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MiFID II: The Business Benefits of Compliance

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MiFID II: The Business Benefits of Compliance

There’s a wave of change sweeping across non-equity markets driven by regulatory initiatives and the rise of non-bank liquidity providers. Other factors driving buy-side adoption of Transaction Cost Analysis (TCA) in FX are the need to generate alpha on investment returns, and regulatory scrutiny of trading practices in over-the-counter (OTC) instruments.


TCA is a broad term which doesn’t describe the actual analysis to be carried out. Asset managers who rely on custodian banks to execute currency trades have a compliance obligation to analyze these FX trading costs.

By monitoring fill rates, TCA tools can help traders determine if ‘last look’ is occurring, and then decide whether or not to shift their trades to other venues.


New regulations such as MIFID II are imposing best-execution standards on non-equity securities, including fixed income and foreign exchange; under MiFID II’s delegated acts, the buy-side will need to prove best execution in cash bonds, derivatives and FX forwards.

A renewed focus on execution quality has driven adoption of TCA in the FX markets, writes analyst firm Greenwich Associates in its 2015 FX report. “And with this deeper insight into the cost of trading, investors are also beginning to explore their counterparty options.”

According to Greenwich’s Trade Optimization Study released in February of 2016, 100% of the buy-side use TCA in equities, 26% in FX, 9% in corporate bonds, 8% in government bonds, 6% in options and only 2% in swaps.


Data source: Greenwich Associates

Under MiFID II, investment firms will need to evaluate the quality of the execution based on time stamping and getting information on market conditions at the time of the trade. Until recently buy-side firms lacked the technology to capture time stamps. Today, traders can time-stamp each and every trade through an execution management system (EMS), which captures all the current trades and market data, allowing for real-time evaluation of the currency process.


In the past, most TCA has been historical with reports and analysis delivered at the end of the day. But this type of post-trade TCA is sub-par because it’s unable to accurately capture information at the time of the trades. Traders increasingly want actionable TCA so that they can adjust their strategies intraday in order to compete with algorithmic strategies or to counteract high frequency traders.

Today, TCA consists of three aspects: post-trade, in flight (also known as At-trade or real-time) and pre-trade. The goal of pre-trade is to help traders determine the optimal trading horizon based on impact cost and price impact over time, as well as a number of other factors, including volume, spreads, volatility and instrument correlations. In-flight TCA monitors and analyzes executions in real-time against the pre-trade and shows if those assumptions are still valid. Post trade determines the quality of any execution.

When used in conjunction with a rules-based EMS,a TCA service can enable traders to automate low-touch order routing – reducing costs and freeing traders to concentrate on more complex, high-value orders.

TCA is evolving from measuring the execution quality at the point of contact to looking at the overall execution process. This is possible because traders can integrate streaming liquidity feeds into an execution management system.


One of the reasons FX TCA lags behind equities is that there is no centralized source of market data and no definitive closing price or post-trade source. In FX, TCA providers have moreof a challenge given the size and opaqueness of the market. This leaves TCA providers working hard to gather data from market centers and market participants. Since MiFID is expected to drive more trading in OTC markets onto platforms, more data will be captured electronically. EMS vendors perform a lot of data scrubbing, and also some data interpolation to ensure that there is a consistent view across venues and brokers.

While most large sell-side firms provide TCA, many buy-side clients feel the TCA provider should be an independent entity that is not involved in the execution itself.


While TCA is often initiated for compliance purposes in response to regulators, there is widespread recognition that TCA is a positive move for controlling costs and reducing market impact. While compliance is motivating TCA adoption, clearly TCA can help improve trading performance and generate alpha to the benefit of the buy side trader and their end-client.

Liquidity providers also benefit from TCA since the more transparency investors gain, the more confidence they feel about their executions, a point made in the Greenwich report. With regulatory mandates such as MiFID II shaking up the trading business and raising the bar on investor protections, the value of utilizing a modern EMS capable of delivering, or interfacing with, a TCA solution will become essential for capturing a complete audit trail of fills. In Europe, MiFID II requirements for best execution will mean that buy-side firms need to connect with multiple exchanges and venues, which is the strong suit of an EMS.

As the market for TCA expands in FX, the focus on proving and planningbest execution will keep TCA in the spotlight. Incorporating pre-and post-trade TCA into the analysis will be critical as traders look for actionable information to shift their strategies in a fast and complex market.


gOvgeljqfESmCJx03Ac5GV2vX0rOKrsuXIslEys2.jpegThis article is an exstract from a full-length white paper entitled, “TCA & MiFID II: The Business Benefits of Compliance” by Ivy Schmerken. Download a copy at