Now that the equity market reform is behind us, the Spanish industry can refocus on other things. One of the topics that seems to take much momentum is the question of Best Execution. Not that it will create business but not addressing it could have dramatic consequences.
Last time ESMA looked into it (2015/494 Peer Review Report: Best Execution under MiFID), Spain was saved from receiving bad notes because with the very high concentration of the activity on the primary exchange (the analysis was conducted in 2013. By then the primary exchange concentrated over 80% of the market), there were no real concerns about best execution. The picture has significantly changed now with between 30 and 40% of the volume that moved away from the primary exchange to the alternative venues, so called MTFs. We need to consider a range here as there seems to be no number all stakeholders agree on, but even if we don’t agree on the numbers, the trend is very clear. Also comparing with the other European markets, Spain was exceptionally resisting the trend. This is now over and one might wonder whether Spain will not actually become the European market where the primary exchange will lose the largest market share (comparing with data provided by LiquidMetrix). Time will tell but this might happen in a not too distant future. The percentage today is only made of flows coming from international brokers. Spanish institutions are still mostly concentrated on the primary exchange. But many now seriously look at the alternative trading venues, understanding that this is an unstoppable trend that will have to be addressed.
And better earlier than later! The information that recently came out in the press that CNMV is investigating how Spanish brokers address the Best Execution requirements dictated by MiFID raises many concerns. Is the Best Execution principle being applied in Spain as it should be? Today, the concentration argument mentioned above does not apply anymore.
Beside the regulatory angle which is obviously the one Spanish financial institutions and asset managers should be the most concerned about, there is also a commercial argument which should not be underestimated. There is a clear first mover advantage and no one will want to be the last one to adapt to this new reality. There has been news recently in the press of first Spanish institutions moving in that direction and positioning themselves commercially on that ground of Best Execution capabilities, using Smart Order Routing technology to direct orders in the best interest of the investor.
The problem is that adapting quickly to this new reality is very challenging. Offering best execution over different trading venues requires some technology and more precisely a Smart Order Router (SOR). Developing one from scratch is probably the least realistic option. Buying one still represents the challenge of implementing it and feeding it with the right data to work properly. Here this is not so much about the cost of buying a license but more about implementation, maintenance and upgrading to industry or regulatory changes. Another option is to use a broker to access the alternative venues and leverage their SOR. The benefit of this option is that by using a leading broker, you will most certainly enjoy the most advanced technology but also automatically benefit from all the upgrades that broker will have to implement for their own business anyway. This solution however means that you do not access directly the alternative trading venues. Is that a problem?
Accessing directly the different alternative trading venues also present some challenges. First there is the cost of each membership and the time to implement. But more importantly, once you are a direct member of a trading venue, you have to set up a clearing solution. Do you want to become a self clearer? Is this a core business you want to invest in because it adds value to your clients? Alternatively you can look for a general clearing member to clear your activity. On this last option, the question is how much appetite is there out there for this business, particularly if it does not include the custody that you will want to keep on your Iberclear account.
Coming back to the option of using a broker to access the alternative exchanges, there is also here an issue: Spanish entities probably want to keep their membership on the primary exchange and therefore don’t want all the activity to be executed by the broker, only the transactions the SOR would send to the alternative venues.
The solution is for the broker to set up a mechanism through which it re-routes to the client’s membership the orders that the SOR will have directed to the primary exchange. Then the client can process completely that flow under their membership. The broker will only execute the orders directed to the MTFs, clear them and get them settled directly on the Iberclear account of the client.
That way, the client gets both of both worlds: it gets Best Execution, maintains its membership on the primary exchange and gets an all-in solution for the flows directed to MTFs.
This should be the fastest and cheapest option, avoiding expensive technology build and allowing to concentrate on the core business, be it brokerage, private banking or else, and focus on things that really add value to the underlying client.
In short, alternative trading venues are now a reality that cannot be ignored anymore. Regulators will increasingly monitor whether investors get the best execution service. It will become a requirement to be able to execute on the venues available, be it for regulatory reasons or simply competitive pressure. There are different ways to achieve this, some will take a lot of time and require significant financial and human resources. Others will ask for the support of brokers to get it sorted fairly quickly, allowing the client to direct their energy and resources to other tasks and add value to their own underlying clients.
It is now high time to move on that front if you want to stay in the race.
Opinion article by Benoit Dethier, Head of Sales and Relationship Financial Institutions, Citi Securities Services in Spain
For Funds Society, Madrid