Best execution in Asia
MiFID II compliance for funds with European offices or clients, as well as industry best practices, have made firms more aware of the benefits and challenges of execution testing. Hong Kong and Singapore are bringing out best execution guidance that requires firms to create and publish their execution policies. Firms will need to collect trade data, isolate outliers in trade execution, investigate these outliers and document their findings.
International regulations like MiFID II have a significant impact on markets like Hong Kong and Singapore due to the large presence of international asset management firms. However, these markets do not have as many brokers as Europe and the evolving regulatory standard for analysing execution quality is still ostensibly focused on the volume weighted average price (VWAP).
Broadly speaking, best execution is the process of conducting trades in a way that generates the best possible outcomes for the customers. This could take many forms, including minimising trading costs or executing the trade in the shortest possible time. However, transaction cost analysis (TCA) provides the best picture of the most efficient strategies or brokers to use for different types of orders, especially for equities. While TCA is widely accepted and utilised in developed markets, the use of this method is not widespread in Asia.
At the moment, best execution through the use of TCA in Asia takes several forms. Testing execution quality forms a big part of best execution in Asia. At the same time best execution tools like TCA can also be used to pinpoint suspicious trading or market abuse like spoofing or rate fixing. The latter is the most common use of TCA in Japan, according to Kelvin Ng, a Bloomberg BTCA specialist.
Best execution efforts can take different forms depending on the order type and the nature of the fund. For example, for index trackers, firms need to pay more attention to market closing prices whereas for long-only funds best execution is likely based on VWAP.
Regulatory guidance from Hong Kong and Singapore does not specifically ask asset managers to conduct TCA. Instead, it asks fund managers to do "everything they can" while documenting their efforts for submission in monthly reports to the regulator.
The SFC’s guidance on best execution, however, does specify the requirement to have ongoing controls and monitoring for anomalies:
“Controls and monitoring carried out by second and third lines of defence, such as compliance and internal audit functions, should be in place to review the quality of execution and to detect and address anomalies. Based on the characteristics of different financial instruments and the complexity and scale of the LC’s [licensed corporation’s] operations, it should determine appropriate metrics and reference benchmarks to assess execution quality.” Quantifying best execution using past trade data through TCA and reporting the relevant results is a globally accepted best practice by both investors and regulators. TCA is also an easy to use tool that provides the clearest picture of execution quality.
Bloomberg TCA specialist Jeroen Rodenberg adds that the trading and compliance divisions should be collaborating in writing the execution policy and the execution testing.
"The trading department should conduct TCA and find patterns to reduce slippage as much as they can. The trade results should be tested against execution policy by the compliance department. Trading can assist compliance by commenting on unexplained outliers as they have the best inside of the transaction." he says.
Bloomberg’s Cheng says that Asian firms are moving towards creating a culture where best execution concerns are permeating the organization from the back to the front office, creating an internal infrastructure to support the regulatory obligation.
“A lot of asset management companies are shifting gears and bringing best execution to the front office where it impacts the firm’s competitiveness and strategic focus. Firms want to be seen to be making sound judgements for their clients, not just for prudence but to create competitive advantage,” she says.
Bloomberg’s TCA solution (BTCA) provides firms with the flexibility to test best execution in a way that suits their business best. A compliance officer can set up execution rules and then test data on every single historical transaction against these rules. The service flags exceptions and outliers as well as problem cases, allowing firms to investigate these instances and document their findings.
This “exception-based” process allows firms to quickly determine the extent to which historical trade data complies with their execution policy. By focusing on exceptions, BTCA makes it easy for firms to focus on only the problem areas, and implement targeted solutions, without having to trawl through large data sets.
In its 2017 thematic review on best execution, the SFC raised concerns that traders tended to look at execution quality through only one or two metrics. BTCA allows firms to break down their trades according to several parameters including market cap, order size, spread and jurisdictions. What sets the service apart is its ability to do this to every trade automatically on a daily basis.
“BTCA can help you categorise all your trades after which you can build your compliance workflow for MiFID II or the SFC rules, which is the ability to identify outliers and use other pricing and trade data to build the necessary documentation for regulatory review,” added Ng.
