Best execution. What does it mean, exactly?
Brokers and the buy-side can have very different views on what the term best ex can mean and how to achieve it. However, that doesnt stop the markets regulators from passing rules and codes of conduct geared towards the opaque and vaguely defined concept.
Best execution is not necessarily the best price. It is not something that can be measured on a trade-by-trade basis. Instead, it is a process that is not quantifiable, but is a set of quality standards, according to many.
Best execution for firms refers to a trading process firms apply that seeks to maximize the value of a client’s portfolio given each client’s stated investment objectives and constraints. This is part of a report and a set of trade management guidelines put out back in 2003 issued by a task force of the Association for Investment Management and Research (AIMR).
Back then AMIR declared the following new guidelines should be adhered to:
* Establishment of trade management policies and procedures that seek to maximize the value of client’s portfolio within that client’s investment objectives and constraints.
* Establishment of a trade management oversight committee.
* Implementation of firm wide trade management policy or policies.
* Implementation of a trade evaluation process.
* Establishment of clear firm-wide guidelines on broker selection and development of an approved brokers list.
* Firms should clearly disclose the actual and potential conflicts of interest that arise from step-outs, research obtained through soft dollars and interest in or material business relationships with market making firms.
Back then it sounded like a tall order and some felt too strict to comply with.
So, what has changed, if anything?
Jack Miller, Chief Operating Officer of Equities at Robert W Baird & Co, told Traders Magazine that it is hard to overstate the changes that have occurred in the equity trading space in years since the AIMR guidelines were published. Especially with the advent of Reg NMS – and the related proliferation of trading venues and fragmentation that followed – evaluation of best execution has become correspondingly nuanced and complex.
As a broker-dealer providing research and execution services to institutional investors, weve seen most of our clients adopt practices for broker selection and trade management that align with the AIMR recommendations, Miller began. That hasnt changed. What has changed are the inputs and level of rigor placed around clients best execution processes.
While access to services like research and corporate access are still important drivers of trade allocation, with MiFID II this became much less so in 2018 and will continue to decline over time, Miller continued.
The unbundling of execution and research services is forcing clients to take a more process-oriented approach to broker selection that looks at execution – performance, liquidity, intensity of service – independent of these other services, he said. And while the evaluation framework remains in place, the information available to investors has changed significantly. As an industry we havent yet solved transparency but at the same time the buysides access to information has never been greater. As brokers, were expected to provide a deeper and deeper level of information about how client orders are handled. Clients demand it, regulation encourages it, and technology – and industry-driven standardization around things like Tags 30 and 851 – has enabled it. The upcoming changes to Rule 606 will accelerate this trend and put even more information in the hands of investors to make informed decisions about execution.
Despite the myriad changes and complexities, Miller said he was excited about all of this as best ex continues to become less of a regulatory check the box exercise and is more and more about driving value in the investment process.
This has provided great opportunities and new avenues for the buy-side and sell-side to collaborate on driving value to end investors, Miller said.
According to one former buy-side trader who is now in the sell side, not much has changed when it comes to conflicts of interest that could arise from the use of step-outs and soft dollars.
While nothing new has developed on the whole since 2003, there is the exception that the SEC has fined at least one asset manager for misrepresenting the extent that step outs occurred, he began. Also, a handful for brokers were fined for not disclosing the extra costs incurred when their sub advisors traded wrap orders away from those brokers (sponsors).
On the soft-dollar issue, he added that soft dollars are still a concern in that asset managers must be very careful to only use commissions appropriately under the safe harbor of Rule 28e.
Section 28e deals with exchange, broker, and dealer commissions. It states:
(1) No person using the mails, or any means or instrumentality of interstate commerce, in the exercise of investment discretion with respect to an account shall be deemed to have acted unlawfully or to have breached a fiduciary duty under State or Federal law unless expressly provided to the contrary by a law enacted by the Congress or any State subsequent to June 4, 1975, solely by reason of his having caused the account to pay a member of an exchange, broker, or dealer an amount of commission for effecting a securities transaction in excess of the amount of commission another member of an exchange, broker, or dealer would have charged for effecting that transaction, if such person determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such member, broker, or dealer, viewed in terms of either that particular transaction or his overall responsibilities with respect to the accounts as to which he exercises investment discretion. This subsection is exclusive and plenary insofar as conduct is covered by the foregoing, unless otherwise expressly provided by contract: Provided, however, That nothing in this subsection shall be construed to impair or limit the power of the Commission under any other provision of this title or otherwise.
(2) A person exercising investment discretion with respect to an account shall make such disclosure of his policies and practices with respect to commissions that will be paid for effecting securities transactions, at such times and in such manner, as the appropriate regulatory agency, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors.?
(3) For purposes of this subsection a person provides brokerage and research services insofar as he-?
(A) furnishes advice, either directly or through publications or writings, as to the value of securities, the advisability of investing in, purchasing, or selling securities, and the availability of securities or purchasers or sellers of securities;?
(B) furnishes analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy, and the performance of accounts; or
C) effects securities transactions and performs functions incidental thereto (such as clearance, settlement, and custody) or required in connection therewith by rules of the Commission or a self-regulatory organization of which such person is a member or person associated with a member or in which such person is a participant.?
(4) The provisions of this subsection shall not apply with regard to securities that are security futures products.
The following article originally appeared in the January 2003 edition of Traders Magazine
FLASHBACK FRIDAY: A Closer Look at Best Execution
By Gregory Bresiger
Among the new AIMR guidelines:
* Establishment of trade management policies and procedures that seek to maximize the value of client’s portfolio within that client’s investment objectives and constraints.
* Establishment of a trade management oversight committee.
* Implementation of firm wide trade management policy or policies.
* Implementation of a trade evaluation process.
* Establishment of clear firm-wide guidelines on broker selection and development of an approved brokers list.
* Firms should clearly disclose the actual and potential conflicts of interest that arise from step-outs, research obtained through soft dollars and interest in or material business relationships with market making firms.
