Trade Surveillance and Regulatory Compliance Solutions | eflow

Best execution compliance in a global context

sales@eflowglobal.com (eflow) — Mon, 13 Jan 2025 14:32:05 +0000

In the fast-paced world of global finance, where literally every second counts and market volatility is accepted as the norm, ensuring clients get the best execution is more than a priority; it’s a regulatory necessity. Relatively simple in theory, in practice, best execution regulation has evolved into a complex global challenge, with expanding markets, technological advancements, and ever-evolving regulations in Europe, the US, and further afield.

Regtech companies now face a challenging balancing act: delivering compliance across diverse jurisdictions while managing obstacles from data integration to cross-border market dynamics. This article considers the critical role of best execution compliance, the challenges faced by firms trying to navigate it, and the innovative solutions emerging from the Regtech sector, paving the way forward.

The global regulatory landscape and best execution compliance

To address best execution compliance requirements across numerous markets and jurisdictions, it’s important to appreciate the diverse nature of current regulations and the impact on and challenges faced by the Regtech sector.

Diverse regulatory standards

When it comes to best execution, the global regulatory landscape is still somewhat varied, though growing more standardised with each passing year. As financial markets have grown increasingly globalised, there has been a clear move towards international harmonisation of regulatory standards. Best execution is just one such area that has been impacted by this trend.

Generally speaking, regulatory stances shift towards the dominant regulations from major market players, such as MiFID in the EU, and the SEC’s rules in the US. While other countries and regions will fight to maintain a degree of independence when it comes to regulations, they will need to adhere to the more dominant regulations to encourage confidence amongst global institutions and investors.

For the time being, however, the fact of the matter is that there exists a degree of variability across regulatory jurisdictions. As such, the main challenge for both financial institutions and Regtech providers is aligning local variations and formats across multiple jurisdictions.

Impact on Regtech

Outsourcing the monitoring of regulatory responsibilities is now commonplace across the financial services industry. There are two primary reasons for this:

Cost savings: Maintaining in-house teams focused on different market regulations is costly and time-consuming.
Technological advances: Cutting-edge Regtech innovations have significantly reduced time requirements by enabling the use of diverse data types.

This enables financial institutions to focus on core strengths—client interactions, investment strategies, and growth—while knowing that advanced Regtech systems handle best execution compliance, a benefit well-regarded by regulators.

In this section, we will explain how these diverse standards impact the development and implementation of Regtech solutions.

Data management and integration challenges

Data management is a very complex area in the Regtech market. It involves ingesting and analysing both structured and unstructured data to monitor ongoing best execution compliance while flagging any potential infringements or shortcomings. Aside from the challenges of converting different data types into more useful formats, there’s also the issue of integrating data from multiple systems into a single compliance platform.

Data collection and quality

When integrating data from diverse global sources, the focus is on quality and accuracy. Among other factors, this can be impacted by different formats and field variance across jurisdictions. As mentioned above, global regulators are working more closely together than ever before to align the type, depth, and format of data made available for compliance issues, but data harmonisation remains a challenge.

In an attempt to more closely integrate into the global investment market, many of the peripheral markets and associated regulators are now aligning their operations with leading counterparts. This introduces a critical element of trust and could be the difference between financial institutions operating in different jurisdictions. As global standards emerge regarding data collection quality, this makes it easier to tweak and make changes in the future.

Data integration

Collecting different forms of data than reformatting while maintaining accuracy is a challenge in itself. Beyond that, an additional challenge is found in the integration of data from different systems, different markets, and pertaining to different asset classes.

Recent example

Monitoring best execution in one particular market in isolation is dangerous, as we saw with the US subprime mortgage crash in 2007. At the height of the housing boom, mortgages were approved where the client had little chance of ever fulfilling their financial obligations. The leading financial institutions quickly sliced and diced these arrangements, creating income and capital-focus bonds that often failed to reflect the underlying risks.

The complexity of these arrangements and the challenges in connecting them back to the original mortgages meant it was near impossible to accurately reflect the growing risk. When the housing market cooled, the default rate on subprime mortgages increased, leading to the collapse of what had become a huge mortgage-backed bond sector.

Lack of interconnectivity

If financial institutions and regulators had been able to connect systems, markets, and different asset classes, creating a complete virtual paper trail, warning signs would have emerged much sooner. This brings us to the issue of streamlining data integration and ensuring consistency so that Regtech companies, financial institutions, and regulators can join the dots.

Technological infrastructure and real-time monitoring

Enhancements in technological infrastructure are critical when it comes to best execution regulations and the wider regulatory framework. There is also the holy grail of real-time monitoring, which is, for many, the ultimate goal, but is it really achievable?

Technological demands

As with any investment transaction, it’s essential to address the risks and potential rewards of ongoing investment in technological infrastructure. We know that using advanced analytics, AI, and machine learning undoubtedly improves monitoring capabilities, but what’s the ultimate aim? In the world of business, there is an inevitable trade-off between investment and return, and it is no different for technology. Does the industry need to invest a few hundred million dollars to capture the outstanding 0.001% of questionable transactions?

In many ways, real-time monitoring is a fallacy because as soon as the data is received, many would argue systems are taking a reactive rather than proactive approach. This is at odds with the definition of real-time monitoring, but in reality, it is as close as we will get. Looking further down the line, the emergence of potential red flags will require the human touch at some point to decide whether further investigation is required.

Scalability and costs

As a financial institution looking at Regtech compliance systems, scalability is one of the major attractions. This allows many financial institutions to grow with the confidence that cost-effective scalability of existing compliance systems is achievable. However, it is important to appreciate that widespread scalability can place pressure on the availability of skilled personnel and storage and processing capacity.

We can’t simply continue scaling high-tech systems without appreciating, albeit expanding, broader capacity. There is also the ESG angle, with many investors, financial institutions, regulators, and governments more acutely aware of their wider responsibilities. To suggest that we can scale and expand technological capacity going forward is certainly naïve and potentially dangerous if not conducted in a controlled manner.

