Investment managers still failing to ensure effective oversight of best execution

We expect firms to deliver consistent best execution for their clients. We have completed several pieces of work in this area and published a thematic review on best execution and payment for order flow[2].

We publish thematic reviews to initiate improvements across the whole sector. We expect all firms in the sector to consider the findings in that thematic review and the recent asset management market study[3].

Firms should have a strategy to ensure that all relevant parts of the business are compliant in ensuring best execution. There should also be clear management responsibility and co-ordination between the front office and compliance to ensure a robust monitoring framework.

What we found

We were concerned to find that most firms had failed to take on board the findings of our thematic review. The pace of change in improving client outcomes in best execution was slow, with few firms having a cohesive strategy for improving client outcomes.

Many firms had not conducted a robust gap analysis since 2014 and therefore much of the poor practice we outlined in our thematic review had not been addressed.

We did see some good practice in firms where best execution was considered throughout the investment decision making process, and not just by the dealing desk. Some dealing teams provided feedback to portfolio managers on their preferred trading strategies.

On the equity side there had been improvements where some firms were focusing on decreasing the cost of trading by using low cost trading venues such as broker-supplied algorithms, direct market access and the increasing use of crossing networks for appropriate trades.

Firms showing good practice had an effective governance process in place that challenged the overall costs of execution, renegotiated commissions and identified trends that helped improve future execution, which fed into a high level trading strategy.

All the firms we visited had management information that allowed them to accurately view equity execution costs, however use of these data was inconsistent. Some firms could not evidence any improvement to their execution process based on these data and the review of it was largely a ‘tick box’ exercise.

Best execution monitoring in fixed income was less sophisticated than in equity trading. We recognise there are particular challenges for this asset class, but some firms have been more proactive in how they meet their obligations than others. This highlights that meaningful steps can be undertaken to ensure best execution even in less transparent markets.

We expect all firms to be aware of enhancements to best execution monitoring as they become available and assess whether they are suitable and proportionate for their business model. MiFID II places a specific obligation on firms to check the fairness of prices proposed to clients when executing orders or taking decisions to deal in OTC products. Therefore to ensure MiFID II readiness and future compliance with our rules, firms will need to improve current practices in relation to these types of trades.

We found instances where compliance staff were not empowered by senior management in order to provide effective challenge to the front office on execution quality. Sometimes they lacked access to the data used by the dealing team or they didn’t use data already available such as gifts and entertainment logs. This led to a ‘tick box’ monitoring process where failings were unlikely to be discovered.

We found similar control and oversight concerns during a 2016 review which looked at how investment managers oversee their use of dealing commission.

What to consider as part of your review

We expect you to consider the following as part of your review:

• Who would the FCA hold responsible if the firm fails in its obligation to ensure it consistently achieves best execution?
• Do we have a comprehensive strategy for overseeing best execution?
• Have we tested that funds and client portfolios are not paying too much for execution? Where we identified they have paid too much did we compensate the investors?
• Does our order execution policy accurately reflect our firm’s business model rather than being a generic policy?
• What trades or trends have been identified as deficient through our regular monitoring?
• Is our gift and entertainment policy in line with the guidance set out in our Finalised Guidance 14/1[4] and the FSA’s 2012 Dear CEO letter[5] (PDF)?
• Have our staff been adequately trained to ensure they understand what best execution means and its consequences? How can we evidence this to the FCA?

Our next steps

We will be revisiting best execution in 2017 to see what steps investment management firms have taken to assess gaps in their approach to achieving best execution and how they can evidence that funds and client portfolios are not paying too much for execution.

If we find that firms are still not fulfilling their best execution obligations, we will consider appropriate action, including more detailed investigations into specific firms, individuals or practices.

As mentioned above, we recently completed a follow-up review looking at how investment managers oversee their use of dealing commission. Similar to our best execution findings, we identified that most firms failed to take on board the findings of our previously published work.