X Marks the Spot: Will Greater China Embrace Best Execution Standards?

In this article, we explain how managers based in Greater China can look to optimize their foreign exchange process and oversight.

In our recently released C-Suite Asset Manager Survey, it was evident that the COVID-19 pandemic has accelerated cost pressures on asset managers across the globe. Continued fee compression, a feverishly competitive market, alpha generation on existing products, and the rapid rise of ESG integration across the value chain were some of the most challenging factors noted by senior asset management executives. These themes apply universally across asset managers and are as relevant in Greater China as anywhere else. Here we analyze the impact of these findings on asset managers in Greater China, as it relates to their Foreign Exchange (FX) process and oversight.

C-Suite Asset Manager Survey – FX Findings

One of the leading 2021 business priority items asset managers identified is the desire to assess the effectiveness of the FX trade execution processes. Analyzing performance differentials against benchmarks and peers in the market is more critical than ever, and 41% of managers surveyed are planning to optimize these processes in 2021. This focus is even more pronounced for smaller scale managers (less than $50 billion AUM), where more than half of respondents plan to look at ways to improve their execution and oversight

The Global Regulatory Landscape

Adding to these commercial drivers is the increasing complexity of ever-growing regulatory expectations. A focus on best execution remains a high priority across the global regulatory landscape, particularly within Europe and Australia. The policies and procedures, transparency, and reporting obligations for FX trading under MiFID II represent the highest regulatory bar on a global level. All European regulators continue to look closely at best execution and Transaction Cost Analysis (TCA) on an ongoing basis. An important reminder for the entire industry was published by the Central Bank of Ireland (CBI) in November 2020. Its findings included some familiar points of emphasis:

  • Governance: The CBI found significant shortcomings in best execution governance programs, including a lack of clear decision-making processes and evidence of Board and/or committee oversight and challenge of programs.
  • Best Execution Framework: Firms were unable to provide evidence that best execution frameworks were reviewed on a regular basis. This included a lack of training for staff, resulting in poor general awareness of best execution policies and procedures.
  • Assurance Testing: Lack of independent reviews of the end-to-end best execution process and limited assurance testing being completed.

The CBI letter is indicative of similar scrutiny across most of Europe’s large financial centers when it comes to adherence to FX standards and the incorporation of MiFID II requirements across the trading ecosystem in Europe.

In another example, the publication of the Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services in 2017 was seen as a ‘game changer’ which has continued to drive the shift towards greater transparency around transaction costs of all varieties in the Australian market. The report laid out several areas of bad behavior including misconduct, breaches of confidentiality, collusion on rates among other things. This wide-ranging and high-profile report subsequently drove Australian asset managers to push for greater transparency of trading data and robust TCA so that they can meet their best execution obligations to their underlying clients.

With best execution an increasing focus in Europe, Australia and elsewhere, this is a topic that is increasingly viewed as important in the Greater China region too.

Why Should Asset Managers Care?

Simply put:

The competitive environment is becoming more intense, driven by downward fee pressure, and performance is being more heavily benchmarked. Operational complexity while scaling the business is a key challenge for many, especially for asset managers working with multiple custodians and receiving fragmented and inconsistent trading data, making benchmarking more challenging.

Managers in Greater China are well placed to benefit from the long-term shifts in institutional capital, with benchmark inclusions a favorable tailwind. As managers in Greater China position themselves to onboard international institutional mandates, they should consider their readiness to comply with enhanced requirements.

Seeking best execution in connection with those mandates is not merely a compliance requirement, it is a commercial imperative. By incorporating the concept of best execution into all trading processes as standard, asset managers may be able to secure a competitive advantage. That’s why asset managers overseas are already applying consistent best execution principles.

From a regional perspective, local regulators have indicated that FX is included in the scope of best execution obligations. Both the Hong Kong Securities and Futures Commission (SFC) and the Monetary Authority of Singapore (MAS) have issued guidance for asset managers, setting out their expectations and examples of good practice. In the SFC’s Thematic Review of Best Execution (2018), a minimum expectation for asset managers to have best execution policies in place for both listed and over the counter (OTC) products was set out. The SFC states that asset managers should have mechanisms to review execution quality and disclose to clients their best execution arrangements, including carve outs and the exclusive use of affiliates, connected parties, and third parties. Similarly, the MAS Notice on Execution of Client Orders (2020, effective Q1 2022) requires asset managers to have written best execution policies and procedures, with ongoing monitoring for compliance. The related MAS guidelines also highlight disclosure of these policies to clients.

How Can Asset Managers Optimize Their FX Program?

A significant number of asset managers are assessing the use of external third-party specialists to automate FX processes such as those supporting security-related activity, or rules-based hedging strategies that can help support distribution and investor choice.

Another option is building a foreign exchange desk in-house. However, doing so often requires adding resources and ongoing investments in technology, can increase exposure to operational and trading risks and can introduce additional complexities in addressing evolving regulations.

When considering these options critical factors include scale, the quality and accessibility of transparency available from third-party providers, the robustness of the operational processes underpinning execution and the flexibility to customize programs to portfolio needs.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally.  This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented.  This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co.  IS-07417-2021-06-10
IS-07417-2021-06-10

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