Client consent to execution policy and execution of orders outside a regulated market or MTF - COBS Provision

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The vexed question of how clients consent to a best execution policy in general, and provide permission for their orders to be handled away from regulated exchanges in particular, is covered in COBS 11.2.25 and 11.2.26. As we shall see.

Products which don’t trade on a regulated market or MTF

While at first blush it reads as though 11.2.26 should apply to all orders, even those which cannot be traded on a regulated market in any circumstances (otc swaps for example), the confines of common sense and logic have not entirely escaped the European Commission. In its “Questions on Single Market Legislation” resource, it notes:

However, on a purposive reading of the express consent requirement, an investment firm does not have to obtain express consent from its clients where the relevant instruments are not admitted to trading on a regulated market or MTF.

This view was confirmed in CESR’s “Best Execution under MiFID” document:

21.2 CESR considers that on a purposive reading of the “express consent” requirement, an investment firm does not have to obtain express consent from its clients where the relevant instruments are not admitted to trading on a regulated market or MTF.

Products which trade OTC - can the transaction itself be a consent to execute off regulated market?

In order to comply with this rule, the safest course is to ask clients for a generic permission to execute trades off regulated markets or MTFs across the board. Some clients might object, however, to such a wide-ranging permission.

You can of course ask instead for consent “in respect of individual transactions” (per the wording of 11.2.26). This might seem unfeasible, but consider that for many products that might oherwise be caught (especially OTC transactions) the very act of transacting in a certain way - if that way necessarily entails trading outside a regulated market or MTF - amounts to express consent to trade in that way.

And that is actually a pretty fundamental get-out.

There is an unspoken distrinction in the COBS rules between:

• “agency” or “quasi-agency” orders: orders whereby a broker receives instructions from client and then turns around and interacts with third party venues (including regulated markets, MTFs but also unregulated venues like systematic internalisers), without involvement of the client, to fill that order); and
• “bilateral” transactions where client trades with the broker directly in a principal capacity and any transaction between the broker and the market is by way of hedge and not fulfillment of the customer’s order. These are things like OTC derivatives under an ISDA Master Agreement; spot FX trades and so on. The point is if you ask for an OTC transaction then, by definition, you are consenting for it to not be executed on exchange. In the same way that ordering a cheeseburger is, by definition, consenting to being given non-vegan food.