In an effort to bolster investor protection, European regulators are proposing guidance that seeks to enhance investment firms’ efforts to ensure investors are treated well in trade execution.
The European Securities and Markets Authority (ESMA) launched a consultation on proposed guidance that aims to set standards for how investment firms develop their policies on order execution, and how they assess the effectiveness of those policies.
Under the current trading rules, firms are required to take “sufficient steps” to obtain best execution for their clients on the basis of a number of factors, including price, cost, speed, likelihood of settlement, size of trade and any other relevant considerations.
The rules, which allow firms to distinguish between retail and institutional clients, require that — for retail clients — best execution is determined in terms of total costs (price and execution costs), including all expenses incurred by the client, such as “execution venue fees, clearing and settlement fees and any other fees paid to third parties involved in the execution of the order.”
It also requires firms to factor in their own commissions and costs on different trading venues for retail transactions involving securities traded on multiple markets.
Despite the rules, during compliance reviews regulators have found that firms fall short in the actual implementation of their best execution policies, the consultation paper said.
Among other things, regulators found that firms failed to show they’ve undertaken adequate analysis to justify the choice of trading venues, couldn’t properly demonstrate they executed client orders in line with their best execution policies, and disclosed only generic information about their approach to best execution.
In response, the proposed guidance aims to improve firms’ approach to, and compliance with, best execution rules.
The consultation noted that the highly fragmented trading environment makes the selection of trading venue crucial to the task of seeking best execution for investors.
Along with proposed technical guidance for meeting those best execution obligations, the consultation covers firms’ disclosure obligations to clients, and the need for client consent to the firms’ best execution policy — particularly in cases where trades may be executed off-exchange.
It also sets out ongoing expectations for firms to monitor and evaluate the efficacy of their best execution policies, and to be able to demonstrate to clients that their trades have been executed in accordance with those policies.
The consultation runs until Oct. 16.
ESMA aims to finalize its guidance by the end of the year.