Pension funds are, from a strict regulatory perspective, not challenged the same way as other asset management firms with the necessity to comply with MiFID II regulation. Regardless of regulations, some pension funds are still trying to conform to the benchmark of what is expected as an industry minimum.
Key takeaways from 1H 2017 Alpha Trader Forum (ATF) regional buy-side debates:
The major discussion topic within best execution is how the buy side should objectively prove to auditors and their clients that they have fulfilled their due diligence on their counterparties. There is a need for decisions about which processes and tools should be used and the need for additional documentation. On one side, there is a push to funnel business to fewer counterparties where one can prove proper due diligence.
On the other hand, specialisation is an area that is challenged due to regulatory capital restrictions so some buy side are signing up more counterparties to cover all markets. But additional complexity hits hard as specialised ad-hoc counterparties may not accept the associated technology connection fees for long unless there is re-occurring business. From an inducement perspective, is it right that the broker is solely paying for this connection?
Within foreign exchange we look forward to discussing how the buy side plan to prove best execution when trading through a custodian.
Transaction Cost Analysis (“TCA”) is an old subject we have been researching for years but the new MiFID II regulation suggests that buy side have established stronger ex-ante processes which automatically lead the discussion to pre-trade TCA. With additional asset classes being in scope of best execution, the buy-side head traders are trying to figure out the best technologies to satisfy the requirements for each asset class; should the choice be between best-of-breed or one solution for all? Whilst we all know MiFID II transparency is a double-edged sword, one expected benefit is better data and TCA analysis, especially for fixed income (it’s unlikely it can get any worse).
Most heads of trading are or will be planning to revise their policies ahead of 3rd January 2018. This is proving to be a challenge especially for the OTC asset classes such as fixed income and foreign exchange. We see two very different approaches between the two; the fixed income buy-side head traders are in full progress trying to learn and resolve this upcoming challenge while the specialist foreign exchange buy-side community have generally taken a more passive stance and are waiting for more direction; expecting their fellow compliance colleagues to perform a major part of the heavy lifting to complete this process. K&KGC's experience and concern is that compliance departments are rarely resourced to develop such policies without the involvement of their head trader. K&KGC believe our FX trading community would benefit from the research K&KGC has collected both from our FX buy-side community and other asset classes.
PAYMENT FOR RESEARCH
Most buy side are already familiar with the fact that both Research Payment Accounts (“RPA”) and Commission Sharing Agreements (“CSA”) are going to co-exist under MiFID II. The surprising new findings are that more buy-side firms are going down the route of paying out from their own P&L. More than half of the DACH equity buy side voted that they would do this instead of choosing between CSA or RPA. One buy-side head trader commented that, paying out of P&L is the easiest and cleanest model. Another head trader mentioned that this is likely to be the easiest model for smaller firms that doesn’t have the resource for complex administration. In the end the client will pay so one wouldn’t be surprised to see a bump in management fees. This applies similarly to the fixed income asset class where there are no dealing commissions. There is an indication that most buy side are likely to pay out from their P&L and make a separation between government and corporate bonds.
Some European pension funds, with no need to adhere to MiFID II, are still planning to continue bundling research fees in their commission rates.
TRADE AND TRANSACTION REPORTING
The reporting requirements are still a problematic challenge for the buy-side heads of trading. Will the trading desk be resourced to report on its own or will they need to hire a specialist firm to assist them? The trading desks would need to understand the detail on how to leverage the publication delays where possible to minimise market impact. Within fixed income, some head traders plan to transact all trades electronically to leverage the platform vendors reporting capabilities. Other buy-side are discussing the need for an independent Smart Order Router (“SOR”) for all trades that can route the trade reporting to the correct approved publication agreement ("APA") when needed.