Introduction

Our latest Executive Summary, sponsored by Thomson Reuters, is the white paper “Determining Best Execution: What Role Does Transaction Cost Analysis Play?”.

The Markets in Financial Instruments Directive (MiFID) came into effect on 1^st November 2007 and brought with it a requirement for all European firms to achieve best execution for clients. Not only do firms have to achieve best execution, they must also show they have obtained best execution – or the “best possible result” for clients, which may be determined by price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of an order. 

This Executive Summary looks at the business, market and regulatory drivers for evaluating best execution at global firms and examines whether TCA is appropriate for the institutional buy-side and brokers to ensure orders receive the optimal mix of price improvement, speed and likelihood of execution.

Key Findings

• Environment – Brokers and institutional clients alike recognise the MiFID obligations on best execution are applicable to them, and are a high priority. All those who were interviewed for this paper have put together best execution policies that are reviewed annually. All firms interviewed for this paper were performing their own best execution analysis before the MiFID requirements came into force and continued to do so. Brokers also report clients are increasingly asking to view their best execution policy.
• Concerns – There are some concerns that the MiFID best execution requirements are not currently being met.  
• Establishment – TCA is more established in the US than in Europe and this is likely to lead development in the latter region in two key ways: firstly some firms expect regulators to institute a consolidated market data tape for equities trades in Europe, as already exists in the US. Individual customers of TCA services are also likely to adopt the vendor already used in their US office to ensure commonality of systems.
• Differences across the Atlantic – However key differences between use of TCA in Europe and the US are also likely to continue: MiFID covers a wider range of products than the equivalent regulation, Reg NMS, in the US, and uses broader terms to define best execution, rather than just price.
• Current use of TCA to prove best execution – TCA is viewed as playing a crucial role in meeting the MiFID best execution requirements. However it is not solely used to meet regulatory requirements.
• Desired providers/methodologies – Commonality of systems is important, so European users are likely to use the system that is used in their US offices, TCA being more established in the US.
• Return on Investment and time to market – Cost of TCA services is viewed as expensive but necessary. Despite well-documented cuts to buy-side technology budgets recently, TCA has not suffered widely, perhaps because as a risk-reducing tool it is appealing in the current risk-averse investment climate.
• Benefits of TCA – Clients do not just use TCA in order to meet regulatory requirements. It is also seen as offering commercial advantage with significant return on investment as a result of a refined trading process.

Conclusion

TCA is seen as a vital tool for brokers and investment firms alike to meet their requirements to show best execution under MiFID, and is considered to offer sufficient ROI. However it is in early stages of use and adoption and further development is hindered by a number of issues. Chiefly, the data used to analyse transaction costs is perceived as flawed. The lack of a consolidated market data tape for equities trades in Europe and the exclusion of some trading venues and dark pool data from some TCA benchmarks are seen as major limitations to the usefulness of most existing TCA services.

However TCA providers have taken steps in the right direction to correct this problem and at least two vendors now provide benchmarks calculated from the full universe of equities venues. Real-time TCA is also in very limited use in Europe currently, but its advantages are known to clients and they say they would use it when they see improvements in the data used for TCA and in their own trading technology. 

It is clear there is a sizeable appetite and enthusiasm for useful and accurate TCA, and users would not be put off paying more, or going through the disruption of switching services, to get the right service. As such there is a real opportunity for a vendor who is able and willing to respond to investment firms’ demands in this fast-growing sector. 

To receive a free copy of this report, please send your name, job title, address and phone number to marketing@lepus.com and we will ask the sponsors of the report to email a copy to you.

Tagged with: 2009, Executive Summary, risk, transaction cost analysis, white paper