Cross-border compliance and market dynamics

The key to cross-border compliance, considering different market dynamics, is broad alignment across markets, financial institutions, and regulators. In many ways, you could argue that all parties are being forced to work together to accommodate an expanding global financial market.

Cross-border challenges

There are numerous examples of cross-border challenges, but one topical issue is cryptocurrency. Amid an ever-tightening regulatory burden in Europe, the UK, and the US, regulators in Hong Kong have taken a more accommodating and investor-friendly approach. Many would argue this has placed the region as the global cryptocurrency hub, which brings about its own global regulatory challenges.

This market is relatively early in its regulatory journey within an emerging but not yet finished structure. So, not only are there best execution compliance issues to address in local markets, but in many ways, this perfectly reflects cross-border/global challenges amidst the need to build trust and confidence.

On a more basic level, there are other issues to consider, such as:

Varying market structures
Trading hours
Liquidity

For example, liquidity is one issue often overlooked when it comes to best execution compliance. Without a reasonable level of liquidity, you may be dealing on the best screen/market price, but can you guarantee to a client that this is a fair valuation?

Market dynamics

As a basic point, it’s helpful to look back and see how far compliance and, more lately, Regtech companies have come in recent years. We can only imagine the challenges faced by more manual-focused compliance processes on a local and global scale, taking in issues such as:

Market volatility
Geopolitical changes
Emerging markets

These are still significant issues today for technology development, and more cooperation between global regulators has, to a certain extent, enhanced the ways they are monitored. We are not suggesting that these issues are more controllable in the current environment; they are just situations that are more transparent.

Strategic solutions

While the introduction of AI and machine learning has significantly improved the delivery of compliance monitoring technology, it doesn’t really change the fundamentals. While this article is focused on best execution regulations, the concept of strategic solutions is broader.

Working closely with financial institutions and market operators, Regtech companies constantly collaborate with global regulators while monitoring market conditions. Taking a step back, it’s important to separate the theory of global regulation from the practice of using cutting-edge technology to enhance transparency and compliance.

Ultimately, unless all of the global entities involved in financial markets, transactions, and regulation work together, singing perhaps not from the same hymn sheet but from a similar hymn sheet, the potential of technological advances will not be fulfilled.

eflow’s advanced execution monitoring solutions

Compliance demands extend beyond simple trade reporting in today’s rapidly evolving regulatory environment. Financial institutions require dynamic tools to ensure best execution while maintaining data accuracy, transparency, and auditability across global jurisdictions. eflow offers a comprehensive suite of execution monitoring services designed to address these challenges efficiently and effectively.

Best execution monitoring

eflow’s platform uses analytics and machine learning to track execution quality instantly, identifying issues like price slippage and delays as they happen.

Customisable compliance

Firms can set region-specific parameters (e.g., MiFID II, FINRA) to align with local regulations while maintaining global best execution standards.

Automated audit trails

eflow provides detailed transaction records and customisable reports, simplifying internal audits and regulatory reviews.

Easy system integration

eflow’s platform integrates with legacy systems, minimising disruptions and reducing compliance upgrade costs.

Why choose eflow?

By combining advanced analytics with monitoring, customisable parameters, and robust reporting capabilities, eflow provides financial institutions with a sophisticated, reliable compliance solution that can adapt to the ever-changing landscape of global regulations. With eflow’s tools, firms can confidently ensure best execution compliance, reduce operational risks, and maintain trust with clients and regulators alike.

Conclusion

When looking at best execution compliance globally, it is important to appreciate how this contributes to trust in individual markets and the emerging global market. Similarly to the contagion we saw during the corporate financial crisis, an emerging mistrust in one market can quickly be replicated in others. This gradual reduction in trust can cause significant market volatility and, as we have seen in recent times, potentially expensive intervention by central banks, governments and regulators to reinstate trust and markets.

Regulators worldwide are working together to create a more structured approach to global investment regulations and compliance. While this is an ongoing process, many believe that the future challenges lie in connecting activity in different markets, such as equity markets, derivatives, and futures (and their numerous variations).

As a financial institution, it is important that you continue to invest in advanced technologies, especially with increased regulatory compliance obligations. At eflow, we provide the latest in transaction monitoring and best execution analysis services. Using cutting-edge technology, we are able to monitor and analyse data extremely quickly, creating the appropriate red flags for further investigation.

Navigating the complexities of best execution legislation

sales@eflowglobal.com (eflow) — Thu, 12 Dec 2024 11:18:00 +0000

Before the “Big Bang” of deregulation in 1986, which led to a period of self-regulation, there had been little specific financial services legislation. We can look back to the Prevention of Fraud (Investments) Act 1939, various adjustments in 1958, the authorisation of insurance companies in 1967, and the licensing of banks under the Banking Act of 1979. There had been several industry codes, but there was little, if anything, in the way of legislation regarding best execution.

Reporting statistic: Did you know that the introduction of MiFID II increased the number of transaction data points from 24 to 65?

At the time, self-regulation within a predefined structure offered the best of both worlds for the financial services industry: flexibility within a recognised framework protecting investors and markets. However, it soon became apparent that in a changing world, with a significant increase in trading volumes and the growing influence of financial giants, self-regulation would eventually be replaced.

There was significant movement on the regulatory front at the turn of the century, which resulted in:

Implementation of MiFID I in 2007
Expansion under MiFID II in 2018
Post-Brexit adjustments from 2016

Immediately following Brexit, the UK and EU authorities appeared to be moving in the same direction regarding best execution legislation. However, there has been a degree of divergence in recent times, most notably with RTS 27 and RTS 28 reporting.

Divergence in reporting

As of 2021, UK firms and execution venues operating under UK financial services regulations are no longer required to produce RTS 27 and RTS 28 reports. The guidance from ESMA was slightly different, advising firms and venues to “deprioritise” the reports from 2020 and 2022, respectively. There was also some conflict in the way that ESMA recognised CFD platforms and services as trading venues, even though they did not have access to the required information to produce the statutory reports.

