate venues in the past? Please provide examples of how your firm has changed the venues that it accesses as the firm, its clients, or markets have changed. In addition, we invite comments on the following issues: Q.8: Have we identified the key criteria? Q.9: What data is available to carry out these reviews? If no data is available, are market solutions likely to provide it? Page 5 Ad. Q1: As a trade association, we are not in a position to answer the above questions directly. However, our members generally determine the venues access directly or indirectly based on a review of the needs of their customers. It is in their own interest to do so, since their commercial viability depends on ensuring best execution to clients in ever changing market conditions. It is important for the regulatory framework to leave sufficient space for the commercial review to be done. An imposed review of the venues would not benefit the clients. An investment firm must be able to have it s own scheme of venues. If the client desires a venue, which the investment firm does not have direct or indirect access to and the investment firm is not able to execute the client s order, the client will go to an investment firm that provides execution on the specific venue. Monitoring requirements Q.1: What kinds of monitoring arrangements do firms use now? Q.3: What data is available to aid firms in their monitoring obligations? What does the data cost? Ad. Q1 and Q2: Firms are able to monitor the prices they obtain against time and price information that is available from the venues they use. Firms can obtain data directly only from the venues which they use. Data may also be obtained from other venues, but at an often, considerable cost. Timing of venue assessments Q.1: How frequently do firms review the venues to which they direct orders on behalf of clients? Q.2: Do firms re-evaluate their trading venues:
whenever there is a material change at any of the trading venues? whenever there is a material change at the firm that affects its execution arrangements? whenever the firm's monitoring indicates that it is not obtaining the best possible result for clients on a consistent basis? Ad. Q1: In practice, the timing of venue assessments will vary depending on the nature of the market, clients, and instruments. Changes to the firm s business model may require a reassessment of venues. In practice firms will review venues as and when market conditions or developments make it appropriate to do so. Page 6 Ad. Q2: Because of the cost implications, in practice firms ability to be aware of material changes to trading venues that it does not currently uses, is limited by the difficulty of obtaining consistent and reliable information from such venues. In any case, it is not realistic to think that different prices will exist for the same instrument for any period of time without being arbitraged out by market professionals. Information to clients Q.1: At present, how many venues do firms access directly? Indirectly? Q.2: Should an investment firm be required to provide clients and potential clients with information on the percentage of a firm's orders that have been directed to each venue? Q.3: For example, should an investment firm be required to disclose to clients and potential clients what percentage of its client orders were executed in the trading venues to which the firm directed most of its client orders (to cover, at least 75% of the transactions executed)? Q.4: How frequently should investment firms make this information available to clients? On a quarterly basis, for example? Q.5: Should firms be required to update the information to reflect recent usage? How frequently? Q.6: Are there any other categories of information that a client or potential client needs to be adequately informed about the execution services provided by firms? Q.7: Should the information provided by portfolio managers and firms that receive and transmit orders be different from that provided by brokers? What are the key differences? Q.8: Have all of the key conflicts of interest been identified? Q.9: When should firms be required to provide required disclosure to clients and potential clients? Q.10: Is there any reason to impose different timing requirements for disclosure under Article 21 than are required in the Level 2 measures under Article 19(3)? Ad disclosure: What CESR is considering requiring regarding information to clients would hugely exceed what any client would find useful. Clients need to know no more than a high-level description of the firm s general ap-
proach towards seeking best execution, and how the firm goes about it. CESR s advice should reflect this approach, tailoring disclosure to clients needs. Furthermore, disclosure should be done in a general way and on the basis that the client will have access to this information rather than information being sent to all clients. Conflict of interest should be dealt with under article 13 (3) and 18. CESR is considering obliging investment firms to disclose the names of the trading venues. Such a disclosure would be to excessive since the execution policy would have to be updated each time a new venue is added; it would be unreasonable to require the firm to inform all clients each time such a change occurs. Page 7 Pre-trade transparency requirements for Regulated Markets and MTFs (art. 44 and 29) First, CESR proposes a level of detail and prescription in Level 2 measures that would risk setting in stone certain current market structures. We therefore caution CESR against giving preference through EU legislation to markets, as they happen to operate today. Second, CESR s approach would over-regulate matters which should be dealt with under RMs and MTFs own rules. Too much prescription of the details of RMs and MTFs market models would limit their ability to adapt the services they provide to their users needs. These impacts of CESR s proposals could be particularly marked for illiquid market sectors. CESR should therefore instead adopt a more principled and less