What is Best Execution?
At its core, best execution is about outlining a set of rules and practices that require authorised financial services firms to seek the best possible result for their clients when executing their orders. The factors that need to be monitored encompass more than just price, with other components being taken into account such as:
- likelihood and size of execution.
Why is Best Execution Required?
The rise of retail focused brokers, the gamification of financial markets and the availability of low-cost transactions has allowed non-institutional investors to participate more easily than ever in buying and selling complex OTC Derivatives. As a result, regulators have taken steps to create laws to place clients’ interests first.
This is an attempt to create a framework to ensure that before any broker incentives are considered, for example payment for order flow, the end user is offered the best possible outcome to a transaction.
Requirements of Best Execution
ESMA have outlined that firms owe a duty of best execution to retail and professional clients. When implementing the overarching best execution obligation, firms are required to take steps to obtain the best possible result when executing client orders.
The best execution factors to be considered and their practical implications are outlined in the table below.
|Price of instrument
|Number of markets checked, availability of quote
|Comparison of all costs built into the order execution
|Speed of execution
|Depth of price discovery, execution latency
|Likelihood of execution
|The terms and conditions that lead to order execution
|Likelihood of settlement
|Exploring multiple exchanges
|Size of order
|The size and type of the transaction
|Nature of order
|The character of the market for the security
|Any other unique characteristics for the instrument
Drilling into these factors, ESMA (Article 44(1) of the L2 Directive) directed that firms consider the following attributes when determining relative importance of key factors:
- the characteristics of the client including whether the client is retail or professional
- the characteristics of the client order
- the characteristics of the financial instrument that is the subject of that order
- the characteristics of the execution venues to which that order can be directed.
The Challenges of Best Execution
There are many potential difficulties for financial institutions under the best execution framework. For example, applying the best execution same methodology across all asset classes becomes troublesome, with certain areas more difficult than others.
Foreign Exchange and public equities are priced constantly with large volumes allowing for accurate price discovery and the ability to execute the transaction across a range of trading venues. Fixed Income and other more unique, illiquid investments can be much more difficult to monitor. The amount of data that is required to be analysed to prove that the best possible result has been achieved over all of a broker’s transactions is almost unfeasible. Brokers would have to create systems and compliance processes that are able to handle the vast quantities of high-quality data and then compile these into useful datasets. For this reason, the rollout of best execution monitoring has been less scrutinised than other regulations with more tangible implementation requirements. Businesses and regulators seem to still be coming to terms with the relatively broad and open ruleset and implementation of the framework in a dynamic real-world scenario.
Best Execution Implementation Recommendations
You should regularly monitor your compliance with, and the effectiveness of, your Best Execution policies and procedures. In doing so, you should assess whether your execution of transactions has delivered the best available terms to customers on a consistent basis. Such monitoring should reflect the nature, scale, and complexity of your business. Monitoring of all asset classes and transactions executed will be incredibly difficult. As a result, best practice would likely be to regularly analyse a subset of your clients’ orders to ensure that they are compliant and achieving the best possible outcome when balancing all the factors.
|Inspecting for large or excessive discrepancies between executed and references prices.
|Analysing the difference between executed and references prices for all notable discrepancies. Investigate some outliers from each asset class.
|Compare the number of trades in the period executed at a price
better than requested against those completed below the reference rate.
|In conjunction with RTS27, timeliness and slippage should be analysed, along with speed of execution, cost and likelihood and the nature of the order.
|Under RTS28, investigate whether using each Liquidity Provider enhances client outcomes, checking their rejections and successful fills.
The above is an example of the type and frequency of checks that could be performed by a firm to ensure compliance with Best Execution regulations. More frequency and scope would be applied to a high frequency derivative market maker than a hedge fund.
How do TRAction Help Their Clients with Best Execution?
TRAction aims to reduce the regulatory burden for our clients by offering an all-inclusive service which covers all of our client’s needs. In light of the best execution requirements under MiFID II and potential implementation of similar requirements in other jurisdictions, TRAction developed a Best Execution Monitor and services to help our clients comply. Our Best Execution Monitor is a smart system which collects, analyses and compares your transaction data against market data to identify where the execution received by clients is outside of your execution parameters.
TRAction’s RTS 28 assistance
Under MiFIR, huge quantities of data are collected. Regulated firms are expected to mine their datasets to a granular level in an attempt to continually prove that they have met their best execution requirements. The RTS reports are a further step by the regulator in obtaining information to monitor that these obligations are being met across all transactions.
At TRAction, we help our clients to prepare their RTS 28 reports (and RTS 27 where it remains in force), aiming to leverage our industry knowledge and sector expertise to boost our client’s reporting efficiencies.
If you are interested in learning more about how Best Execution may affect your reporting requirements please reach out to our team at TRAction.