The RTS 27 report covered a number of execution quality metrics enabling investors and third parties to compare and contrast trade execution standards across different venues. RTS 28 was focused on the five main venues at which individual firms carried out the majority of their trade execution activity.

US regulatory adjustments

Looking further afield to the USA, SEC Rule 606 was introduced in 2000 and amended in 2018 and 2023 to reflect an evolving market structure. Changes to Rule 606 have enhanced transparency for investors and also brought an array of different revenues under the umbrella of best execution regulations.

Key elements of best execution legislation

In essence, best execution legislation obligates firms carrying out investment business to obtain the best possible result for their clients when executing client orders. This obligation relates to transactions carried out by the firm or passed to others to execute. There are numerous factors, the most basic of which are:

Price
Cost
Speed

Beyond these three core factors, there are also more complex considerations such as likelihood of execution under the prevailing market conditions, prompt and efficient settlement, the size of the transaction, and the nature of the business. All of these factors come together to create a transparent trading procedure that gives clients confidence and assists with market efficiency.

The European Securities and Markets Authority (ESMA) published a consultation paper on 16 July 2024 covering order execution policies and obligations under MiFID II and MiFIR. The deadline for comments is 16 October 2024, and the final draft report must be submitted to the European Commission by 29 December 2024.

Details of the consultation

The consultation paper was the result of research carried out by ESMA, which revealed several common issues in the best execution strategies of financial firms, such as:

Limited documentation to justify the choice of execution venue
Only disclosing generic information about order execution policies
Limited clarity that company execution policies were followed

Under the consultation, investment firms will be encouraged to revisit their order execution policies to include the following:

Details of trading venues which ensure continuous best execution
Identifying particular venues for different financial instruments/types of client
Information used when seeking best execution with different venues
Further details of automated trading services

In relation to the ongoing assessment of an investment firm’s order execution policies, they will need to set out clearly:

The frequency and methodology used to monitor their order execution policy
If monitoring is delegated to a third party, the process must be regularly assessed
Policies must be reviewed at least annually
The annual review process must include consideration for new execution venues

The consultation also includes reference to execution policies about client instructions and the execution of client orders through the company’s own account dealing. Individual firms must set out:

Arrangements for dealing with specific instructions from clients
Identify how orders with specific and non-specific client instructions are executed
Document how client instructions might impact the venue used for best execution
Detail instances where client transactions may be executed via the company’s own trading account
How potential conflicts of interest are identified, managed and prevented

It still remains to be seen whether the FCA will follow in ESMA footsteps, or if we will see a further divergence of policy and approach with regards to best execution legislation.

Challenges in implementing best execution legislation

Historically, financial markets have been relatively adept at responding to emerging trends and new financial instruments. However, the exponential increase in the complexity of financial services over the past 20 years has caused serious challenges for global financial regulators. .

While the recent introduction of Consumer Duty Regulations has attempted to put client protection front and centre with the emergence of new checks, procedures and legal undertakings, a number of ongoing challenges still persist.

Data capture

The use of cutting-edge technology has facilitated the capture of in-depth trading data, which is required to monitor best execution practices. This has also expanded the amount of data reviewed and analysed compared to years gone by. The increase in the number of data points from 24 to 65 required systems to be adjusted, but this certainly won’t be the last significant change.

Potential conflicts of interest

As we mentioned above, regarding the ongoing ESMA consultation, financial firms are now obliged to disclose how they identify and manage potential conflicts of interest. This doesn’t change the focus on best execution for clients, but it does address potentially unavoidable conflicts of interest.

Regulatory complexities

In the immediate aftermath of Brexit, EU and UK financial regulators seemed to move in the same direction and appreciate the broader consequences of any significant diversions. Recently, there have been signs of slight divergence, although this is unlikely to be too dramatic as UK firms regularly trade with their EU counterparts and vice versa.

Technology infrastructure

In the past, many large financial institutions retained monitoring and regulatory activities in-house. As the regulatory landscape became more cluttered, in-depth, demanding, and expensive, implementing solutions from third-party vendors has become the preferred approach. This allows financial services firms to avoid the investment of time, money and human resources required to implement and maintain best execution monitoring systems in house.

The growing number of outsourcing options has allowed financial institutions to focus on their core operations, enhance their business, and increase income. Due to the technological nature of best execution monitoring services, they are easily scalable and have significant capacity.

How can eflow help you meet your best execution legislative obligations?

TZBE is eflow’s Best Execution and Transaction Cost Analysis (TCA) tool, that can accommodate a variety of trading platforms, financial instruments and asset classes. The combination of a considerable increase in trading volumes and regulatory obligations in recent years means that manual best execution testing is no longer an option.

Beyond simply monitoring for best execution, TZBE also provides:

Automated and streamlined best execution testing
Potential cost-saving insights into trading procedures
The ability to evolve/grow with your business strategy
Strengthening of regulatory responses, avoiding penalties and fines
Automated record-keeping saves time and enhances accuracy
The opportunity to tailor the system to your specific requirements

Other benefits include automated data enrichment, testing against industry benchmarks and the archiving and indexing of historical data. There’s much more to consider than just a best execution monitoring service.

Trading statistic: As of 2024, 80% of trades in UK markets are executed electronically, helping brokers achieve best execution more efficiently.

The future of best execution legislation

Amid broader regulatory changes and enhanced obligations for financial services companies, it’s important not to lose track of the core focus: market integrity and client protection. The globalisation of investment markets has increased cross-border trading and could (potentially) bring different best execution regulations into play. In reality, it is in the best interests of regulators to work together, creating compatible regulations and reporting requirements to minimise the cost of monitoring best execution and maximising regulatory protection.

Rather than individual financial institutions constantly investing in new technology and seeking global regulatory interconnection, eflow can react to changes and, working with third parties, encourage cooperation between regulators. This means that all clients benefit from this ongoing investment, not to mention the experience and expertise built up over the years.

