New parameters for best execution in Europe and Asia: challenge or opportunity?
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New parameters for best execution in Europe and Asia: challenge or opportunity?

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Key Take aways 

• Regulatory, technological and market forces are driving a global move towards enhanced transparency and best execution across all asset classes and potentially across regions. 

• Cross-border investment flows mean that regulations such as MiFID II  could affect firms based in Asia as well as those in the EU. 
• Best execution extends well beyond optimal pricing. Therefore, brokers able to move up the value chain by providing comprehensive pre-trade and post-trade services could enjoy a competitive edge.
• This competitive edge is enhanced by access to diverse, high-quality liquidity flows, especially in emerging markets.

With change comes opportunity

In the world of trading, January 2018 could mark the start of a new era, as a result of the changes that will be introduced by the EU’s revised Markets in Financial Instruments Directive and accompanying Regulation (together, “MiFID II”). MiFID II aims to build on MiFID I by establishing a more transparent financial system, restoring investor confidence and improving the way capital markets function “to the benefit of the real economy”.

Simon Cornwell, HSBC’s head of customized execution services, EMEA, says that the focus on the responsibilities of the buy side under MiFID II is probably the key driver of change in execution methodologies today. 

“Buy-side firms are very aware that, within a year, there will be an increased focus on demonstrating why they continue to work with their chosen brokers,” he says. “They will also need to have a monitoring framework in place to ensure that they are delivering the best possible results to their end clients.” 

It is difficult to estimate how far-reaching these changes might be, because the notion of best execution extends well beyond achieving optimal pricing. It also dictates that firms optimize execution in terms of costs, speed, and likelihood of execution and settlement. “As price discovery becomes more automated, clients will increasingly need to work with a partner that can move up the value chain and guide them through the life cycle of the trade, from pre-trade to execution and post-trade analysis and reporting,” says Peadar Ward, co-head of institutional FX & rates sales, Asia Pacific, at HSBC. He adds that the push towards greater transparency in execution affects clients in Asia as much as it affects the buy side in Europe (see text box).

Opportunities for systematic internalizers (SIs)

Broker dark pools are expected to cease to exist in their existing format and trading volumes on dark multilateral trading facilities (MTFs) will also be curtailed under MiFID II. 

This, twinned with the regulatory and technological momentum embracing enhanced transparency, is creating new opportunities for brokers to support their buy-side clients at several levels. Foremost among these is the broadening of the opportunities it opens for systematic internalizers (SIs). A key component of MiFID II, SIs are institutions with sufficient size, technology and access to liquidity to fill orders internally against their own books, whereas broker crossing networks (BCNs) route orders between institutions. Like MTFs and regulated markets, SIs differ markedly from dark pools: they are obliged to meet a number of transparency requirements, notably by providing public quotes. 

Given that the new regime broadens the range of assets that can be traded within SIs, their appeal has been strengthened considerably, and will form a key part of brokers’ client offering, for several reasons. One of these is that under the SI regime, pure matched principal trading – or directly and simultaneously matching a client’s buy and sell order – is not permitted. “This could be positive for buy-side firms as one of their most vocal complaints under MiFID I was the lack of transparency on execution,” says Cornwell. “All broker orders filled within an SI must be with the SI’s own liquidity. This enables the client to hold a broker accountable for the quality of this liquidity.” 

The ‘high-quality liquidity’ concept

Cornwell believes this access to high-quality, customisable block-size liquidity, which should minimize market impact, could be one of the distinguishing features of HSBC’s SI. “Liquidity is a defining characteristic of how a broker can differentiate itself from its competitors,” he says. 

The size of HSBC’s global presence plays a pivotal role in enhancing the quality of this liquidity and further differentiating the bank’s best-execution solutions. “We have always been committed to using our balance sheet to increase our market share and stay relevant to our clients,” adds Ward. “We are confident that with our balance sheet, technology, capital and global reach, we are able to offer a competitive service to our client base.”

Addressing post-trade challenges

In the post-MiFID II world, brokers should have an equally important role to play in guiding the buy side through the post-trade process, which could exert unprecedented pressure on investment managers in terms of quantitative and qualitative data collection, analysis and archiving. “Part of brokers’ best-execution responsibility is to monitor the quality of execution provided to clients and provide data on that and, where acting as an execution venue, to help clients by providing sufficient quality of execution data to assist their best-execution monitoring framework,” says Cornwell. “For example, if we were to notice a degradation of performance in a particular algorithm, venue, or stock segment, we would adjust our platform as needed.”

