The focus on improving best execution transparency is likely to continue in the US, beyond the implementation of updates to the Securities and Exchange Commission’s (SEC’s) Rule 606, says Dermot Harriss, senior vice president at OneMarketData.
In late 2018, the SEC adopted amendments to Regulation NMS (National Market System) Rule 606(b)(3). The new rules require additional metrics reporting by broker-dealers to their customers on the handling of their orders. The amended regulations, which apply to so-called “not held order flow” trades, increase transparency around best execution by providing key benchmark metrics that are comparable on an apples-to-apples basis between firms. The new disclosures are designed to shine sunlight onto potential conflicts between broker-dealers’ venue selection and the best interests of the client for each order.
Amidst outcry from some brokers about the difficulty of adapting home-grown technology systems to provide this additional reporting, the SEC recently delayed implementation of the Rule 606 regime from May 20, 2019 to October 1, 2019. The industry does not expect there to be another delay, however, so the October implementation deadline seems fixed.
The new rules will have an impact on the business models of some broker-dealers. “It will make it pretty much impossible to hide the old game of collecting rebate from venues in order to execute the customer’s order,” says Harriss. “In some cases, this is almost a sole source of revenue for some of these brokers, collecting rebate. Suddenly this is starkly exposed, and they are really not going to be able to survive on it as a sole source of income.” He adds, “Immediately clients will be questioning ‘Why are you collecting so much rebate on this flow? You should be looking for the best execution venues irrespective of fees and rebates.’” There was a similar shake-up in the European Union on the introduction of the Markets in Financial Instruments Directive II (MiFID II), which has similar best execution reporting, although Harriss says the structural impact on the US market should be smaller.
More change to come
However, MiFID II goes farther than the US in terms of the number of asset classes that it covers with its best execution provisions, so it’s likely that the US regulators will be broadening the range of asset classes covered, says Harriss. He notes that there is a lot of conversation at the moment about the possibility of the Commodity Futures Trading Commission (CFTC) introducing MiFID II-style best execution quality metrics more broadly across the derivatives space. Some firms, such as RCM, are already building their business model around an expectation that this new transparency will eventually come to the US markets, he says.
Other global regulators are updating their best execution rules too. In January 2018 Canadian firms had an implementation deadline for complying with updated guidance on Dealer Member Rule 3300 Best Execution of Client Orders from the Investment Industry Regulatory Organization of Canada (IIROC). The new requirements brought greatly increased levels of transparency to best execution around over-the-counter transactions. The new rules “caused a fair amount of activity” in the Canadian markets, says Harriss. He adds that the industry can expect the wave of regulatory change around best execution to continue for the foreseeable future.