Case studies

It is not difficult to see how conflicts of interest may emerge when it comes to best execution; it may be useful to look at practical case studies from recent times.

Barclays Capital’s $2 million fine

Between January 2014 and February 2019, US regulator FINRA discovered that Barclays Capital routed all customer orders through its own trading system, LX, before rerouting to competing venues where applicable. The regulator found evidence of a lower fill rate on the LX platform, which was detrimental to clients.

Deutsche Bank fined $2 million

FINRA was again headline news in 2022, delivering a $2 million fine to Deutsche Bank for best execution violations. Unless otherwise requested by clients, the default routing path for client orders was through the company’s ATS trading platform, known as SuperX. Whether transactions were executed through the platform or rerouted to alternative venues, the regulator found inherent delays and occasions where orders were not fully executed.

GlobaLink Securities issued $200,000 fine and a restitution order

In addition to the $200,000 fine, GlobaLink Securities was ordered to pay nearly £400,000 in restitution payments to customers. The company was found to have charged markups and markdowns ranging from 2.3% to 9.34% on 137 corporate bond transactions. This was despite the fact that the company’s clearing firm carried out the client transactions with no additional costs to GlobaLink Securities.

Unpacking ESMA’s technical standards for best execution: A closer look at the latest consultation

sales@eflowglobal.com (eflow) — Fri, 30 Aug 2024 12:50:00 +0000

Legal background and purpose of the Technical Standards

On 8th March 2024, an amendment to the Directive on Markets in Financial Instruments (MiFID II review) was published in the Official Journal of the European Union. This amendment mandates the European Securities and Markets Authority (ESMA) to develop Regulatory Technical Standards (RTS), aiming to specify the criteria for establishing and assessing the effectiveness of investment firms’ order execution policies.

ESMA’s latest Consultation Paper seeks stakeholders’ views on these proposed standards. Feedback from this consultation will be considered by ESMA, with the final report and draft RTS expected to be submitted to the European Commission for endorsement by December 29, 2024. This blog serves to summarise and contextualise the RTS, providing investment firms with a clear understanding of the new criteria.

Revisiting MiFiD II Article 27 - Best Execution

Understanding MiFID II’s Article 27 is crucial as it contains firms’ current best execution requirements, and is therefore the backbone of the proposed RTS. This article mandates that investment firms take all sufficient steps to achieve the best possible result for client orders, considering factors like price, costs, speed, and likelihood of execution and settlement. For retail clients, it emphasises the importance of total consideration, including all related execution costs. Firms must implement and monitor an effective order execution policy to ensure transparency and consistently optimal outcomes for clients.

Shortcomings in firms’ execution policies

ESMA’s MiFiD II reviews have highlighted shortcomings in firms’ actual implementation of execution policies. Some firms have failed to:

Provide sufficient documentation to justify their choice of execution venue
Properly demonstrate that they executed client orders in accordance with order execution policies
Disclose details other than generic information about order execution policies and their steps taken to obtain the best possible result when executing client orders

As a result, the RTS laid out in the consultation paper are focussed on making sure that order execution policies effectively contribute to enhance the execution quality for retail and professional clients.

Key elements of the proposed draft RTS on firms’ execution policies

1. In their order execution policies and arrangements, firms should distinguish between the different classes of financial instruments they offer.

These classes should be based on ISO Standard 10962, using the first two letters of the CFI to correspond to a class of financial instrument. Additionally, each country of primary listing for equity instruments (CFI code starting with “E”) should constitute a separate class. Firms may, in some cases, cluster several classes of instrument into a single class if it doesn’t impair achieving the best possible result.

ESMA Q1: Do you agree with the proposed categorisation of classes of financial instrument? Could the methodology based on the classification of instruments in the MiFiD II RTS 1 and 2 used in the context of MiFiD II transparency reporting be an alternative?

The alternative methodology ESMA is referring to: A fixed list of classes could be used, based on MiFID II RTS 1 and 2 classifications.
- Equities by country: Each country of primary listing for shares in companies would be a separate class
- Other instruments: Other financial instruments could be grouped into 15-20 classes
- Clustering allowed: Clustering of several classes into a single class could also be permitted under this methodology

2. Firms should pre-select eligible venues for client order execution according to meaningful criteria determining to what extent the best possible result can be obtained for clients.

Venues are to be selected per class of financial instrument, per category of retail and/or professional clients, and by accounting for certain further factors including:

Different order frequencies and values for retail and professional clients respectively
Whether the executed financial instruments are EU or non-EU instruments

Overall, the draft RTS proposes that firms keep an updated list of venues for the execution of client orders. The list must consist of venues authorised by national competent authorities or third-country authorities, and it must be determined according to the firms’ internal governance procedures. The list must include:

Date of approval, name and capacity of the person or name of the governance body that approved the venue
Which classes of financial instrument the venue can be used
Which categories of clients the venue can be used

ESMA Q2: Do you believe that the current wording of the RTS is clear and sufficient with regard to the content of the order execution policy where an investment firm selects only one execution venue to execute all client orders? Or should the RTS provide for specific criteria to be taken into account when assessing if the selected venue achieves the best possible result in the execution of client orders? Please also state the reasons for your answer.

The proposal to categorise venues by class of financial instrument and client type, and to consider order frequency and value, ensures a tailored approach. The requirement for an updated, governance-approved list of venues promotes transparency and accountability. The current wording of the RTS may or may not be sufficient, but including specific criteria for assessing single venue selections would enhance clarity and ensure consistent best execution practices.

3. Firms should distinguish between obligatory and discretionary factors in cases where a client order could be executed at several venues.

Criteria and relative importance must be specified for (i) each class of financial instrument (ii) retail and professional clients and (iii) based on analysis which must include certain factors such as:

All costs directly related to the execution
Real-time market or historical data on the relevant financial instrument or class of instrument
Size and nature of the order

If the firm uses an automotive order routing system, it must describe the main characteristics of the system.