Another important example of an area where brokers might be required to add value for their clients is the provision of enhanced transaction cost analysis (TCA). “Delivering a TCA solution is something that brokers do anyway to meet their own reporting obligations, and providing comprehensive TCA to clients is an extension of this,” says Cornwell. “This is likely to involve qualitative as well as quantitative approaches, because no two different orders will have the same definition of best execution.”

Conclusion: the Dealing Room of Tomorrow

The move towards optimal execution and enhanced transparency is a dynamic process. “We’re working hard to improve our monitoring of data and understanding of the characteristics of liquidity,” says Cornwell. “Our clients have been showing interest in having access to more information, more ideas and more data. This is why we see MiFID II as an opportunity to invest in our execution platform and enhance the integration with our balance sheet and prime finance offerings.”

By delivering forward-looking, bespoke cross-asset-based solutions, which anticipate clients’ requirements by breaking down traditional product silos, HSBC’s Dealing Room of Tomorrow approach could help investors navigate this complex environment. 

Best execution in Asia: what should EU and APAC investors consider? 

“Over my 17 years in Asia, I have observed a marked change in customer behaviour and in internal structures,” says Nick Wheeler, HSBC’s Singapore-based head of institutional and wealth management sales, Asia Pacific.

“There is a strong awareness among customers in Asia of their execution responsibilities,” he adds. “For example, we are seeing a number of firms creating execution desks that are segregated from their risk-taking decisions.”

MiFID from Asia 

There are plenty of reasons why it is essential for the financial services industry to be as responsive to the demands of MiFID II as European firms are, both on the sell side and the buy side. Although Asia might appear to be beyond the immediate regulatory remit of MiFID II, the non-European businesses of EU firms might need to ensure that their Asian operations provide services that are compliant with the new regulatory framework.

But it is not just the Asian operations of multinational firms that could be affected by MiFID II. EU-based investors making allocations to fund managers domiciled outside Europe might require those firms to provide detailed, MiFID-compliant execution reports. As a result, Asian-based investment managers planning to market to European investors might regard MiFID compliance as a competitive advantage.

Peadar Ward, co-head of institutional FX and rate sales, Asia Pacific, at HSBC in Hong Kong, says that Asia is affected by MiFID II in much the same way as the rest of the world. But there are also key differences in market structure that a bank with HSBC’s global presence is well positioned to navigate. “Where Asia is a little different is that there are a number of less liquid and more idiosyncratic markets in the region,” he says. 

He adds: “For example, in the case of a generic euro-dollar or euro-yen trade, automated pricing, execution and liquidity can be provided by plenty of fairly homogenous providers. But when you go to less-liquid markets in Asia, or to those with specific onshore regulations, there are fewer counterparties that combine a strong balance sheet with the necessary expertise and reach in Asian markets.”

The technology advantage 

HSBC is complementing its natural strengths in Asia by investing extensively in the knowhow and technology that will be required to guide customers through the complexities generated by regulatory change. “We have been dedicating additional resources to ensuring that we can have a deeper dialogue with clients about their specific requirements and act as a partner with them at the pre-trade, execution and post-trade stages,” says Wheeler. 

This, Wheeler adds, applies to a broad range of asset classes. “Although there are differences between the way pre- and post-trade analysis will be done across different asset classes, the basic principles of how you achieve best execution for a client is the same,” he explains. Much of this process is increasingly technology-driven, with new regulation calling for an intensified focus on data collection, storage and analytics, which is creating new opportunities for banks that have invested in technology, as well as for specialist technology companies and software vendors. 

In an Asian context, one of the most important contributions made by HSBC’s global footprint to increased transparency and best execution is the diversity and quality of its internal liquidity. “We believe our extensive global footprint and our diverse, uncorrelated customer base creates pairing capabilities in our internal liquidity,” Ward explains. “Being able to access offsetting flows enables us to stand out in the Asian market.”

Specifically, HSBC’s Dealing Room of Tomorrow programme could play a pivotal role in this process. “Within our Dealing Room of Tomorrow initiative we are evolving our business to ensure that it is directly aligned with the interests of our clients,” says Nick Wheeler. “By doing so, overall costs could be reduced over the long term.”

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