The Financial Conduct Authority (FCA) has today published its thematic review on best execution (TR14/13). Best execution is fundamental to market integrity and to the delivery of good outcomes for clients who rely on agents to act in their best interests.
For the purposes of this thematic review, the FCA sampled 36 firms. To reflect a broad spectrum of the industry, the FCA chose to investigate investment banks, contract for difference providers, wealth managers, brokers/interdealer brokers and retail banks. The FCA sent information requests, conducted desk based reviews and carried out a number of onsite visits in order to reach its conclusions. The guidance it has published today will be of interest to all firms that execute, receive and transmit or place orders for execution, including investment managers.
Significantly, the FCA found that there is a substantial and current risk that best execution is not being delivered to all clients on a consistent basis. This is, in part, due to the fact that:
- most firms are not doing enough to deliver best execution through adequate management focus, front office business practices or supporting controls; and
- firms need to improve their understanding of the scope of their best execution obligations, the capability of their monitoring and the degree of management engagement in execution strategy if they are to meet the FCA’s current requirements.
In TR14/13, the FCA covers four main risks to the consistent delivery of best execution, namely:
The FCA found there was a poor level of understanding of which activities require best execution. Frequent attempts were made by firms to limit the scope of the obligation in their dealings with clients, often through the use of general ‘carve-outs’ which are not permissible or through continued reliance on out-dated market conventions. In particular, the FCA has considered the ‘dealing on quotes’ carve-out and noted that many firms misunderstand its limited application.
Most firms lacked effective monitoring capability to identify best execution failures or poor client outcomes. Monitoring often did not cover all relevant asset classes, reflect all of the execution factors which firms are required to assess or include adequate samples of transactions. The monitoring of best execution was often poorly captured within management information, if at all, and resulted in lack of actions to correct deficiencies.
Internalisation and connected parties
Firms which relied heavily on internalisation or on executing orders through connected parties were often unable to evidence whether this delivered best execution and how they were managing potential conflicts of interest. Firms were also unable to show how they separated explicit external costs incurred on behalf of clients from internal costs or how their commission structures for internalisation avoided discriminating against other venues.
It was often unclear who had responsibility and ultimate accountability within a firm for ensuring that execution arrangements and policies met the FCA’s requirements. Firms usually only carried out superficial checks on policy documents. Their focus was predominantly on the process involved rather than delivering client outcomes and often lacked front-office engagement.
What firms should do next?
Following on from TR14/13, all investment firms should review their arrangements for delivering best execution, ensure their business practices are fit for purpose and are supported by appropriate second line of defence controls. Current systems and controls should be improved and firms should be ready for the implementation of future policy changes, bearing in mind the new upcoming MiFID II requirements.
View TR14/13: Best execution and payment for order flow, 31 July 2014