Are you Ready for a Best Execution Inspection?

Achieving the best possible result when executing orders is of extreme importance, as being compliant avoids fines, distractions and enhances the reputation of the firm. Establishing good procedures and processes based on best practices, will allow the firm to be ready for a best execution inspection from the regulator. In a previous article, we discussed ‘the best execution responsibilities of investment firms’, and in this article we go a step further to discuss what would be needed from you in a best execution inspection. Particularly, for an investment firm dealing with contract for differences (CFDs).

Firstly, you will receive a letter from the regulator for an on-site inspection at your premises, giving you 2 to 3 days notice. There are cases where the regulator appeared on the premises without notice, handing over the letter for inspection.

The regulator requires the responsible persons dealing with best execution matters to be present and in particular, they will interview the risk manager, the head of dealing on own account, the head of execution and transmissions of orders, the compliance officer and an executive director. The inspection will be very detailed and requires very good preparation from everyone, well in advance, as the notice is within a few days.

During the roughly 5 hours of inspection, the regulator dives into details through the company’s reports and manuals, the procedures and processes undertaken by the respective people, along with deeper questions on the functionalities of the trading platform(s), the pre-execution and the after-execution procedures.

Irrespective of the order, the regulator will ask you questions and deal with the below matters;

How the internal execution process is reflected in the order execution policy? It is important the three arrangements of;
1) the execution venues,
2) the liquidity providers, and
3) the group structure, (if any),
to be explained with utmost detail for each class of financial instruments, along with the factors taken into account and justifications that enable the company to obtain the best possible result, on a consistent basis, when executing client orders.

Can you verify which version of the execution policy the client provided consent? The company must obtain clients’ consent of the order execution policy upon the establishment of the relationship and upon material changes of the policy, along with the appropriate record-keeping.

You must be able to showcase the so-called ‘pre-trade’ execution settings for each trading platform. You will need to demonstrate evidence in regards to the performed analysis and decision of the chosen execution thresholds. Some of the questions need to be answered on the ‘pre-trade’ requirements are;
– How the company constructs the quoted rates?
– How transaction costs are added to the raw data feed?
– Who has access to the execution thresholds, quotes validations, spreads, swaps, account types, and any other setting?

Further, you must be able to justify the client categorization characteristics, the specific instructions from clients (if any) and how the orders are executed. Needless to say, that they may ask you to explain the reasons and the result of the communication of any abusive trading behavior by any of your clients.

Going deeper, the company must have procedures to monitor the effectiveness of the order execution policy, for each class of financial instruments and among others, you will be required to provide evidence from your record-keeping in regards to;
– the fairness of the price,
– the comparison of liquidity providers used,
– the comparison of the execution venues,
– the slippage symmetry of client orders,
– the slippage symmetry of client orders based on the volume of the orders,
– the slippage symmetry on stop loss and take profit, if any,
– the speed of execution at the opening and closing of a client order,
– the rejection percentage of client orders,
– the daily monitoring of client orders.

Lastly, you must be able to show knowledge, provide proof of evidence and authority on the quarterly reports of the RTS 27 and the summary report of the RTS 28, from the performed analysis of your monitoring of the quality of execution.

We share all these insights from actual inspections we took part. It is important for us to know that this article can be of help for a best execution inspection preparation. If you feel more details are required please let us know.

The information provided in this article is for general information purposes only. You should always seek professional advice suitable to your needs.

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