FCA thematic review on best execution and payment for order flow (PFOF)

On 31 July 2014 the FCA published the results of its best execution and payment for order flow (PFOF) thematic review (TR14/13). The report sets out detailed industry-wide findings, conclusions and required actions based on a review of 36 firms including banks and brokers.

Background

Best execution is a core component in the regulation of financial services, and the FCA considers it fundamental to market integrity and to the delivery of good outcomes for clients who rely on agents to act in their best interests. The three main aims of best execution are:

• to ensure protection for investors;
• to sustain the integrity of the price formation process (which itself underpins all trading activity); and
• to promote competition among trading venues in an increasingly fragmented market.

The FCA also incorporated into its review the practice of PFOF to assess how market participants had responded to its 2012 Finalized Guidance (FG12/13). The FCA said that PFOF can damage the transparency of the price formation process, thus undermining best execution and limiting effective competition in the interests of consumers.

Key facts

The FCA review identified a significant risk that best execution is not being delivered to all clients on a consistent basis:

• most firms are not doing enough to deliver best execution through adequate management focus, front-office business practices or supporting controls;
• firms need to improve their understanding of the scope of their best execution obligations, the capability of their monitoring and the degree of management engagement in execution strategy, if they are to meet the current requirements of the FCA; and
• all firms also need to prepare for the challenges of MiFID II implementation in this area.

The review also noted that a small number of firms continued to receive PFOF in contravention of the position stated in FG12/13. The FCA is keeping this area under active review and will take action (including enforcement) against any firms that continue to evade its rules and requirements on PFOF.

Kinetic Partners’ perspective

In Kinetic Partners’ experience, the regulator expects firms to be proactive rather than reactive when dealing with best execution. Firms need to demonstrate that they do not wait for their clients to complain but instead show that they are proactively taking this key area of regulation seriously. Critical to such compliance is the knowledge that firms perform their own monitoring and make good judgement calls that can be evidenced through MI and senior management interaction.

It is crucial that firms proactively think about how they evidence best execution and that they demonstrate proper accountability and responsibility throughout the process. The front office needs to be engaged throughout the process, including training and monitoring.

Front office engagement is seen by the regulator as a key component in ensuring good outcomes for the client. Another area which needs tighter scrutiny is the policy of carve outs. When MiFID was implemented in 2007, best execution rules changed to cover all products and venues and it is the responsibility of firms to assess any pre-MiFID carve outs that are now outdated and no longer acceptable.

How can Kinetic Partners help?

Kinetic Partners has many years of experience covering all aspects of regulation. We tailor our reviews to each client’s needs and you are guaranteed to receive hands-on and personal attention from our team throughout your engagement with us.

We offer the following services:

• Independent review of your approach, systems, processes and controls to ensure best execution compliance
• Identifying your risks and gaps in your systems and controls environment
• Undertaking a retrospective transactions review
• Designing and implementing a focused, remedial action plan whilst taking a pragmatic approach