As the full effects of MiFID II are still being absorbed by the financial industry there remains a wide range of views about what constitutes a solution to the best execution requirements.
At their heart, the essence of the regulations is to ensure that all participants in the value chain are working sufficiently hard to reduce dealing costs, and therefore improve returns, for the ultimate asset owners.
As with all new regulations, there are a variety of ways to respond to the best ex requirements. Some will continue to resist making any changes to the current model, claiming what they already do constitutes best execution. Others will do the bare minimum to document policies and create a box-ticking exercise to demonstrate some effort towards meeting the requirements. However, the most forward thinking managers will truly embrace the changes, and put in a continuous process to improve their execution outcomes and create competitive advantage via consistently improved returns.
Trade - Measure - Learn
At Ediphy, we take inspiration from The Lean Startup, the seminal book by Eric Ries which lays out how to engineer for success when building a business from scratch. The approach is encapsulated by the BUILD-MEASURE-LEARN feedback loop. Build a minimum viable product (MVP) and get it to market quickly. Measure how customers respond. Learn whether to pivot or persevere. Repeat.
The important thing to note is that this is a process. It is a way of creating validated learning, allowing startups to run experiments that enable testing of each element of their vision.
In our view, the best execution requirements, if implemented fully, fit perfectly into this type of continuous feedback loop. Creating a framework which enables you to capture your complete trading activity, measure the trading outcomes vs suitable benchmarks and then learn from the data whether any alternative execution methods (different protocol, venue, timing etc) might give you better results is essential to realising the full potential of best execution. Using validated learning to run a series of experiments driven by insights from the analysis of the data is fundamental. It is an iterative process which needs to be constantly monitored to check whether improvements are being made. Markets are highly dynamic and therefore execution methods which worked well in the past may no longer be optimal.
This approach has been virtually impossible in Fixed Income markets to date, largely due to a lack of data to drive the measurable insights. Fortunately MiFID II has created a step change in this regard with the transparency requirements of RTS 2. There is now a profusion of data which can be used to create valuable benchmarks and give clarity on which execution venues offer the deepest liquidity for each ISIN. The problem is how to aggregate and harness the potential power of this data - this is where Ediphy can help.
Ediphy is a new company providing an Execution Service for the investment management community. Our integrated execution platform allows you to put the Trade-Measure-Learn process into practice. Come and visit us at ediphy.io and sign up to our FREE MiFID II data product.