DEFINITION of 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. The broker must prove that, after examination of these characteristics, the broker utilized "reasonable diligence" in choosing how to route the order for execution. These key characteristics are the nature of the market for the security (i.e., volatility, communication availability, price, and relative liquidity); the number of markets examined; transaction type and size; and how easily a quote can be obtained.
BREAKING DOWN Best Execution
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 dollar payments. Best execution laws are the SEC's way of making 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. FINRA also conducts routine examinations where brokerage firms' best execution practices are audited.
Additional best execution regulations, called MiFID II, are set to take effect in January 2018. These new regulations are meant to bolster the original round of MiFID regulations that were released in 2007. Main changes for the second round of MiFID rules include the specification that brokerage firms must take "sufficient steps" to ensure favorable execution of client orders as opposed to "reasonable steps," and the added regulation that banks will have to publish on an annual basis their top five execution destinations by trading volume.