The Financial Conduct Authority has warned that it will consider using enforcement action on any firms who are evading its rules and requirements when processing orders on behalf of clients.
The regulator outlines the tough stance in a paper on ‘best execution’ and ‘payment for order flow on trades made on clients behalf, particularly by retail and investment banks, brokers and wealth managers.
Best execution is a set of best practice requirements to ensure clients get the most suitable deal, which goes beyond simple pricing concerns. Payment for order flow refers to the commission that a broker receives for transacting a client’s execution by the a third party.
According to the watchdog, such payments have historically been common on the London International Financial Futures and Options Exchange market, where “brokers call around to market makers to get quotes that are not displayed on the electronic order book”.
The regulator found that four firms out of 36 attempted to evade rules by changing the description of services they offered to clients so they could continue to receive payment for order flow, despite previous guidance on this practice in 2012.
The FCA warns it is keeping these arrangements under “active report” and is set to take action against any remaining firms which continue to evade its rules and requirements in this area.
The review states: “PFOF arrangements create a clear conflict of interest between the clients of the firm, are unlikely to be compatible with our inducements rule and risk compromising compliance with the best execution rules.”
The FCA review of 36 firms also found that many firms do not understand “key elements” of the rules and were not adequately controlling client costs when executing orders.
It found these failings were compounded by “insufficient managerial oversight or engagement from front office staff for delivering best execution”.
The report concluded that most firms lacked the capability to effectively monitor order execution or identify poor client outcomes. Firms were also often unable to demonstrate how they managed conflicts of interest when using connected parties or internal systems to deliver best execution.
David Lawton, FCA director of markets, said: “Firms told us that best execution is a simple commercial imperative – yet our review shows many firms unacceptably fail to put their clients’ interests first, undermining market integrity and inhibiting competition.
“The FCA expects to see firms act as good agents, placing equal focus on controlling client costs as delivering returns, and will take action where firms fall short of our standards.”
This review comes ahead of the introduction of enhanced EU-wide rules on best execution and is linked to the FCA’s work on firms’ use of client dealing commission and how they discharge their duty to act as “good agents”.