ESMA Q3: Do you agree with the proposed factor of “order sizes” respectively for retail and professional clients, to be considered in investment firms’ selection of eligible execution venues in their order execution policy and internal execution arrangements (see Article 4(1)(d)(i and ii) of the draft RTS)? If not, what alternative factor would you propose?

Differentiating order sizes for retail and professional clients aligns with the principle of best execution by ensuring that larger, more complex orders are handled with the necessary sophistication, while smaller orders receive appropriate attention to detail. Some alternative factors include liquidity conditions or market impact considerations to further refine the execution quality.

4. Firms must continuously monitor their execution quality, triggering reviews of their execution policies and venue selection if significant events impact quality or if performance is deemed to be insufficient.

Firms are to specify the frequency and methodology of their monitoring within their execution policies, allowing them to assess all transactions or representative samples for each class of financial instruments. Monitoring performance against specific thresholds can prompt venue reviews if performance falls below predetermined levels. Firms may use third-party monitoring but must carefully evaluate the third party’s processes.

Firms are also required to conduct regular reviews of their execution policies and arrangements, assessing venues at least annually or upon material changes. Reviews must consider new venues and services, and firms must update their policies and correct deficiencies promptly, within three months at most. Assessments should compare transaction prices against reference data and distinguish between execution-related fees and venue membership costs. Third-party analysis is permitted but must be thoroughly reviewed by the firm to ensure it represents the firm’s client base accurately.

ESMA Q4: Do you agree with ESMA’s proposals for the specification of the criteria for establishing and assessing the effectiveness of investment firms’ order execution policies?

ESMA Q5: Do you agree with ESMA’s proposal that investment firms may rely on monitoring and assessments performed by third parties, such as independent data providers, as long as firms assess the processes of these third parties?

Continuous monitoring and regular review of execution policies are vital for maintaining best execution standards. ESMA’s proposals to specify monitoring frequency and methodology ensure consistent oversight and prompt action when performance falls below set thresholds. Allowing third-party monitoring and assessments is practical, provided firms rigorously evaluate these processes. This balance of internal and external oversight helps firms stay compliant and adapt to market changes effectively.

5. Firms must outline how they handle specific client instructions, detailing the impact on venue selection and best execution criteria.

Within their order execution policies, firms must differentiate between orders with and without specific instructions, explaining that specific instructions involve choosing from multiple options or directing the firm to handle the order differently from the policy. Only the instructed part of the order is treated as specific instruction, with other parts processed normally. Additionally, if firms allow clients to choose execution venues, the policy must explain measures to avoid inducing venue choices and include a warning about the potential impact on achieving the best possible result.

ESMA Q6: Concerning the specific client instruction, should it be possible for an investment firm to pre-select an execution venue in the order screen, where the firm invites its clients to choose an executing venue out of multiple options? And if so, do you agree that only if the client chooses a different venue than the one pre-selected by the firm, the choice of execution venue does constitute a specific instruction?

Allowing clients to choose execution venues requires clear measures to prevent undue influence and ensure clients are aware of the potential impacts on execution quality. The proposal for pre-selecting venues streamlines the process, but it’s essential that any client deviation is explicitly treated as a specific instruction to maintain transparency and regulatory compliance. This approach balances operational efficiency with client autonomy and regulatory standards.

6. Investment firms’ order execution policies must ensure the best possible result for clients when executing orders on their own account.

Firms must specify that “own account dealing” is allowed only if it is expressly provided for in the policy and results in the best outcome for clients. The policies must also address conflict of interest management and ensure fair pricing for OTC products, complying with organisational and methodological disclosure requirements.

ESMA Q7: Where an investment firm executes client orders by dealing on own account (including back-to-back trading), in light of the specificity of this execution model and since it is bound by the rules governing best execution, do you believe the current text is clear with regard to what kind of obligations an investment firm applying such models should comply with? Or do you believe it would be useful to provide in the RTS list and explanations of information that should be included in the order execution policy, such as related to the method and steps to be taken by the firm to establish the price of client transactions in back-to-back trading, or the methodology for the firm’s application of mark-ups or mark-downs in such order executions?

Dealing on own account inherently involves conflicts of interest, as firms may prioritise their own profits over clients’ best interests. Specific guidelines in the RTS for price setting and applying mark-ups or mark-downs would mitigate these conflicts by ensuring transparent and fair pricing practices. These guidelines would provide a clearer framework for firms to follow, potentially enhancing compliance and protecting clients from unfair practices

Conclusion

The proposed RTS under MiFID II aim to elevate the standards of best execution by requiring investment firms to adopt a granular and data-driven approach to order execution. But while the new rules should drive better client outcomes, they present operational challenges for firms reliant on more manual, spreadsheet-based evaluation.

eflow Global’s TZBE system is specifically designed to meet these demands, automating the analysis of cost, speed and likelihood of execution, broken down by asset class. The platform is entirely customisable and firms are able to tailor the system to account for organisation-specific requirements and client instructions, ensuring ongoing compliance with the detailed stipulations of the RTS.

The ESMA consultation serves as an opportunity for investment firms to have their voices heard in the development of the RTS. But with a limited feedback period and a likely short implementation window, it’s important that firms are proactive in evaluating their current execution policies and surrounding technology stack to ensure they are prepared for more rigorous standards. By embracing advanced solutions like TZBE, firms can not only navigate these regulatory changes but also position themselves at the forefront of industry standards, ensuring they deliver the best possible outcomes for their clients in an increasingly competitive market.

Enforcements update: almost $400 million dished out in fines in the first two months of 2024

sales@eflowglobal.com (eflow) — Tue, 05 Mar 2024 09:00:00 +0000

On February 13th 2024, eflow launched an extensive research-based report exploring global market abuse trends, including quantitative analysis on market abuse enforcement from 2019-2023 across eight jurisdictions. This shed valuable insight on the challenges that firms are facing, and the key areas of focus for regulators.

This piece is eflow’s latest update on global market abuse enforcements, providing an overview of the busy start to 2024 which has hit broker-dealers, investment advisers, pension providers and major investment banks alike.

