Twilight hours of the b-book? FCA thematic review criticizes brokerages on best execution


The Financial Conduct Authority (FCA) has today released a thematic review on best execution and payment for order flow, which encompasses all market participants in the electronic trading business, including FX brokerages.

The FCA’s review deals a severe blow to the entire industry, and whilst it does not single out specific entities, concluded that there was a poor level of understanding of which activities are covered by the obligation to provide best execution.

According to the results, frequent attempts were made by firms to limit the scope of the obligation in their dealings with clients, often through the use of general ‘carve-outs’ which are not permissible or through continued reliance on out-dated market conventions.

In terms of monitoring, the FCA found that most firms lacked effective monitoring capability to identify best execution failures or poor client outcomes. Monitoring often did not cover all relevant asset classes, reflect all of the execution factors which firms are required to assess or include adequate samples of transactions. In addition, it was often unclear how monitoring was captured in management information and used to inform action to correct any deficiencies observed by firms.

There has been a vast number of retail and institutional clients and companies which have developed strong opinions on whether b-booking is acceptable if in the clients’ interests, or whether all trades should be passed directly to the liquidity provider by using an agency model. The FCA’s thematic review covered this aspect by investigating internalization and connected parties. To this effect, the regulator found that firms which relied heavily on internalization of order flow or on executing orders through connected parties were often unable to evidence whether this delivered best execution and how they were managing potential conflicts of interest.

Firms were also unable to show how they separated explicit external costs incurred on behalf of clients from internal costs or how their commission structures for internalization avoided discriminating against other venues.

The FCA found that having conducted the review, it was often unclear who had responsibility and ultimate accountability for ensuring that execution arrangements and policies met FCA requirements. Despite the significant volume of change in European markets since 2007, firms were still conducting only cursory reviews of policy documents which did not address the full scope of their best execution obligations. Moreover, these were largely focused on process rather than delivering client outcomes and often lacked front-office engagement.

Along with many prominent regulatory authorities in Western nations in which a large amount of electronically executed order flow takes place such as North America, Australia and Great Britain, the FCA considers that best execution is essential to ensuring a high standard of wholesale conduct by delivering good client outcomes and is not a tick-box process.

The soundness, stability and resilience of financial markets and the transparency of the pricing process relies on participants behaving appropriately and taking the necessary steps to ensure that they are acting in the best interests of their clients.

There is a connection between wholesale and retail markets which may lead to risks, including additional transaction costs, being transferred from one to another. There is an even more direct link to the retail market and the FCA’s review assessed several firms which executed retail client orders, particularly in the cash equity market.

Different participants in wholesale markets have different degrees of expertise. Some therefore need more protection than others and the FCA’s rules reflect this. The FCA has stated that its work on best execution has also addressed these differences in sophistication and the way in which client categorization affected the protection that clients were offered, the information they were provided with and ultimately the execution outcome they received.

Whilst the FCA has been overtly critical of practices employed by many brokerages in this particular review, many firms which were included in the review explained to the FCA that best execution is simple – a commercial imperative expected by clients and automatically delivered to them. However, the FCA considers that its findings suggest that not enough is being done by firms to ensure best execution is being consistently delivered to clients, including taking into account the impact of changing market structure and the emergence of new products.

In a consistent drive to put the customer first, yet ensure longevity of business for brokerages in what is widely known as the world’s largest financial center and home to most of the largest international FX dealers, Britain’s FCA has put into context some serious matters which could alter the methodology by which many brokers process order flow in future.

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Twilight hours of the b-book? FCA thematic review criticizes brokerages on best execution

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