intrusive or prescriptive approach. Q12.1. Do consultees agree with the specific proposals as presented or would they prefer to see more general proposals? Ad. Q 12.1: We strongly recommend a more general level of principles: Q12.2. Is the content of the pre-trade transparency information appropriate? Ad. Q 12.2: No it is too excessive. While disclosure of the type of trading interest, security identifier, and number of shares is common sense (and should not therefore need to be spelt out in EU law), the number of shares the market participant is ready to buy or sell element appears to prevent RMs and MTFs from advertising iceberg orders, which is likely to result in investors diverting large orders for which they find iceberg facilities useful to other trading venues. It is crucial to keep the possibility to use iceberg orders. Q12.3. Do consultees agree on the proposal regarding the depth of trading interest and access to pre-trade information? Ad. Q 12.3: No, RMs and MTFs determine the amount of information about bids and offers that they made available on the basis of the needs of various
users, and the costs involved. One of the costs of requiring too much information to be displayed is, paradoxically, a reduction in the quality of pretrade transparency. Page 8 Q12.6. Do consultees support the same minimum size of trade for the waiver to transparency pre-trade and delayed publication post-trade? Are there circumstances in which the two should be different? Ad. Q 12.6: It is not appropriate to use the same size for pre-trade exemptions (if they are necessary or desirable at all, which is very questionable) and post-trade exemptions. The value of transparency is different in the different contexts: the need to avoid disclosing the scale of a trading interest in the case of pre-trade transparency; the need to reduce a position taken on in the case of post-trade transparency. This is not to be decided at EU-level but at national level due to huge differences in market structure and liquidity. Q12.7: Do consultees have a preference for one of the options proposed for defining the block size; are there other methods that should be evaluated? Ad. Q 12.7: It must be kept simple. An amount would be appropriate. Post-Trade Transparency requirements for Regulated Markets, MTFs (art. 28, 30 and 45) Q13.1: Do consultees support the method of post-trade transparency (trade by trade information), should some other method be chosen (which)? Ad. Q 13.1: CESR should adopt a more high-level principled approach that is appropriate to any market model. A requirement to make public all of this information for every trade is excessively prescriptive for several reasons. RMs, MTFs and investment firms should have more discretion to provide post-trade information to different market users in ways, which are relevant to their information needs. CESR must take account of the fact that every additional required piece of information will add costs to the system, and that exchanges charge fees for every trade report costs which will ultimately be borne by users of the market. Q13.2: Do consultees support the inclusion of "aggregated information" in paragraph 22 or should it be left for market forces to provide on the basis of the information disclosed under paragraph 21. If it is included what should the content be? Ad. Q 13.2: This should not be legislative measure, and should be left to market forces.
Q13.3: Do consultees support the two-week period for which the post-trade information should be available? Page 9 Q13.4: Should some minor trades be excluded from publication (and if so, what should be the determining factor)? Ad. Q 13.3: No, we do not see a need to keep historic data. Ad. Q 13.4: Ideally minor trades should be excluded. Though, it is more important to exclude trades that do not contain important pricing information, and to ensure that firms are not required reporting a trade more than once. Q13.5: Do consultees agree on the method of defining the time limit in paragraph 4 and is the one-minute limit capable of meeting the needs of occasional off-market trades? Ad. Q 13.5: No. The one-minute deadline is not realistic. In Denmark such a time limit has been tried without success. It caused huge difficulties. The five minute deadline is not always enough either. CESR should propose a Level 2 measure which requires publication as close to real-time as physically possible given the characteristics of the trading and reporting mechanisms and the linkage between them. Q13.6: Do consultees support the view that only intermediaries who have created a risk position to facilitate the trade of a third party should benefit from deferred publication or should all trades that are above the block size be eligible for deferred publication? Ad. Q 13.6: All trades above block size should be eligible for deferred publication. We strongly recommend a simple model to define the appropriate block size e.g. an amount. Q13.7: Should the identifier of a security be harmonised and if so to what extent? What should be the applicable standard (ISIN code, other)? Q13.9: Should CESR initiate work, in collaboration with the industry and data publishers, to determine how best to ensure that post-trade transparency data be disseminated on a pan-european basis? Ad. Q 13.7. It depends on the development in the rest of the world. The problem of static information needs to be addressed at a global level. For Europe to maintain its international competitiveness it will be important not to try to develop a European solution which takes no account of the rest of the world. Ad. Q 13.9: There is an important debate to be conducted about appropriate methods of collation and dissemination of trade data, recognising the fact
that opinions differ as to the most appropriate methods. Such work should be carried out separately from the development of Level 2 measures under MIFID. It should also be done at a later stage and be left to the market forces. Page 10 Kind regards Berit Dysseholm Fredberg Direct 3370 bef@finansraadet.dk