In the first two months of 2024, we saw 24 market conduct enforcements:

These enforcements were across four jurisdictions:

They totalled $397.6 million

These numbers tell their own story. There is clearly a continuous regulatory drive to clean up market conduct, led by the US with a sharp focus on eComms Surveillance and a heavy hand for failures in trade reporting.

The following sections provide details on the key enforcements that you should know about.

Trade reporting

Trade and transaction reporting represent a complex set of obligations that many firms have struggled to fully implement. Their importance is not up for debate however, as accurate and timely trade reporting forms the basis from which fundamental risks such as market abuse can be monitored and mitigated.

The most substantial fine so far in 2024 was issued for lapses in trade reporting. Specifically, JP Morgan Chase and Co is set to pay ~$350 million civil penalty for failing to feed certain trade and order data to its internal trade surveillance platforms. These surveillance platforms are a critical piece of the puzzle, used to ensure the integrity of markets, monitor for fraudulent activities, ensure regulatory compliance and, ultimately, protect the interests of investors. Any related reporting deficiencies, whether it be incomplete, missing or incorrect data, significantly diminishes the efficacy of firms’ surveillance algorithms.

The firm has undertaken corrective actions, which involve improvements to both the inventory management and the data accuracy controls within its Corporate and Investment Banking division. Additionally, as a condition of the anticipated agreements with the two regulatory bodies, the firm has indicated it will be required to “complete its remediation, engage an independent consultant, and pay aggregate civil penalties of approximately $350 million.”

Trade surveillance

The start of 2024 saw regulators uncover two notable instances in which institutions did not have appropriate procedures and/or technology in place for analysts to identify suspicious trade activity.

Online broker, TradeStation, failed to reasonably escalate suspicious customer trading activity flagged by their automated surveillance system due to inadequate procedures for analysts reviewing the alerts. Certain examples of potentially suspicious activity were said to have slipped through the cracks as a result; these include a customer involved in potential pump-and-dump schemes and an institutional customer with significant alerts for wash trades and layering.

Goldman Sachs, on the other hand, was found to have had more fundamental gaps in their surveillance technology, with circa 5,000 alerts for potentially manipulative trading going undetected between 2009 and 2023. During this time, Goldman failed to include warrants, rights, units, and certain over-the-counter (OTC) equity securities in automated surveillance reports used to detect potentially manipulative trading by the firm and its customers.

eComms surveillance

2022 and 2023 were record-breaking years for all the wrong reasons, with regulators issuing north of $2.6bn in financial sanctions to a host of banks - including some of Wall Street’s biggest - for widespread use of private messaging, or “off-channel” communications. At the end of 2022, Chair of the U.S. Securities and Exchange Commission, Gary Gensler, made it clear that the regulator was just getting started in its punishment of recordkeeping violations.

The latest swathe of penalties demonstrate the supervisors unwavering intent to pursue and penalise institutions who fail to monitor business-related communications. At the beginning of February, the SEC ordered sixteen firms to pay more than $81 million combined to settle charges for widespread recordkeeping failures.

The SEC’s probe uncovered pervasive and longstanding uses of unapproved communications (from at least 2019 or 2020) across five broker-dealers, seven dually registered broker-dealers and investment advisers and five affiliated investment advisers. Importantly, investigators found that employees at all levels of the organisation, including supervisors and senior managers, had sent and received off-channel communications related to recommendations made or proposed to be made.

Insider trading

At the start of 2024, the Financial Conduct Authority (FCA) delivered its first insider trading conviction since 2019. A former Goldman Sachs analyst was sentenced to 22 months in prison after being convicted of nine counts of insider dealing and fraud. The individual falsely obtained bank loans for home improvements but used these funds for 46 illegal trades under his siblings’ names, hiding the activity from Goldman Sachs. The FCA’s proactive stance is evident, with 17 ongoing insider dealing investigations, signalling the need for firms to align with regulatory standards.

The role of technology

The role of modern, specialised technologies in solving these problems is now clear to the industry, with 96% of compliance professionals planning to invest in technology. However, these enforcements point to the importance of holistic coverage, due to the knock-on effects of a single weak link.

For example, JP Morgan’s trade reporting failures meant that its trade surveillance capabilities were also compromised, as they were operating without the necessary data. Similarly, the recent wave of eComms enforcements reflect the realisation that market abuse is easier to detect when supported by contextualising communications data.

Actively tracking enforcements enables eflow to continuously innovate and shape its solutions to the present demands of the market. This involves developing solutions specifically tailored to the problems that are causing enforcement actions against firms, including the need for a comprehensive compliance suite:

TZTR Transaction Reporting

eflow’s universal transaction reporting module includes solutions for EMIR and MiFIR via a single platform. It acts as the centralised digital hub from which you can manage all aspects of your reporting strategy.

TZTS Trade Surveillance and Market Abuse

eflow’s dynamic and highly configurable trade surveillance tool is powered by machine learning and behavioural analytics to automatically monitor your trades for over 40 forms of market abuse.

TZEC eComms Surveillance

eflow’s eComms surveillance system generates a comprehensive view of various communication channels, identifies potentially suspicious behaviour, and helps you to make informed, data-led decisions.

TZBE Best Execution

TZBE is eflow’s Best Execution and Transaction Cost Analysis (TCA) tool and offers your firm a configurable digital solution to comply with these requirements quickly, efficiently and accurately.

If your firm could benefit from additional expertise and tooling in navigating the regulatory landscape, book a consultation today.

Please note that the above does not constitute an exhaustive list of all regulatory enforcements across all jurisdictions, nor does it constitute legal advice. It is intended as a thorough sampling and analysis of regulatory enforcement from the world’s largest financial regulators.

Market conduct in the US: An evolving regulatory landscape

sales@eflowglobal.com (eflow) — Tue, 31 Oct 2023 08:00:00 +0000

Regulatory change in the US

Background

Over the past few decades, the US financial sector has witnessed unprecedented growth, diversification, and complexity. As markets expanded, so too did the challenges associated with ensuring transparency, fairness, and investor protection. Historically, while regulations played a crucial role in maintaining market integrity, certain gaps and grey areas increased the potential for abuse and manipulation.

