The more stringent requirements to demonstrate best execution under MiFID II is likely to lead to investment firms having to select more than one execution venue and increase their use of automated order routers.

MiFID II, the new rules covering European financial markets, are due to be implemented at the start of 2018.

TOM, a Dutch exchange for equity and options trading, commissioned a legal opinion from law firm Norton Rose Fulbright on the application of MiFID II best execution rules in the context of routing client orders. The shareholders of TOM are ABN Amro Clearing Bank, BinckBank, IMC, Nasdaq and Optiver and the Dutch exchange has developed a search engine, TOM Smart Execution, to compares prices between markets.

Norton Rose Fulbright said: “Under MiFID II, an investment firm is allowed to select a single execution venue, as long as it is able to demonstrate that this allows it to satisfy the overarching best execution requirement.”

However an investment firm will have to show that the single execution venue would obtain results for its clients that are at least as good as the results that it could reasonably expect from using alternative execution venues. “This reasonable expectation must be supported by relevant data or information published under article 27 of MiFID II or by other internal analysis conducted by the investment firm,” added the law firm.

Norton Rose Fulbright said that under MiFID II, an investment firm is not obligated to use an automated order router.

“However, for an investment firm that has selected multiple execution venues, we believe it will operationally be necessary to use an AOR that takes into account all criteria and information in relation to those different execution venues to achieve best execution on a consistent basis and in order to demonstrate this to its clients,” added the opinion.

Norton Rose Fulbright said it assumed that the AOR has been programmed correctly, taking into account all the relevant criteria of all execution venues as determined by the investment firm in its order execution policy. “Because the biggest amount of trading is done electronically with an enormous speed we don’t think that a natural person will be able to process all criteria set by its investment firm while taking into account the trading data of the different execution venues that have been selected by its investment firm,” added the opinion.

Norton Rose Fulbright said it had based its opinion on the information available from the European Securities and Markets Authority before the regulator has released the technical standards, the so-called Level 2 legislation.

The European Commission has said the best execution obligation is closely linked with the availability of data on execution quality and pre- and post-trade and is consulting on a proposed requirement for execution venues to publish data and what kind of data should be published.

An associated requirement under MiFID II is the need for high-resolution, synchronised time stamping to help prevent trading irregularities and aid forensics. The ability of a smart order routing system to make decisions on where to send an order relies on synchronised delivery of market information from the execution venues in question.

Patrick Lastennet, director of marketing and business development, financial services segment at Interxion, which provides colocation data centre services in Europe, said in blog that under MiFID II every reportable event in a transaction’s lifecycle must be time stamped to millisecond accuracy and granularity.

“With the mandated level of granularity and breadth of data being an entirely different proposition from current levels, there are concerns that the impact of time stamping requirements is being overlooked,” he added.

Lastennet said typical time source feeding systems, including the satellite-based Global Positioning System, are unable to meet the required level of granularity demanded by MiFID II, which calls for knowledge of the traceability of the time signal to Coordinated Universal Time (UTC) at each step. UTC is the international time reference maintained by 75 time laboratories globally and based on the average of some 450 atomic clocks.

“From an interference perspective, it is relatively straightforward to jam a GPS signal, with jamming devices readily available online,”Lastennet added. “It’s also possible to spoof GPS signals and submit an alternative clock signal, while other causes of interference include urban canyon effects and solar storms.”

He continued that for many market participants, it will make sense to outsource key capabilities required under MiFID II.

The UK’s National Physical Laboratory has developed NPLTime, a certified precise time signal directly traceable to UTC, which meets MiFID II requirements.

Dr Leon Lobo, Time and Quantum, at NPL, said in the blog: “Traceability to UTC offers the sector the basis of a ‘common clock’ and underpins a developing Consolidated Audit Trail. Realisation of the requirement put forward by MiFID II for high-resolution traceable time stamping will enable significant improvements in clarity within and across markets.”

Featured image by Sikov/Dollar Photo Club