Wary Brokers Sound Alarm on Mifid II's RTS 28

At the start of this year, fundamental changes to Europe’s trading rulebook kicked in, often resulting in last-minute panics, system changes, and Christmas lunches eaten at office desks. 

While most of Europe managed to survive the revised Markets in Financial Instruments Directive’s (Mifid II’s) January 3 deadline, brokers have become increasingly nervous about April 30. On that day, new rules kick in, requiring firms to disclose specific details about the venues they use and the quality of execution they provide to their clients.

It sounds simple, but look beneath the surface, and the provisions within Regulatory Technical Standards 28 (RTS 28) are keeping traders and compliance officers awake at night.

“The reports are due now on April 30 and when I’m getting a call as recently as last Tuesday from people asking for help, you can see that it can’t be simple,” says Andre Nogueira, director of trading analytics at ITG. “Firms have had almost a year to prepare for this—almost a year and some are still not ready.”

Crunch Time

As just a fraction of a larger puzzle that makes up Mifid II, RTS 28 and the reporting of execution quality have been the subject of huge debate and controversy for years. 

The mandate has set new regulatory and technology hurdles for investment firms, including categorizing the top five execution venues and entities used across asset classes, summarizing how best execution was achieved, managing the costs of implementation, understanding what is expected of regulators and combining these efforts to meet the first deadline on April 30.

John Jannes, head of product trading analytics at IHS Markit, says he has spoken to firms, which up until recently intended to produce the RTS 28 reports alone, describing the workload as an “operational nightmare” and “spreadsheet hell.” Within his role working for a provider of trading analytics and information solutions, Jannes is in constant talks with firms about their ability to fully comply, and believes that many are still not ready. 

“What I have seen so far leads me to believe that firms are not well prepared,” he says. “We have a few large clients who have regular calls with us trying to sort through their own data. They are constantly talking to their legal counsel and figuring out what data they need, or additional data they need to send us. Even though we provide them file specs and everything on what we want, what they can provide doesn’t always line up perfectly.”

While many claim that, although European authorities have largely regarded the contents of RTS 28 as a simple exercise, the scale of the workload, the costs of implementation and the challenges at hand have been largely underestimated. 

“Starting to get this information together is going to be a significant drain on resources, a significant effort within the firm and investment within the firm to prepare this information,” says Allan Goldstein, COO of Trade Informatics, a provider of quantitative analytics.

For medium to large firms, let alone multi-asset, multi-market-making heavyweights, RTS 28 has become a major data challenge that requires extensive flexing of resource and technology muscle. Just to begin, firms are having to capture, categorize, and publish in a readable format streams of trading activity across a range of asset classes, sub asset classes, and execution destinations. This is no easy task and can often come with a hefty price if a third-party provider is added to the mix. 

“Mifid II, from an implementation perspective, is expensive—from a data perspective, from a technology perspective, from a workflow and process perspective,” says ITG’s Nogueira. “Try to do things in Mifid II without automation, without technology—it’s just not possible.”

To add to this data exercise, firms are required to report whether an explicit order executed on a trading venue was passive or aggressive but this does not apply when a passive or aggressive order is sent to an entity such as a broker, unless the portfolio manager or order transmitter has specifically given instructions to do so. This can become a logistical nightmare in cases where firms operate across multiple brokers and have to capture data such high-touch or low-touch orders, broker instructions, and algorithms that have a particular trading style that is passive or aggressive. 

In addition to the multiple tables, classifications and data capturing, firms are also obliged to publish an assessment of how they achieved quality execution in the best interests of their investors. Since January 3, firms have had to update their execution policies, but the first reports are expected to demonstrate how these polices were adhered to and pinpoint areas where improvements need to be made. Although proving this process of quality execution may pose challenges to begin with, Rebecca Healey, head of market structure at trading venue Liquidnet, and co-chair of the EMEA regulatory subcommittee of the FIX Trading Community, says firms have come a long way in the UK compared to other European markets on improving best-execution policies and processes. 

“There has been real progress in terms of the whole concept of best execution, and rather than hiding behind a woolly statement, firms—particularly in the UK—have done a huge amount in looking at the best-execution process, and it is much more than getting three quotes or looking for the best price,” she says. “It should be a much more holistic overview of what a best-execution policy should entail.”

The underlying objective of RTS 28 is to set a benchmark for all investment firms across the industry and provide a new level of accountability and transparency that has never existed before. The European Securities and Markets Authority (Esma), the regulator responsible for turning Mifid II into actionable standards, indicates that to allow investors to scrutinize and make robust comparisons between firms’ performances, the annual public disclosure must be made available in machine-readable format on a web-based platform for a minimum of two years.

“Effectively, by shining a light on it, they expect people to make better decisions, and that’s really what this is about,” says Ben Stephens, managing director at Instinet, an agency broker owned by Japanese bank Nomura. “By making firms be transparent, they have to publish their routing policies and have to show the outcomes of those, and can effectively be held accountable. Putting that data in the public domain means that it’s difficult for firms not to behave in the way they state they are behaving.”