The Trump era witnessed a push for deregulation in many sectors, including finance. However, the winds of change have been blowing hard since Gary Gensler took over the helm at the SEC. Gensler’s tenure has seen a regulatory blitz, reminiscent of the agency’s response to the 2008 global financial crisis. With a whopping 47 rule proposals impacting market participants, many of which weren’t mandated by congressional legislation, Gensler’s approach signals a paradigm shift

These changes serve as a clear call for market participants. The subsequent wave beckons firms to rethink their strategies and bolster their compliance infrastructures. As the SEC adapts to modern market dynamics and challenges, the era of laissez-faire seems to be on its way out, replaced by a new age of proactive oversight and diligence.

In this blog, we explain and assess the impact of developments by the SEC under Gensler’s leadership:

Closing the Oversight Gap: The New Regulatory Mandate for Proprietary Trading Firms
Proposed “Regulation Best Execution”
Security-Based Swap Rules

Three key developments

Closing the oversight gap: The SEC’s new regulatory mandate for proprietary trading firms

Overview

In a significant move to strengthen market transparency and fairness, the US Securities and Exchange Commission (SEC) has broadened the oversight scope of the Financial Industry Regulatory Authority (FINRA). Historically, proprietary trading firms (PTFs) that conducted their trading activities solely on exchanges were exempt from the oversight of FINRA. This exemption was based on the understanding that these firms were trading exclusively on centralised exchanges where there was already a certain level of transparency and oversight. However, an evolution in trading behaviour has led to a situation where, despite participating in off-exchange activities, some PTFs are still operating under the original exemption - constituting a “regulatory gap”.

The SEC’s amendments are set to remove this exemption, and thereby close the gap, compelling these firms to now register under the new regulations. The objective is clear: to bring previously unmonitored trading activities into the light, levelling the playing field across firms.

SEC Chair Gary Gensler underscored the importance of this measure, remarking, “Today [23 August 2023], a significant portion of broker-dealers participate in cross-exchange or off-exchange trading. Yet, they lean on an exemption from national securities association registration that pre-dates the cell phone era. This has carved out a regulatory void, where firms with monthly trading volumes amounting to hundreds of billions stand outside the national securities association oversight.”

What does this mean for firms?

As PTFs transition from being registered solely with exchanges to falling under the purview of FINRA, several new requirements and responsibilities come into play. The most significant of these include:

Capital adequacy requirements: FINRA has specific rules ensuring firms maintain sufficient capital.
Best execution obligations: FINRA mandates that broker-dealers ensure they provide the best execution for their customers’ orders, even if it means routing them to different venues.
Comprehensive reporting and record-keeping: Beyond just trading data, FINRA requires detailed reporting related to firm operations, sales practices, and customer interactions.

SEC’s proposed “Regulation Best Execution”

Overview

The landscape of regulatory requirements for broker-dealers is on the cusp of transformation. The SEC has recently unveiled its proposed “Regulation Best Execution.” While best execution as a principle is not novel, the depth and breadth of this proposed regulation marks a significant shift. Here’s a closer look at what’s on the horizon:

Elevated due diligence: Broker-dealers will be obligated to construct policies and procedures addressing best execution. This encompasses a meticulous assessment of market data, the characteristics of orders, and the balance between enhancing price and managing execution risk.
Standardisation across security types: The proposal institutes a cohesive best execution framework across diverse security types.
Regular reviews and documentation: Firms will be mandated to perform quarterly reviews of execution quality compared to other markets as well as an annual introspection of policies, presented to the governing body of the broker-dealer.
Expanded recordkeeping: Rule 17a-4 will now encompass additional record keeping obligations, ensuring firms maintain detailed records stretching back for a minimum of three years, including documentation of compliance with the best execution standard, especially for conflicted transactions.

What does this mean for firms?

The proposed regulation is consistent with existing FINRA and Municipal Securities Rulemaking Board (MSRB) best execution rules in some ways, but goes beyond them in imposing additional/more specific requirements in certain areas. This means even firms with best execution policies in place will need to ramp up their efforts to ensure compliance.

In light of past enforcement issues surrounding best execution, including hefty fines and thematic review findings, this proposed regulation serves as both a reminder and a warning. Broker-dealers should proactively gauge the impact of the proposed regulation, refining existing policies and bracing for the incorporation of newer, more rigorous standards.

Security-based swap rules

Overview

On June 7 2023, the SEC adopted rules to prevent fraud in security-based swaps (SBS) and protect the autonomy of chief compliance officers (CCOs) for certain SBS entities. Rule 9j-1 targets fraud, manipulation, and insider trading linked to SBS, adding specificity to existing securities prohibitions. Key changes:

Rule 9j-1

Clarifies misconduct related to SBS transactions.
Defines “purchases” and “sales” of SBS with added specificities.
Explicitly bars trading in an SBS with knowledge of material nonpublic information about the underlying security.

Additionally, Rule 15fh-4(c) safeguards the independence of CCOs at SBS entities by forbidding coercion or manipulation by entity personnel.

What does this mean for firms?

These rules underscore the SEC’s objective to refine the securities-based swap (SBS) market’s integrity. Given its comprehensive coverage, firms must be proactive to ensure they remain compliant:

Policies review: Firms should revise their procedures and test their systems to ensure they prohibit and detect actions that appear manipulative, like hedging activities that might seem deceptive in SBS transactions.
Information barriers: Establish stringent barriers between operational groups, such as lending and SBS trading teams, to deter potential manipulations.
CCO role & resources: Ensure Chief Compliance Officers (CCOs) are sufficiently resourced and their roles clearly defined to avoid potential conflicts and ensure effective compliance oversight.

