What Is Best Execution?
Best execution is a legal mandate that requires brokers to provide the most advantageous order execution for their customers given the prevailing market environment. Best execution encompasses several key characteristics that brokers must examine, track, and document when choosing how to route equity, an option, or a bond order for execution.
- Best execution says that brokers get their customers the most advantageous order execution.
- Best execution is a law that requires brokers to put clients’ interest first—above incentives, such as soft dollars, offered by trade routing entities.
- Key factors brokers consider when executing customer orders include the opportunity for a better price than quoted, speed of execution, and the likelihood of trade execution.
How Best Execution Works
Best execution is not just an ethical guideline; it is also the law. Essentially, it is a law put in place to ensure brokers place their clients' interests first. Brokers have choices about where they route trades for execution. Sometimes entities that execute trades can offer incentives to brokers to use their services. These incentives can come in many forms, such as soft dollars.
Best execution laws allow the Security and Exchange Commission (SEC) to make sure clients' interests are not compromised in the name of brokers accepting these incentives. To comply with this measure, broker-dealers must report to the SEC quarterly on how customers' orders are routed. The Financial Industry Regulatory Authority (FINRA) also conducts routine examinations where brokerage firms' best execution practices are audited.
The SEC requires broker-dealers to offer quarterly reports about customer order routing, as well as monthly reports on execution quality.
For a broker, the best execution relies on examining many factors, including price, fees, and information leakage. In particular, with price, the broker must determine that it’s the best from all liquid sources.
As well, in terms of fees, the broker must decide whether the source is relatively cheap to use. Then there’s information leakage, where it must be determined whether the information will be leaked as to hurt the cost of executing the positions.
Requirements for Best Execution
Key factors brokers consider when executing customer orders include the opportunity for a better price than quoted, speed of execution, and the likelihood of trade execution. Best execution is not just about getting the market price but must take into consideration other factors, such as the time for settlement and the size of the trade.
Brokers assess all the orders they receive from all their customers. Yet, investors can direct their own trades. Investors can tell brokers what exchange or market maker to use when executing their trade. This service may come with an additional charge, however. And when it comes to execution, investors have the option of requesting the policies of routing practices from their broker.
For Europe, there have been best execution regulations introduced in 2018, called Markets in Financial Instruments Directive (MiFID) II. These regulations helped boost the initial MiFID regulations that were put in place in 2007. This new regulation said brokers must take “sufficient steps” to ensure favorable execution for clients, versus “reasonable steps.”