But it’s not all doom and gloom. Regulatory authorities have offered a glimmer of hope that, even if firms can’t do everything perfectly the first time around, there may be some margin for error.

Best Efforts

In an effort to ease into the first year, investment firms are expected to provide the first annual report on what is described as a “best-effort basis.” Esma has acknowledged the difficulties of compiling all of the requested data in cases where it is tied to the previous year and stems from the provisions under the original Mifid. 

In the months following the adoption of RTS 28, Esma published various Q&As to help market participants grasp a greater understanding of the mandate, its interpretations and what is expected of investment firms. Despite these efforts, some firms have struggled to interpret what is meant by best efforts. The real question is how will this translate to the regulators when assessing the first batch of reports published? According to some, this could potentially impact firms’ approach to subsequent years.

“The regulators give a lot of latitude to firms and the sufficiency of the reporting for the first year, but I think there is an implicit risk that reporting firms use that as a rationale for not addressing the full scope of the rule until much later, which is a bad thing,” says IHS Markit’s Jannes. 

Broadly speaking, however, queries about what constitutes “best efforts” are often a case of splitting hairs. Most brokers spoken to for this article consider it to mean assessing all the data required, filling in the gaps where possible and acknowledging in the reports where and why the gaps are present. 

“It is important to know that you don’t have to be perfect in the first year but if you do have gaps, from a transparency perspective and to keep with the spirit of the regulation, you should disclose what these gaps are and make sure that you address them for the next year, says ITG’s Nogueira. 

Liquidnet’s Healey, who actively works with trading firms and organizations to help address key industry issues such as RTS 28 is under no illusion that the first reports will be perfect, but rather sees this as the first step for the industry in the right direction.

“Firms are working on this now—has everybody got it right yet? Probably not,” she says. ”I think we need to be very clear here. Esma has outlined in its Q&A that it is not expecting the first report to be perfect—it’s best endeavors, it’s a best-efforts basis but it’s important that we start the process, because starting the process is how you can refine it and learn from it and then improve it.”

As assessments of the first annual reports are expected to officially begin at the end of the month. RTS 28 will authorize local regulators to take legal action and issue heavy fines in cases where firms fail to comply. Historically speaking, regulators have shown that they are more than willing to clamp down on best-execution failures. In the US, regulators have issued heavy fines, in some cases penalizing major banks and trading firms to the tune of millions of dollars, in response to breaches of SEC Rule 605, a regulation that requires broker-dealers to publish a quarterly report on best execution. 

The UK’s Financial Conduct Authority (FCA) is similarly expected to ensure investment firms meet its best-execution reporting requirements under RTS 28 and Mifid II, even if it has promised to be lenient in the beginning with firms that are making good-faith efforts.

“We expect firms to be compliant with their obligations under Mifid II and where they are not, action will be taken and that is consistent across the board; it’s not just for Mifid II,” said Mark Steward, director of enforcement and market oversight at the FCA, during a press conference held on April 9.

Survival of the Fittest 

The problem with RTS 28 isn’t necessarily a compliance issue, most say—rather, it’s a data-management issue. Instinet’s Stephens says the secret is to ensure all data is order and that keeping a close eye on it makes the process much easier. 

“If your data is already in good working order, then producing these types of reports is quite easy,” he says. “Markets are becoming more and more electronic and if you’re already running electronic trading infrastructure then this should be bread and butter to you. If you are not then it’s much harder.”

By this point, firms will have a good idea of what their best-execution policies are and would have been updated since the beginning of the year. Up until the RTS 28 deadline, firms should fully understand and have mapped out how they are achieving quality execution according to its policies. This summary of analysis of best execution asks firms to fully assess where best execution was realized and to scrutinize where improvements need to be made in the next year. 

Esma recognizes that firms may choose to provide “more granular reporting” in addition to what is required, as this can be used to justify orders made, decisions taken or gaps in the information. Overall, regulators will be looking to see if firms can justify any discrepancies and demonstrate the efforts to comply with the mandate, and provide its clients with “meaningful information” that allows investors to scrutinize the execution quality achieved and compare that with other investment firms. 

“We are very conscious, from our own perspective as well, that Mifid II is a very challenging piece of legislation, but by the same token we do expect firms as well as ourselves to be in compliance with what’s needed,” said the FCA’s Steward, at the press conference. “It produces a lot of data for us that is enormously valuable and helps us to do our job better and more efficiently in the future so it’s really important that we make it work.”

The key is to understand RTS 28 is an evolving process—a challenging process for firms, but one that many believe will bring about new changes and dialogue that never existed before. Ultimately, this mandate is expected to force firms to clean up their data, improve best-execution methods, and inject new transparency and accountability. The underlying lesson is to meet the challenges head on, embrace this new level of transparency, and expect more changes to come.

“You either embrace change or you resist it. Overall, providing information to people is a positive, says Stephens. “Where there is more information made available, where there is better governance, there is better government.”