| Regulation: no way round best execution |
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| 07/11/2004 | |
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Who wouldn't agree that achieving the investor's best interest should be the priority of all asset managers? In this respect, best execution is nothing new and has always existed since fiduciary duty has always been around. But there is trick, European-style: finding a common technical approach to best execution, which has been formalised in the Directive on markets in financial instruments. The article 21 of the directive defines "best execution" as the obligation for investment firms to take all reasonable steps to obtain, when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size nature, and any other considerations relevant to the execution of the order. Once the directive is fully implemented in May 2006, it will be the first time that a comprehensive regulatory framework governs the organised execution of investor transactions by exchanges, alternative trading systems and investment firms. The consultation held by the Committee of European Securities Regulators (CSER), which has been mandated by the European Commission to provide technical advice on the implementation of the directive, shows that there is still much confusion regarding the measurement of the "best execution" performance of asset managers. "Best execution, the holy grail for both brokers and fund managers, is an extremely difficult concept to pin down", comments Nick Collier, European Director of Compliance, Risk Regulatory and Government Affairs at Instinet Europe, an execution-only broker. According to Nick Collier, the understanding of "best execution" varies along market participant lines. For instance, he says that pension fund trustees may define "best execution" simply as the preservation of asset value, and some investment managers may see it as the reduction of commissions. "Others may determine success as the successful implementation of their trading strategy over the desired time period", he adds. But most participants to the consultation seem to agree on one thing. "Best execution is not only about setting the lowest possible price for the trading costs", explains Robert Priester, a senior legal advisor at the European fund management association, the FEFSI, which submitted a paper to the CSER consultation. According to the association, the variables that should be taken into account include the bid-offer spread, market depth and trend that may create positive or negative risk during the period of execution, market impact, as well as relevant taxes and settlement fees and costs. Clashing with reality Depending on the weighting of the variables taken into account to assess best execution, directive-compliant asset managers vary. The question is then how to apply those variables and, if possible, compound them into a single formula that would allow investment firms to monitor the effectiveness of their execution arrangements in order to identify and correct any deficiencies. But there lies the problem. "Best execution is not an exact science", notes the British Investment Management Association in a paper submitted to the CESR. "No formula is really capable of accommodating the multiple and varied situations engendered by client demand", adds the French association of investment banking and services (AFEI). That's why the AFEI rings the alarm bell. According to its analysis of the first version of the technical paper, the CSER seems to be attempting to determine a "perfect" execution formula for investment firms, pitting the cost side against the price side of the equation. "Attempting to devise such a predefined formula is not only pointless; it is downright dangerous", warns the association. At best, say most asset managers, the CESR could make recommendations on the criteria to be used when selecting the trading venue. But the AFEI's worries might be nothing more than hot air given that the CSER clearly says that it does not have the mandate to determine the weighing of the criteria to be used by the asset managers when assessing their best execution policy and arrangements. "That job is left to investment firms", says the CSER in its consultation paper. "Rather, CESR is asked to provide criteria that firms may use to assess the relative importance of the factors." The AFEI is also concerned by the fact that CESR designed some of the execution policies for implementation with automated trading systems, while those systems are not available everywhere. Such a technical provision is likely to hinder competition by excluding some of the current venues, which would raise execution costs, the reverse effect that is sought for. In the end, fund managers want to keep much liberty with their best execution policy. "We believe that any advice in relation to best execution should avoid being overly descriptive", says Ilene Hersher, an adviser on EU legislation at the Investment Management Association. The German asset management association BVI fully backs this position. "[T]he proposed implementation advice should leave sufficient space for self-regulation of the industry", believe Stefan Seip and Marcus Mecklenburg of the Bundesverband Investment und Asset Management. Julien Laplante |
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