EXCHANGES CANNOT HOLD BACK THE TIDE.
Two key measures contained in MiFID II will provide respite to European brokers: greater clarity around what constitutes ‘best execution’ and an attempt to restrict what incumbent European exchanges charge for market data. Mark Hemsley, CEO of BATS Chi-X Europe explains.
At present, brokers operating in the brave new world outlined in the first implementation of MiFID in 2007 are facing something of a limbo. For while MiFID I outlined a vision for markets, it failed to truly define the specifics of its banner initiatives.
‘Best execution’ is a case in point. In the US, ‘best execution’ is a defined metric that takes into account price, time and likelihood of execution. The same cannot be said in Europe, where any combination of: ‘price, cost, likelihood of execution or settlement, size, nature or any other consideration relevant to the execution of an order’ can constitute ‘best execution’.
While this elasticity can benefit investors pursuing specific trading strategies, a recent paper published by the FCA (Thematic review: Best execution and payment for order flow, July 2014) established that the ephemeral notion of ‘best execution’ creates considerable variance of service between broking firms.
It is helpful that MiFID II will seek to remedy this issue by creating a more prescriptive data regime to which brokers can respond to, and organise around.
But it remains the case that even with a more rigid, data-driven ‘best execution’ framework, exchange groups could do more to equip brokers with the fullest possible view of the pan-European marketplace at the most competitive price.
At present incumbent exchanges i) charge too much for European market data, and ii) further complicate the issue with a vast array of contractual terms and requirements. Given data should underpin any proper analysis of best execution, limiting data costs is of vital importance.
It is encouraging then that the European Commission, in its mandate to ESMA, agreed that data costs in Europe are too high. A combination of three steps, already outlined in the MiFID II consultation paper, will help to remedy the issue.
Greater transparency around costs is vital. Considerable opacity exists around existing market data agreements to the extent that exchanges do not use standardised definitions for common use. This impacts the ability of brokers to make like-for-like comparisons, and determine which solutions work best for them and their customers. A rational following step would be to mandate data unbundling – for example by offering auction and intraday trading data separately.
The proportion of income exchanges derive from data sales should also be measured and reported to customers, to address the issue of incumbent exchanges squeezing data sales to bolster net revenues as their share of trading declines. Very few brokers are happy to prop up exchange revenues, and many more would like to see venues address their internal management and long-term strategy to reflect the new competitive landscape in Europe.
However, transparency around either products or revenues will not be sufficient in limiting data costs. To that end, implementing a Long Run Incremental Cost (LRIC) model, similar to that used by telecommunications and energy industries, charging for ‘raw’ trading data, is essential. In effect, this will mean that data suppliers recover no more than it should cost to provide this basic service – plus a reasonable operating margin (hence ‘LRIC+’). In turn, this should prompt greater competition among data providers for ‘value-add’ products that deliver tangible benefits and insights to customers.
But exchanges also need to simplify the market for trade data. It should not be a stretch, for example, for exchanges to provide per-user pricing, or agree to a single definition of what (and what’s not) ‘non-display’ data. Clear reporting models should also be a minimum requirement. Yet incumbent national exchanges are furiously fighting any such intervention – either on the issue of cost or clarity.
Amongst other things, this ill-advised policy hinders the commercial realisation of a pan-European consolidated tape: bundling data costs and attempting to rationalise contractual terms from each exchange is far too costly and complex.
Yet such a tape would provide a very valuable tool for brokers, and ultimately, their end-customers. All trading participants would have the same view of consolidated liquidity, and the same access to post-trade data. Irrespective of how ‘best execution’ comes to be defined, creating a single, minimum data source significantly reduces the chances of miscalculation and misinterpretation.
There are also tangible benefits to making trade data cheaper and simpler: as the FCA notes, ‘every basis point of cost saving could translate in £264m in additional client returns each year. Over a thirty year period, a 1 basis point improvement in trading costs could represent an additional £37.5bn in client returns.’
That incumbent exchanges in effect conspire to prevent their customers fulfil best execution requirements is indefensible. Then again, given their history with MiFID I, perhaps it’s not surprising that they are still to learn you cannot turn the tide.
© BestExecution 2014