For a long time, guidance by regulators regarding Best Execution responsibilities for investment advisors has not gotten the attention it deserves. As markets have evolved and become more complex, high-speed and data-driven, the Best Execution Review Committee of the past simply does not cut it.
Best Execution has long meant different things to different firms, whether they are hedge funds, pension plans, mutual funds or even broker/dealers and internalizers. In the US, a firm’s Best Execution obligation is a part of their fiduciary duty if they are an investment advisor (Section 206 of the Advisor’s Act of 1940), or FINRA Rule 5310 if they are a broker/dealer. FINRA’s recent enhanced guidance and attention on Best Execution shows that firms need to continue to improve and modernize their approach. We expect the SEC to follow FINRA down this path.
In Europe, the obligation stems from the original MiFID rules passed in 2004, and has been strengthened by MiFID II. MiFID II places a heavy emphasis on improving investor protection and extends to the introduction of robust controls to avoid conflicts of interest, to encourage greater transparency both pre and post-execution and to ban the use of soft dollars (so-called unbundling).
In Canada, Best Execution is defined under National Instrument 23-101 as the “most advantageous execution terms reasonably available under the circumstances”, and the NI 23-101 obligation is to use “reasonable efforts” to achieve best execution. For IIROC regulated dealers, the obligation as set out in Rule 5.1 of the Universal Market Integrity Rules (UMIR) is to “diligently pursue the execution of each client order on the most advantageous execution terms reasonably available under the circumstances.”
KOR has helped firms of all sizes adopt industry-leading Best Execution policies, procedures and quantitative analysis. We strongly believe that Best Execution needs to be tailored to individual firms based on their size and trading activity. We also believe that firms can learn from each other and from good regulations around the world, even if they are not subject to them in their jurisdiction.
Best Execution does not mean just getting the best price in the market, nor does it just mean performing transaction cost analysis. Best Execution is a firm-wide responsibility which should involve Compliance, Legal, Trading and Portfolio Management all working together. The “regular and rigorous” aspects of Best Execution should at a minimum include meetings with actionable results, robust quantitative analysis, simple and forthright policies and procedures, and strict broker/venue (and potentially sub-advisor) diligence and oversight.
Broker and venue diligence is a particularly hot topic, and even garnered a comment from SEC Chair Mary Jo White last week. The SEC will be unveiling a plan this week to force brokers (and routing operations of exchanges) to provide better information to their clients and publicly. This is a critically important step for investment advisors, so that they can compare brokers to each other. Most importantly, enhanced public disclosure will allow firms to better evaluate brokers they are not using, a recent addition to Best Execution standards from FINRA. KOR has helped clients design and maintain broker scorecards and continues to believe this technique provides the best oversight.
Firms should assess whether they are staying ahead of their Best Execution obligations by asking themselves the following questions:
- Have you looked at your Best Execution Policy lately?
- Are you maintaining industry-leading Best Execution procedures?
- Are you appropriately accounting for soft dollars? Have you tried to unify your policies with MiFID II’s unbundling requirements coming?
- Are your annual broker surveys covering all the right items?
- How are you evaluating the venues your broker sends orders to?
- How do you evaluate brokers and venues that you are not connected to?
- Are you still relying on reports from the sell-side to analyze execution quality?
- How detailed are your quantitative analytics, and are you sure brokers are calculating metrics and recording data properly?
- Do you know what other firms of your size are doing?
KOR can help you with all of these questions and more. Where we lack the expertise, we have partnered with firms who specialize in securities law and regulation, securities lending, transaction cost analysis and more. We provide the only independent Best Execution consulting that combines quantitative and qualitative analysis, compares it with industry-leading best practices, and provides concrete, actionable recommendations prioritized by effort and impact. Whether you manage $100M or $500B, Best Execution requires this holistic approach.