“I love deadlines. I like the whooshing sound they make as they fly by”
MiFID II is here. From all accounts, January 3rd 2018 was similar to Y2K day, in that everyone woke up, went to work and, generally speaking, everything carried on as usual. It is clear that the ‘soft’ launch of MiFID II has resulted in no discernible disruption from a liquidity or execution perspective, but there are a number of looming elephants in the room that were postponed e.g. the additional 6-month grace period for assignment of LEI codes. So, those that were waiting for January 3rd to come and go in the hope that they could leave MiFID II behind them, and get on with their day jobs, are going to be disappointed. 2018, and probably beyond, will continue to have a significant MiFID II focus as much remains to be done.
One of the next key dates in the implementation timetable is April 30th, by which time, institutions will need to have submitted their RTS 28 reports. RTS 28 encompasses many aspects of the best execution obligations for an institution, and represents a large data gathering, cleansing and reporting exercise. That is burdensome enough, but it is further complicated by ambiguity in what exactly needs to be reported, especially for an OTC market such as FX.
If we look at the RTS 28 Top 5 report alone, which is the only RTS 28 report where the legislation provides a specific template, then ambiguity exists even here, and can be summarised in the following areas:
a) Venue vs Channel vs Counterparty
For the FX market, with a hybrid market structure of both quote- and order-driven activity, there is confusion over the definition of these terms. If you are executing an RFQ order, over a multi-dealer platform (e.g. FXall or FX Connect), with a panel of 5 liquidity providers then you could define the multi-dealer platform as the Channel, and the winning liquidity provider as the Counterparty. So, in this example, there is no Venue? But what if the multi-dealer platform is an MTF? Clearly, even in the simplistic case of an RFQ trade there is scope for confusion.
In the case of an algo trade, that has been initiated via a multi-dealer platform, with a bank, then additional complications arise. The bank’s smart order router will be directing the algo child fills across multiple venues, so in this case Channel, Counterparty and Venue for each child slice, at least, of the algo would appear clear. However, if the algo was spot and not linked to an underlying securities transaction, i.e. does not fall into the ‘Associated Spot’ category for MiFID II reporting purposes, then technically speaking this trade should not be included in RTS 28 reporting. But, once the algo had completed, what if forward points were then applied to the algo spot rate to roll the trade forward? The parent trade is no longer spot, and does now fall within MiFID II reporting requirements.
b) Passive vs Aggressive
Again, for the hybrid world of FX where there is still a very large proportion of quote-driven business, how should the definition of passive or aggressive be applied? Reading the regulatory text would indicate that any trade which has paid bid-offer spread is technically an aggressive trade, whereas ‘earning’ spread would constitute a passive fill. There are conflicting views in this across the industry. For many of our clients, these fields are generally ignored for FX if they do not execute any of their business via orders or algos, or have direct market access. For orders and algos, however, data is provided by the majority of liquidity providers on whether the order was filled passively or not. This is not yet consistently available across the industry yet, or provided in a consistent format, but is becoming increasingly prevalent.
For many mandates, FX transactions are ‘directed’ to a specific counterparty under the terms of the IMA. Such transactions should be split out and identified in the Top 5 report. However, many asset managers net transactions across portfolios, the net execution result of which is then allocated back across the individual accounts within the block. This can potentially result in complications whereby trades for non-directed accounts can be included in a directed block, as there was a benefit from a netting perspective, so the parent block can no longer simply be included in Top 5 directed field. This would need to be done at the level below, i.e. individual allocations or child trades, so the concept of multi-tier trade hierarchies are required.
Other reporting requirements
RTS28 is not just about supplying a Top 5 report. Analysis of the execution obtained across these Channels, Counterparties or Venues is also required with a view to understanding if there is consistency across allocated volume and performance. But the definition of performance is no longer simply ‘best price’. Indeed, the MiFID II definition of best execution refers to a range of factors, including price, some of which may be relevant to some institutions in they way they execute in a hybrid FX world, some of which won’t be. Clearly, these factors need to be defined, prioritised and set in accordance with each institution’s best execution policy. Only when this has been done can any view of overall ‘performance’ be measured, aggregated and reported.
Over time it is fair to assume that these ambiguities will decrease as market consensus develops and further guidance from bodies such as ESMA is provided, especially once a review post the first reporting cycle is concluded. In the meantime, however, institutions are figuring out for themselves. At BestX, our approach has been to take outside counsel advice from Linklaters, which has helped provide clarity on reporting requirements in addition to the Top 5 report (e.g. the approach taken to the associated performance reports), and also to ensure that the reporting software is as flexible as possible to accommodate different interpretations and requirements.
BestX allows an institution to define exactly what execution factors are relevant for their specific business and best execution policy. This allows a customised measure of performance to be constructed across any entity, including Channel, Counterparty and Venue. This framework forms the foundation for our Regulatory Reporting module, which allows a client to fully customise and configure exactly what they would like to include in their RTS 28 Top 5 report and also generates the associated performance reports. For example, some clients may wish to generate Top 5 reports for Channel, Counterparty and Venue. Some clients have made the decision to include all spot transactions, regardless of whether the trades are associated or not. Given the delay in LEI code assignment, we also allow reports to be constructed without this official designation to at least ensure that the first round of reports in April can be generated.
It is clear that regulators are looking for evidence of a best efforts approach to satisfying the reporting requirements, so a pragmatic and flexible approach is probably a decent strategy in these early months of a post January 3rd 2018 world.
 For younger readers, this relates to January 1st 2000, when the world waited with bated breath to see if computers would continue to function
 Please contact us if you would like further information on this legal opinion (email@example.com)