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Best Execution Compliance Workstation Helping Brokers Comply with MiFID The European Union’s Markets in Financial Instruments Directive (MiFID) Article 21 places an obligation on brokers from 1 November 2007 to “execute orders on terms most favourable to the client” - ‘best execution’. Most brokers rely on traditional management oversight of the trading process or sampling, neither of which can cope with today’s volumes. What’s missing is the ability to show that a specific trade was executed at a reasonable price. The only effective method of monitoring hundreds of thousands of trades per week is to have an automated process identifying a sensible set of anomalous trades for examination. Basically, firms need a ‘sifting engine’ that identifies potentially anomalous trades – ‘best execution compliance automation’.
Z/Yen, in co-operation with Sun Microsystems, the London Stock Exchange and four leading brokers, has just completed a large, formal research study to trial PropheZy – a commercial application of a support vector machine. Using three months of data comprising over 190,000 trades with a value of over £54bn in order to predict a fourth month, the objective was to see if PropheZy could predict the likely price range of a trade (specifically one of twenty price movement bands, based on a logarithmic scale). The project proved that PropheZy successfully predicted price movement bands. Setting the level of acceptable accuracy at “within 0 to 4 bands” out of 20, PropheZy was able to predict over 50% of the trades price bands acceptably.
Using these predictions, it was possible to set a level for best execution anomalies using price band prediction differences. Excluding trades inside the bid/offer spread from the PropheZy selection, the number of anomalies is reduced to approximately 1%. Participating brokers said:
During the course of this research project the team built a prototype ‘Best Execution Compliance Workstation’ combining a number of tools (PropheZy, VizZy, FractalIntelligence and Decisionality) that helps a compliance officer process, visualise and manage best execution outliers: Process: The compliance workstation has a workflow management tool that helps the compliance officer. The first stage of the process is filtering for anomalous trades. These trades are referred to the trader for explanation – do client instructions, market conditions, the size of the trade or any other factors explain the execution price? This system tracks investigations and provides a compliance ‘audit trail’.
Visualise: The compliance officer sees the predicted price movements plotted against the actual price movements. The length of the yellow link shows the difference between the actual and predicted values. The longer the link the more anomalous the trade.
Manage: The compliance workstation provides a ‘drill down’ tool for a compliance officer to home in on specific trades by drilling down through a variety of hierarchies. Shown here is a set of trades that fell outside the bid/offer spread and is arranged in 10 circles, showing trades with increasing differences between actual and predicted price movement.
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