Central Bank reports on MiFID Best Execution thematic inspection

PUBLISHED: 17th November 2020

On 10 November 2020 the Central Bank of Ireland (the “Central Bank”) released its findings from the recent inspection of MiFID firms’ compliance with best execution requirements in the format of a “Dear CEO Letter” (the “Letter”).

Under Article 27 of the Markets in Financial Instruments Directive 2014/65/EU, investment firms are required to take all sufficient steps to obtain, when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature and any other relevant consideration. In addition to this requirement, there are various obligations in relation to reporting and governance that apply to MiFID investment firms and their best execution frameworks.

Findings and Expectations

The Central Bank’s recent review focussed on the effectiveness of these best execution frameworks, including the associated governance processes. The Central Bank’s main finding was an overarching failure across firms to demonstrate how they were complying with best execution requirements. Gráinne McEvoy, Director of Consumer Protection at the Central Bank, is quoted in the press release accompanying the publication of the findings as saying:

“The findings of this review do not reflect the consumer-focused culture that the Central Bank expects to see embedded in firms.”

With that in mind, the Central Bank requires all MiFID firms to:

1. consider the contents of the Letter;
2. review their best execution frameworks and processes against the findings;
3. develop and immediately implement actions to mitigate any risk to clients identified as part of this process; and
4. discuss the Letter at the next board meeting and record the discussion in the meeting minutes.

An overall message from the Central Bank is that complying with best execution processes should not amount to a “tick-box” exercise and that the implementation and oversight framework and governance of a firm’s best execution process should involve the Board.

Set out below is more detail on the Central Bank’s key findings and expectations for MiFID firms in respect of best execution frameworks. Importantly, the Central Bank will have regard to the contents of the Letter when conducting future supervisory engagement.

Best Execution Framework

The Central Bank found that the quality of best execution frameworks varies across firms. Good practice and the Central Bank’s expectations for best execution frameworks include the following:

1. A holistic best execution policy that is reviewed on an annual basis or whenever a material change occurs.
2. Widespread awareness of best execution policies and procedures amongst staff. This awareness should be effected through training programmes with sufficient scope, detail and frequency to assist staff at all levels to understand and implement the process. Good practice in this regard includes requiring staff to sign an annual declaration that they have read and understood the policy.
3. Compliance with best execution reporting obligations under RTS 28 and Commission Delegated Regulation (EU) 2017/565.

Governance

The Central Bank found that that there was insufficient governance around best execution monitoring.

It is expected that MiFID firms will implement the following in relation to best execution:

1. Clear decision-making processes, including a mechanism for senior personnel to review and challenge escalated results of execution monitoring and for the results of any review to be fed back into execution policies and procedures.
2. Evidence of Board and/or committee oversight and challenge of best execution activities.
3. A documented and detailed compliance monitoring programme that covers best execution activities, is more than a ‘tick‑box’ exercise and has been approved by the Board.
4. Maintenance of error logs for both internal and external errors where a third-party provider has been appointed.

The Central Bank noted that the Board has responsibility for ensuring that governance structures deliver sufficient oversight and monitoring capabilities at all levels of the organisation.

Assurance Testing

The Central Bank highlighted that despite auditing elements of the best execution process, many firms failed to audit the end-to-end best execution process, either by an internal audit function or otherwise.

The Central Bank expects firms to have an assurance testing programme in place to review the robustness of their current oversight, monitoring and assurance practices, and to initiate improvements where deficiencies are identified.

Other findings

The Central Bank also recommends that firms:

1. Establish a core list of over the counter (“OTC”) instruments and ensure that such list is updated as necessary.
2. Maintain an inducement policy and gift/hospitality log to capture gifts or inducement for staff.
3. Obtain client consent as part of the onboarding process.
4. Maintain a Board-approved record-keeping policy that clearly identifies how the firm records initial and subsequent orders from clients intended to result in transactions or that relate to client orders. These records should be maintained for the mandated time periods and permit a full audit trail.

Next Steps

The Central Bank requires all firms to consider the contents of the Letter and review their best execution frameworks and processes against its findings and the good practices set out in the Appendix to the Letter. Where gaps/weaknesses are identified, firms are expected to immediately develop and implement actions to mitigate any risk to customers.

As noted above, Firms are required to discuss the Letter at their next Board meeting and to record the discussion in the minutes. The Central Bank will have regard to the contents of the Letter when conducting future supervisory engagement.

Please contact a member of the LK Shields Financial Services team if you have any questions or would like assistance in completing the necessary gap analysis.