One of the things that I’ve often been asked when talking to prospective customers, journalists or analysts about single-dealer platforms (SDPs) is, “Won’t using an SDP conflict with a buy-side client’s best execution requirements?”
This question highlights two commonly held, but erroneous, beliefs – first that a multi-dealer platform will always offer the best price, and that best price and best execution are the same thing. Let’s deal with these one at a time.
First: “Being able to see multiple prices (on a multi-dealer platform) will give a trader the best price at which to trade.”
Not necessarily it won’t. Remember that there is a cost to the dealer contributing an executable price to a multi-dealer portal. Charging models vary – Bloomberg merely charges a hefty monthly fee for each terminal – but if a dealer’s putting prices on Bloomberg they need a terminal on each desk so they can see their own (and other people’s) prices, so the amount most investment banks pay annually to Bloomberg is substantial. Other platforms have different models, but in general there’s an annual fee plus a per-transaction cost which is generally a percentage of the value of the deal. The only way the dealer can cover this is from the bid-ask spread they offer on the instrument, so the price they offer their client won’t necessarily be the best price for the instrument – it’ll be the best price plus a margin to cover their transaction cost.
If they offer the same client the same instrument via an SDP there are no transaction costs, so they can offer better prices and tighter spreads. Although on the MDP the client can see multiple prices, the SDP may well offer that client a better price for that particular instrument. A win-win situation: the client gets a better price and the dealer makes more margin.
Of course the dealer has to amortise the cost of building and maintaining the SDP – but now that there are single-dealer platform frameworks available on which to build them, the all-up cost of building an SDP is an order of magnitude less than it was five years ago, and the ability to re-use the infrastructure to offer portals for additional asset classes can massively reduce the total cost across the bank. That means the amount the bank needs to recover from each transaction can be much smaller than that on each and every transaction on an MDP.
Second, “The client has to see multiple prices and get the best price to comply with his firm’s best execution policy”. Does he? If the client is another dealer – these are the majority of users of SDPs* – then they are very likely to fall into the “professional client” or “eligible counterparty” categories defined by MiFID, and therefore not subject to best execution requirements. If the client, usually but not always in a buy-side firm, is trading on behalf of a retail client then they do have to comply with the best execution policy that their firm has agreed with the client.
This doesn’t necessarily mean “best price” though. Article 21 of MiFID requires firms to “take all reasonable 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” or any other relevant considerations. For a more detailed discussion of best execution see this excellent Freshfields article.
So it’s entirely reasonable for a buy-side firm to state in their best execution policy that they have found trading with one particular sell-side counterparty gives them overall the best combination of price, research, settlement and availability of instruments, and therefore they will conduct all transactions of a particular type with that dealer, and review the situation periodically. So trading on an SDP could easily comply with the firm’s commitments under its best execution policy.
* Caplin’s analysis of Bank of England FX trading data for the last two years – to be the subject of another blog in due course.