New trading platforms that emerge as a result of the Markets in Financial Instruments directive (MiFID) must take into account the clearing and settlement environment if they are to provide best execution to their customers, says a white paper on the impact of MiFID on clearing and settlement, published by pan-European trading platform Equiduct.

The directive notes: "Where an investment firm executes an order on behalf of a retail client, the best possible result shall be determined in terms of the total consideration, representing the price of the financial instrument and the costs related to execution, which shall include all expenses incurred by the client which are directly related to the execution of the order, including execution venue fees, clearing and settlement fees and any other fees paid to third parties involved in the execution of the order."

So providing lower up-front fees for execution services that do not take into account clearing and settlement issues runs the risk of providing a poor service to customers, says Equiduct. The total cost of the trade is likely to be larger than on the "home market" that uses the existing clearing and settlement liquidity.

The aim of MiFID is to promote competition in cross-border securities trading by abolishing concentration rules in Europe, where investors are forced to execute or report trades via the local exchange, and by introducing a harmonised regulatory framework. It does not specifically address clearing and settlement, except in two articles - numbers 35 and 46.

Article 35 relates to central counterparty, clearing and settlement arrangements for multilateral trading facilities. It says member states shall not prevent investment firms and market operators running an MTF from entering into arrangements for clearing and settlement with a CCP or clearing house and a settlement system of another member state.

It adds that authorities must not oppose the use of a CCP, clearing house or settlement system in another member state, except where necessary to maintain the orderly functioning of the MTF.

Article 46 stipulates provisions for CCP and clearing and settlement arrangements. "Member states are not permitted to prevent regulated markets from entering into appropriate arrangements with a central counterparty or clearing house and a settlement system of another member state with a view to providing for the clearing and/or settlement of some or all trades concluded by market participants under their systems," it says.

Equiduct says these provisions will give investment firms more freedom to select the most appropriate clearing and settlement location, whether in their capacity as an intermediary or as an execution venue (or systematic internaliser).

Newly created regulated markets and MTFs will have to choose which post-trade access they grant to their market participants. Existing trading venues could face pressure from participants to increase the number of post-trade options available, says Equiduct.

Many of the requirements for the different players under MiFID are fundamentally the same, says Equiduct. For example, they all require liquidity, connectivity, a standard settlement model, minimal intermediaries processing, fungibility of stock - for risk and position keeping - and for fees to be as low as possible.

For this reason, says Equiduct, regulated markets and MTFs should use the same criteria as participants on their markets when setting their clearing and settlement policies.

In a market where a CCP is available, says Equiduct, a trading member firm executing through a regulated market or MTF will expect the clearing member to seek a post-trade environment at least as cheap and as straightforward as for domestic transactions. Equiduct says the elements a trading firm would look at include CCP membership, the regulatory environment, liquidity, fees, cost of settlement, and risk management.

The clearing member would prefer membership of a CCP in a jurisdiction with which it is familiar and a
regulatory environment it is already part of.

With regard to fees in the CCP market, both professional and retail clients under Mifid best execution rules require the trading firm to prove that clearing and settlement is organised so that best economic value is provided. As a result, the firm will want clearing and settlement to take place where the fees are transparent (which is why some clearing and settlement venues are unbundling their fees in order to provide more transparency).

Where there is no obligatory CCP, Equiduct says trading member firms will expect that the custodian representing it as a settlement agent will seek the cheapest and least different solution for the post-trade environment when compared to the one already in place in the home market.

The elements a trading firm would expect to be considered are CSD membership, the regulatory environment, liquidity, fees, costs related to settlement and risk management.

In cases where MTFs or regulated markets partner with a CCP or a custodian, Equiduct says the arrival of Mifid and the possibilities for cross border-trading that are opened up, will mean that in order to ensure compliance with some of the national legal and regulatory requirements MTFs and markets will prefer to link with the CCP or settlement agent that has the same regulator or regulators as the MTF/market activity, although this may be difficult to maintain when a wide range of solutions must be offered.

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