10.7 - Dealing and Managing

Dealing and Managing

This section covers MiFID regulations, focusing on best execution, order handling, aggregation, allocation, and personal account dealing. Remember, the examiner will not use the term "MiFID" directly in questions.

Best Execution

• Applies to all customers, not eligible counterparties (ECPs). Investment banks are assumed to contact you because you are showing the best price.

• MiFID II tightened the rule: requires "sufficient steps" to obtain the best possible result for clients.

• Factors to consider (the "whole package"): price, cost of execution, speed of execution, likelihood of execution, and settlement considerations.

• The rule does not apply to regulated collective investment schemes because their price is based on the net asset value (NAV), calculated by the manager typically once per day.

  • Price based on the NAV, the net asset value.

• When buying shares, consider multiple venues and the overall package.

• Regulators consider the ease of execution, influenced by:

  • Client categorization (e.g., large professional clients buying large orders in illiquid securities).
  • Order type (e.g., "at best," "fill or kill," or limit orders).
  • Financial instrument type (e.g., equity, debt, derivatives).
  • Venue characteristics.

• The key consideration is the likelihood of getting the best price based on these factors.

Order Execution Policy

• Ensures the firm gets the best possible result for the client.
• Must be provided to all customers before any transactions occur.
• It is prescribed information, meaning the regulator mandates its contents.
• Includes:
  • List of venues: official stock exchanges, Multilateral Trading Facilities (MTFs), Organised Trading Facilities (OTFs), and Systematic Internalizers.
    • Systematic Internalizers: Firms matching client orders internally (agency cross). Orders are entered into systems that hunt for internal counterparties.
  • Factors affecting the choice of venue.
• Consent can be tacit (implied through non-response).
• Systems must be monitored and reviewed at least annually.
• Clients must be notified of material changes (e.g., acquisition of an MTF).
• If a client provides specific instructions (e.g., execute only on the LSE), the firm is deemed to have obtained best execution by following those instructions. Keep a record of the instruction.

Taking an Order

• Orders should be dealt with promptly and sequentially.
• Timestamping is crucial for recording order entry times.
• Exceptions to sequential handling:
  • Interest of the client: Delaying an order to potentially secure a better price for the client; firms are reluctant to do that.
  • Market or security suspension: Execution is impossible until the suspension is lifted.

Aggregation

• Putting multiple client orders on the same ticket to achieve economies of scale or access block trades.

• Permitted if it is unlikely to disadvantage the client.

• Disclosure is required because it can sometimes operate to the client's disadvantage (e.g., delay).

  • Due to the possible delay in assembling the order.

• Disclosures:

  • Normal procedure: include in client agreement (written).
  • Specific block trade opportunity: inform the client orally.

• Aggregation is a pre-trade activity assembling an order.

Allocation

• How the order is distributed post-trade.
• Must be done promptly and according to a pre-existing order allocation policy.
• Common in fund management where a single order is allocated across multiple funds $20\%$, $15\%$, $10\%$, etc.
• Clients receive priority in allocation, especially in partial fills, unless there are reasonable grounds for pro rata allocation.
• Pro rata allocation is appropriate when the firm's participation was necessary to execute the order (e.g., client alone couldn't fulfill the order).

Limit Orders

• Specifies a quantity and a price or better.

• If the firm cannot execute immediately, the order should be displayed on a public system if it's not executed immediately.

  • Regulated market (e.g., LSE).
  • MTF.
  • OTF (for derivatives).

• Exceptions:

  • Client instructs otherwise (doesn't want the order displayed).
  • Regulator size rule: orders exceeding approximately $10\%$ of the average daily volume should be hidden.
  • Techniques like iceberging can be used to hide the full order size.

Personal Account Dealing Rules

• Applies to all clients, preventing front-running of client orders, even for eligible counterparties.
• Aims to prevent inappropriate dealings by staff.
• Staff must be aware of the restrictions through contracts and employee handbooks.
• Key rules:
  • Pre-trade permission required from the firm.
  • Post-trade notification with contract note submission.
• Exceptions:
  • Blind trusts where the employee has no input on trading decisions.
  • Shares in certain collective investment schemes where the employee has no influence over fund manager decisions.
  • Potentially, back-office staff deemed far from price-sensitive information (though rare).