Do you invest or do you execute?

Under MiFID II, both buy-side and sell-side firms are required to record and to report on, separately, the algorithms used in making both the investment decision and the execution decision. In most agency workflows that should be straightforward enough; the buy-side makes and reports the investment decision, and the sell-side is responsible for the execution decision. But how does this work in other cases – market making, for example?

In the long run market makers typically don’t want to invest, but rather stay flat and earn the spread. So there are no investment decisions to be made, right? Well, looking at it from a short-term perspective, it’s rather more complicated than that. A market making algorithm might observe that the net trading position is getting too short and therefore adjust the bid/ask prices upward. Was that an investment decision to buy? Some might argue that the decision to increase the exposure is investing, while others could counter that there is still a two-sided quote in the market that could move the inventory going either way. So what was really decided here?

Bottom line, don’t be surprised if your colleagues ask whether you invest or execute. Chances are they’re not trying to be either philosophical or funny, they’re simply trying to implement MiFID II.