The road ahead

Under Gensler’s proactive leadership at the SEC, the US regulatory framework is rapidly evolving. This shift underscores the need for firms to leverage advanced technology. Firms must adopt technology that meticulously addresses specific market concerns like best execution while also being versatile enough to adapt to wider regulatory shifts, especially as transparency demands influence a wide range of areas such as record-keeping, periodic reviews, and reporting.

Best execution and beyond - What’s happening to RTS 27 & 28 post-Brexit?

sales@eflowglobal.com (eflow) — Wed, 31 Mar 2021 23:00:00 +0000

The Brexit transition period has now ended, and the UK has severed its legal framework from the EU. For those expecting a marked change in the way business is done outside of the trading bloc, the past few months may have come as a shock. EU legislation that applied to the UK before 11 pm on 31 December has been

transposed into domestic law

– including the majority of provisions concerning financial firms and the securities markets.

Although the UK’s financial reporting and market abuse regimes continue to closely mirror those in effect across the EU, cracks are starting to emerge. Notably, the UK has temporarily ended the need for firms to file RTS 27 reports on execution quality. While the EU has also enacted its own suspension, the UK’s Financial Conduct Authority (FCA) looks set to abolish the requirement altogether.

As the first signs of divergence between the financial regimes of the EU and the newly independent UK begin to show, we’ve summarised the requirements firms must still meet and outlined where things might change.

RTS 27 reporting requirements suspended

RTS 27 reporting (under Article 27(3) of MiFID II) involves providing quality of execution data on all instruments traded with reference to cost, price, and speed of execution. The obligation usually applies to all execution venues including regulated markets, MTFs, market makers and all firms that execute client orders under the Best Execution regime. EU law requires firms to submit such reports quarterly and in a machine-readable format.

On 19 March 2021, the FCA announced that it would not take action against firms that fail to produce RTS 27 reports for the remainder of 2021. This move follows concerns about the general utility of such reports along with their relevance given that the upcoming round of submissions would have been based on pre-Brexit execution quality data. The FCA’s misgivings about RTS 27 reporting requirements have also been compounded by the EU’s own two-year suspension of the same provision.

While some firms breathe a sigh of relief as they are relinquished of their RTS 27 reporting obligations, the regulators are considering their positions. A

press statement

from the European Securities and Markets Authority (ESMA) commented on the potential for a review of the adequacy of execution quality reporting requirements by the European Commission. In the FCA’s equivalent notice, the UK’s financial regulator made clear its intentions to pursue the outright abolition of the requirement.

Although both regulators have temporarily suspended the reporting requirement, only the FCA has given a firm indication that it intends to do away with the RTS 27 obligations altogether. ESMA’s current position is much softer, and naturally depends on the findings of any review by the EU Commission along with the input of member states.

RTS 28 reporting obligations remain

Although firms may not face penalties in respect of RTS 27 reporting omissions, it is important to note that RTS 28 remains in force for UK and EU investment firms. With a due date of 30 April 2021, this provision requires firms to summarise their top five execution venues by trading volume and to provide quality of execution data for each relevant class of financial instruments.

These obligations apply to execution venues, but also firms receiving and transmitting orders along with portfolio managers.

Change on the horizon

Even though there is relative parity between the ESMA and FCA positions regarding RTS 27 reporting, there are indications of a split in direction between the regulators. As already mentioned, ESMA’s promise of a review is far more cautious than that of the FCA. This is perhaps not surprising given that the UK’s regime is not tied to the political machinery of 27 distinct partner nations.

The FCA’s RTS 27 announcement also included a pledge to review the MiFID II notification requirements that obliged financial advisers to notify clients if their investment portfolios fell by 10% or more in value. While this provision was

suspended in light of the financial pressures of the COVID-19 pandemic

, the potential for a review suggests that the FCA may pursue a more liberal approach to financial reporting in the future.

It could be that the UK’s new-found legal agility leads to greater divergence from the EU in the future. For firms that are subject to reporting and compliance requirements, this all makes for an uncertain situation that looks set to disrupt the relative stability of the MiFID II regime.

Make regulatory reporting simple

As the gulf widens between the recently separated financial regimes of the EU and the UK, firms face a more complex regulatory environment than ever before. Even despite the relaxation of RTS 27 reporting rules, there can be no doubt that the coming months and years will bring further changes on both sides of the English Channel. New legal hurdles will be created, and reviews of market abuse and reporting obligations are already underway.

The prospect of change can be frustrating for firms who invest significantly in the development of their compliance procedures – and especially those who have become subject to dual reporting obligations following Brexit. As new developments complicate regulatory compliance, firms need to ensure their systems can keep pace with transaction monitoring and reporting obligations.

For more information on how eflow can help you fulfil your regulatory reporting needs, book a demo using the form below.

eflow Shortlisted for TradingTech Insight Awards 2020

sales@eflowglobal.com (eflow) — Thu, 24 May 2018 17:20:00 +0000

A-Team’s shortlist for their European TradingTech Insight Awards 2020 was announced this week on December 16th. eflow is delighted to announce that we have been shortlisted in the Best Transaction Cost Analysis (TCA) Tool for Best Execution category.

First taking place in 2019, this will be the second TradingTech Insight European Awards ceremony in as many years. The awards celebrate innovation and quality in the field of financial technology.

In A-Team’s own words, the ‘European awards reflect the different challenges facing market practitioners and suppliers as they seek to develop trading and data solutions in the rapidly changing European marketplace.’

eflow’s best execution solutions have proven themselves to be effective and innovative solutions. Our TZ system can perform TCA against countless benchmarks using market data from over 250 global venues.

Our TCA solution can perform comprehensive implementation shortfall and slippage calculations and handle extremely large volumes of data. It is a comprehensive solution for all MiFID II best execution requirements.

The TCA solution we offer also allows users to compile reports at the click of a button. Both preset and custom, bespoke reports are easy to generate, making best execution compliance easier than ever.

For more information visit our TCA page. To set up a free proof of concept or ask us a question, fill out the contact form below, or click the ‘Get In Touch’ button in the menu bar above.

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