In December, the FCA brought out its findings on best execution in UK listed cash equities in relation to wholesale banks. In recent months, we have become used to these multi firm reviews which conceal considerable informal guidance which the FCA is indicating is good or bad practice. So, in that context, I wanted to take a look at some of the headlines. It is important to note that the good and bad practice will be applicable to brokers as well as banks. There is a considerable amount of detail and here are there are some key themes.

First, the scope of best execution. The FCA reiterates the classic European Commission examples of when best execution will or will not be owed to professional clients, in particular whether the firm is working a client order and whether the firm is dealing as principal and the different fact patterns that go with that. The FCA accords with market practice in recognising that in order driven markets, which is mostly the case in equity markets, the best execution obligations will be owed.

But it is really in relation to the quote driven market context that the FCA makes some really interesting comments. The first relates to confirmation that the old European Commission four-fold cumulative test continues to apply: as a reminder, this relates to (1) who initiated the transaction, (2) market practice and the ‘ability to shop around’, (3) levels of price transparency in the market and (4) the information provided by the firm and the agreement reached with the client. The important point here is that the FCA is critical of the automatic assumption in quote driven markets that these factors will always lead to the conclusion that there will be no best execution obligation. What FCA is saying very clearly in its feedback, is that firms need to consider this on a case-by-case basis. There is arguably nothing new here but the FCA is clearly aware that parts of the market do not take such a case-by-case sensitive approach to these factors and adopt a general view.

Moving on to the assessment of the scope of the obligations, the FCA also makes some interesting comments in relation to direct market and sponsored access. The argument has always been that there is an ouster of a best execution obligation as a result of the existence of a client specific instruction. Again, whilst the FCA does not deny the market approach, it is critical of blanket exemption type approaches and is looking for something more tailored to the specific circumstances.

Turning to the next area, the ongoing review of scope in relation to a firms’ order execution policies, the FCA is critical of cases where the firm has not done adequate monitoring on an ongoing basis and has quite abit to say about that. I think that’s where things get really interesting is in relation to governance and oversight and there are a few key things here. The first is that there needs to be adequate first and second line oversight, in particular the FCA is critical of the lack of relevant experience in the compliance function and I think this is a sensitive issue in the market because almost by definition much of the expertise sits on the desks in the front office. Unless compliance can recreate all of the metrics and market knowledge, it is a tall order for compliance to effectively, through independent sources, challenge the front office but that is essentially what the FCA is asking for.

I think that this could be challenging for small to medium size firms, particularly those that do not have a 1.5 compliance line (where there is a front office compliance function which then liaises with the second line compliance). The second area of governance which the FCA criticises is the extent to which there is real challenge in relation to the various committees and working groups and the hierarchy. In other words, I think the message is that it is not enough just to have formal committee oversight and management information but there needs to be evidence of challenge on an ongoing basis. Again, this is easier said than done.

The FCA is a little more flexible in relation to the precise mix of data and frequency of sampling and monitoring. Again, I think it is clear that firms need a comprehensive management information and data pack approach. So, putting all of those points together, it is important to note that the FCA is asking firms to think carefully about their management information mix. The other area that the FCA talks about is the mix of real time monitoring and post trade monitoring and it strongly makes the point that there needs to be both, and anything that is just a T+1 or equivalent basis will not cut the mustard.

I am not sure that there is anything particularly exciting to report on the execution factors other than that the FCA confirms the ability for firms in relation to professional clients to have a mix of factors, which is in itself a helpful reiteration of current market practice. I think perhaps more interesting is the extent to which the expectations on investigation of outlier trades are set out by the FCA. Nothing new in a sense to see here but an important reminder that management within firms needs to be setting up proper metrics for investigation of outlier trades and, crucially, to have feedback loops in relation to the outcome of those investigations. The FCA is critical of this latter piece, in that often this is not evidenced.

And finally, I think it is interesting to note that the FCA encourages firms to get client feedback and views this as a valuable source. There is also the final little twist that the FCA discusses which is the need to be very careful about internalisation versus going into the market and to avoid bias towards the internalisation engine, that certainly larger firms may have and the resulting actual and perceived conflicts of interest.

So I think putting all of this together, this is classic feedback on a sectoral theme set of visits which contains some really important information in some areas reiterating what the market knows and then the others breaking some interesting new ground and reiterating that the level of effort that the FCA is expecting firms to make.