MiFID II: The Buy-Side Transparency Challenge

October 27, 2015 | By: Ivy Schmerken

By Ivy Schmerken, Editorial Director

MiFID II is going to boost transparency in financial markets and improve and broaden best execution standards for the buy side, but not everyone is prepared to handle all the data.

Last month, the European Securities and Markets Authority (ESMA) published the final regulatory technical standards for MiFID II/MiFIR detailing its vision for how the regulation should be implemented.

While MIFID II standards go into force as of January 3, 2017, buy side market participants have suggested there is not enough time to prepare for the technology changes.

A group representing UK asset managers is asking for a delay in the implementation of MiFID II rules, suggesting they need more time to prepare for sweeping changes to execution, unbundling of research payments, limits on dark pool trading and transaction cost analysis. Overall, MiFID II will establish pre-and post-trade transparency rules for equity-like instruments, bonds, derivatives, structure finance products and emission allowances.  One controversial issue of concern to the buy side is that MiFID II creates a transparency regime that will require fixed income trading venues to publish quotations, based on the liquidity characteristics of the bonds. ESMA is also planning to bring the majority of non-equity products into a regulatory regime by moving a significant portion of OTC products onto regulated platforms and require trade reporting.

Surge of Data

So, what does the surge in data publication and trade reporting mean for buy-side dealing desks and portfolio managers investing on behalf of clients? In the long term, it stands to reason that buy side firms will benefit from increased transparency for trading across asset classes.  Yet buy side firms are wary of fixed-income transparency, though they will get valuable resources to obtain reliable price discovery, reports Financial News. Trade reporting is a top concern for the buy side, even exceeding product governance and rules on dealing commissions, which require separate payments for research, notes the Financial News — The Tally. With all the data reporting and data publication, asset managers and hedge funds will need automation and alerting systems to make sense of the data and to explain their execution strategy to clients.

Transparency and data publication will heighten the buy side’s responsibility for measuring trade performance and proving best execution to their clients.   Asset managers will also be obligated to explain their execution strategies to clients.

Asset managers and hedge funds are still waiting for the final rules on best execution as part of the investor protection requirements to be published in November in the European Commission’s delegated acts. MiFID II is going to strengthen and broaden best execution standards that were already part of MiFID I.

MiFID II Best Execution

Under MiFID II the buy-side has the obligation to prove best execution to their clients across multiple asset classes. Best execution is defined as the obligation to execute orders on terms most favorable to the client.  It’s no longer enough to send an execution off to a broker and know that it had slippage of a couple of basis points. As such, buy side firms will need to consider cost, price, speed, likelihood of execution, likelihood of settlement, and size of transactions in providing best execution. It’s safe to assume they will need systems to capture, store and analyze these data points as part of proving best execution.

Firms need to develop a rationale for choosing this particular execution strategy. It’s also about having a consistent way of measuring execution across multiple asset classes.

Though best execution was a concept under MiFID I, “its implementation has been patchy at best,” according to an article in ACA Compliance (Europe). “There have been difficulties regarding the objective measurement of best execution in nearly all asset classes save liquid shares (where, by definition, poor execution is unlikely).

This will increase the burden on the trading desk, as their compliance teams will be calling them asking for information on every trade whenever a client makes a query.

The legislation also requires the buy side to provide more transparency to investors in terms of execution strategy. It’s not enough to prove best execution in terms of venue selection, but the buy side must be able to explain the execution strategy, and use that information to plan and schedule how they are going to achieve best execution.

Buy side firms must provide an execution policy in sufficient detail and in clear, easy to understand language and report to clients on the quality of results.  Investment firms must summarize and make public, for each class of financial instrument, the top five execution venues where they executed client orders and the quality of those execution results.

TCA to the Rescue?

As MiFID II mandates more transparency, transaction cost analysis (TCA) will be an essential technology component for meeting the best execution guidelines.

TCA offers a way to capture the trade results and prove that the execution strategy was aligned with the firm’s best execution strategy. TCA will be important for certain data reporting requirements, such as disclosing to clients across all asset classes which execution venues they were executed in.

With MiFID II, the buy side must prove they are complying with their best execution policy, and show where they are identifying and resolving issues. For example, if an order was overweight in dark pools, especially with dark pool volume caps in place, that could raise questions.  If an order was routed to a dark algorithm, but executed in a lit venue, an alert could notify the manager; or, if the PM routed an order to the trading desk where it sat for an hour that could trigger an alert back to the PM.  TCA can be used to generate automated reports showing best execution “exceptions”, which can then be used to refine the policy, and ensure ongoing best execution.

MiFID II allows clients to request information around each trade, or submit a request for information around policies or certain orders and executions. Client requests for information need to be answered clearly and within a reasonable amount of time, according to ESMA.

However, sending out overwhelming amounts of data to the desktop is not enough.  What’s more important is making sense of the data and presenting it in a straightforward way. TCA should understand what the client is requesting and what the firm is seeking to accomplish.  TCA is a tool that can reduce the administrative burden falling on the buy side to provide clients with information on executions.

If the trading desk is inundated with information requests from clients or from the compliance team, then the trading desk is not going to have time to actually trade. TCA is a “self-service” process for the compliance team (or the clients) to request a best execution report without requiring intervention from the trading desk or compliance. It gives the client the ability to go into an automated information engine and check for the best execution strategy, perhaps asking for the last 10 or 100 days of orders.

Risk Alerts

MiFID II also calls for risk alerts and controls in execution management systems. The regulation calls for maximum message rates, execution throttles and price collars to ensure that a firm doesn’t trade against one’s self.

The Road Forward

While it’s too early to know the full impact of MiFID II, these sweeping reforms could trigger changes in front-end trading technology to stay on top of global regulations. In the meantime, since MiFID II is intended to broaden the scope of reporting and apply it to non-equities, firms will want to have a consistent execution and performance measurement approach across all affected asset classes. Some suggest that a wholesale change of technology in the front office will become necessary.

For a questions concerning how FlexTrade’s TCA solution, FlexTCA, can help address MiFID II transparency requirements, please contact us at

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