New RTS on Best Execution of Investment Firms under MiFID II

Background:

• May 15, 2014:

The Directive 2014/65/EU of the European Parliament and of the Council, known as MiFID II (Markets in Financial Instruments Directive II), is published. This directive establishes the best execution requirements for investment firms.

• July 14, 2016:

The European Commission adopts several Delegated Regulations that complement MiFID II, including Delegated Regulation (EU) 2017/587 (RTS 1 on transparency for equities, etc.), Delegated Regulation (EU) 2017/583 (RTS 2 on transparency for bonds, etc.), and Delegated Regulation (EU) 2017/576 (RTS 28 on annual publication of execution information).

• January 3, 2018:

The majority of MiFID II provisions enter into force.

• March 29, 2024:

The MiFID II Review Directive enters into force.

• • Article 1(4)(e) of the MiFID II Review Directive: Requires ESMA to develop a draft regulatory technical standards (RTS) on the criteria for establishing and evaluating the effectiveness of the order execution policies of investment firms.
  • April 10, 2025: ESMA publishes the Final Report containing the draft regulatory technical standards (RTS) specifying the criteria for establishing and evaluating the effectiveness of the order execution policies of investment firms. This report also includes an executive summary, background, policy context, a summary of the feedback received during the public consultation, and annexes with the cost-benefit analysis and the draft RTS text.
  • Next Steps (as mentioned in the report): The draft RTS is submitted to the European Commission for adoption. The Commission has a three-month period, according to Article 10 of Regulation (EU) 1095/2010, to decide whether to adopt the technical standards.

What elements should investment firms include in their order execution policies regarding the selection of execution venues?

Firms must detail in their order execution policies the internal governance procedures for selecting execution venues, the measures taken to ensure that venues are authorized, and maintaining an internal list of selected venues. For each venue, they must specify information such as its name and identifier, the approval date, the approving person or governance body, the classes of financial instruments for which it can be used, the types of permitted transactions, whether it is for retail or professional clients, and any other limitations.

Factors Determining the Choice of Execution Venues:

(1) Policies must include the factors referred to in Article 27(1) of MiFID II, the availability of certain order types, and for the size criterion, the typical or relevant order sizes of their clients.

(2) For the cost criterion, they must consider trading and order execution fees, membership or connectivity costs to execution venues, and settlement, clearing, and custody costs.

(3) For the price criterion, a comparison of the execution prices of possible venues with a reference data set is required. It is mentioned that “Where available, investment firms may use information for the reference data set from consolidated tape providers.”

(4) The use of alternative reference data sets is permitted if they provide a reliable and accurate position.

How should investment firms address the “order size” factor when establishing their execution policies?

Firms must consider the typical or relevant order sizes of their clients and the typical or relevant frequency of orders when selecting execution venues. Although a minimum number of order sizes to consider was initially proposed, ESMA adjusted this to allow firms to analyze for themselves how many different sizes are necessary, based on the characteristics and needs of their clients.

What criteria should investment firms consider when defining fees and costs in their evaluation of execution venues?

When evaluating costs, firms must consider trading and order execution fees, the cost of membership or connectivity to execution venues, and the costs and charges for settlement, clearing, custody, and other administrative services related to the choice of venue. These costs must be considered to the extent they are directly or indirectly passed on to clients.

How should investment firms monitor and evaluate the effectiveness of their order execution policies? Can they rely on third parties for this?

Firms must continuously monitor whether their execution arrangements based on the selected venues comply with their execution policy and achieve the best possible result for clients. This includes defining thresholds per class of financial instrument to monitor the consistency of execution quality. They must perform a periodic evaluation of the effectiveness of their policy, at least annually, and also when monitoring identifies that thresholds have been breached or when a material change occurs. Firms can rely on monitoring and evaluations performed by third parties, such as independent data providers, as long as they assess the processes of these third parties.

How should specific client instructions be handled in the order execution policy, and when does the preselection of an execution venue by the firm constitute a specific client instruction?

Firms must establish in their policies how to adequately handle specific client instructions, including the impact of these instructions on the general requirements of the policy and on the firm’s ability to achieve the best possible result for that client. A specific instruction implies a client’s choice among multiple options offered by the firm or an instruction to handle the order differently from what is provided in the policy. If a firm preselects an execution venue on the order screen and invites clients to choose among several options, only if the client chooses a venue different from the one preselected by the firm does the choice of venue constitute a specific client instruction. If the client does not modify the preselection, it is not considered a specific instruction, and the best execution obligation falls entirely on the firm.

What specific obligations do investment firms have when executing client orders by dealing on own account (including back-to-back trading)?

• When a firm executes orders by dealing on own account, it must specify in its execution policy how it obtains the best possible result for its clients and the measures implemented to identify, prevent, and manage conflicts of interest related to this practice. When setting prices for OTC products, they must verify their fairness by considering the observed market price of the instrument. If no reliable price is available, they must use the price of similar, comparable, or underlying instruments. In the absence of these, they must utilize an internal pricing model based on reliable data that reflects market conditions.
• Therefore, the requirements to ensure the fairness of prices when firms execute orders on own account, especially for OTC products, are detailed, referring to comparable market prices or internal pricing models.

What additional clarifications did ESMA provide on the scope and implementation of these RTS?

ESMA clarified that the RTS establish requirements for the policy and internal processes of order execution and not for client disclosures, which are addressed in other regulations. The RTS apply to the order execution service, with an exception for firms offering both RTO and order execution for the same class of financial instruments. ESMA also indicated that firms have flexibility to rely on third parties for monitoring and evaluation and that proportionality has been sought in the requirements. Additionally, it has been clarified that references to consolidated tape data do not imply mandatory consumption of these data, allowing firms to use data they consider useful for best execution, as long as they are reliable and accurate.

The application deadline for these RTS will be 18 months after their entry into force.