Best Execution

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21 Aug, 2024

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The best execution is the legal mandate that demands brokers to assess, track and study the market for their clients and ascertain the execution of the most favorable and best trades for their clients.

Every brokerage firm must submit quarterly reports to the U.S. Security and Exchange Commission (SEC) on routing the trade orders for their clients. The law is to safeguard every client's best interest because they trust and believe in the best execution by brokers with their money.

What is Best Execution?

Best execution trading is the legal obligation of all brokers to track, study, execute and timely report the trades for the clients with the best interest and maximum advantageous options to the client.
A broker is entitled to work and ensure that they have the best interests at the heart of their clients. In other words, the monitoring is to keep the client's interest first and before the personal interest of the broker.
It is regulated by the SEC in the US along with Financial Industry Regulatory Authority (FINRA). In Europe, the Markets in Financial Instruments Directives (MiFID) is the European regulation performing a similar function.
Rule 5310 of FINRA (Best Execution and Interpositioning) demands the best execution for every transaction occurring.

Best Execution Explained

The best execution meaning comes from the fairest trading practices brokers and investment firms execute for their clients. Therefore, whenever an individual connects with a broker or brokerage firm for their investments and portfolio management, it is understandable that every firm will try to provide the individual with the best trading options and invest their money correctly, ensuring perpetual growth.

Still, again this is just a mutual understanding between the individual and the broker, and it doesn't need to be the case. The best execution law is introduced by the SEC in the US to keep track, record, assess, and monitor how investment firms and even brokers are operating in the market with their client's hard-earned money.

The best execution definition portrays keeping the client's interest first and before the broker's gain or belief. It is regulated by the SEC in the US along with Financial Industry Regulatory Authority (FINRA). In Europe, the Markets in Financial Instruments Directives (MiFID) authority does the same framework and monitoring. It applies to all types of financial instruments. If a broker or firm fails to submit the quarterly reports to the SEC, they can be charged with penalties and misstatements.

Rule 5310 of FINRA (Best Execution and Interpositioning) demands the best execution for every transaction occurring. Accordingly, an entity associated with them shall use reasonable diligence to ensure that it is the most profitable trade and shall operate in such a market so that the outcome is the most favorable for the client. In addition, firms must review the execution quality of the orders initiated mandatorily.

Examples

Let's look into some of the examples for a better understanding of the concept:

Example #1

Jamie is a businessman; he is busy and cannot keep up with his investment tracking daily. So Jamie hires Anthony, a broker, and trusts him with all his money. Anthony has been in the market and trading activities for quite a reasonable time, has substantial knowledge of the equity markets, and acts on behalf of Jamie. He readily tracks Jamie's investments and trading opportunities to ensure that the investments reap the maximum benefits and returns in the future.

Anthony quarterly submits a report of all the trades he executed on behalf of Jamie to the SEC. Of course, Anthony wants the best options for Jamie, but the law forces that there has to be an allegiance and find the best execution price and trades for Jamie.

Example #2

Taking the first example further, Jamie has discovered a new stock and finds it attractive enough to buy. As a result, therefore, he wants Anthony to execute a corresponding order. Still, Anthony, who daily follows market news, asks for time and assesses the company fundamentals to inform Jamie that it is not a good stock and a risky investment.

The duty of best execution bounds Anthony to inform Jamie about every risk and the best investment options. In risky situations, the broker must inform and act on Jamie's behalf and rebalance the portfolio or exit from loss-making trade. This way, Anthony gives the best execution advice to Jamie and manages his investment, registering a profit before incurring a loss.

Why Is It Important?

The best execution policy is managed and regulated by the SEC to protect investors' rights and safeguard their investments.
It ensures that brokers always keep their client's interests first and before their interests and seek the best execution price for their clients' trade orders.
It help authorities bring complete transparency and better communication between brokers and their clients to ascertain clarity of work and trade.
Best execution trading is a practice in line with the law. Therefore, it is a vital tool to keep track and monitor every trade made by brokers and keep a check on them when the brokers submit quarterly order reports.

Frequently Asked Questions (FAQs)

What is the best execution of MiFID II?

In Europe, MiFID's best execution rule requires investment firms to use all reasonable efforts to achieve the best outcome for their clients, taking into account factors such as price, costs, speed, the likelihood of execution and settlement, size, character, and any other factors pertinent to order execution.

What are the factors influencing the best execution?

There are general factors that influence the best execution strategy:
- Trade size
- Execution speed
- Trade likelihood
- Settlement time
- The best interest of brokers for their client's money

Does the best execution apply to funds?

Yes, the best execution solutions apply to every financial instrument and product. All financial and investment firms are bound to abide by them while executing trades or acting on behalf of their clients. A trader must study and analyze the prevailing market conditions before deciding because they deal with their client's money and should operate carefully.