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Word document ‘Best Execution:’ Will It Work?
Canadian Regulatory Initiatives
There are currently six Canadian regulatory initiatives that impact ʻBest Execution.ʼ They are:
- ʻBest Execution,ʼ Trade-through, and Reporting Obligations involving Multiple Venues
- Soft Dollars
- Trade Information Collection and Distribution (Information Processor)
- Trading Surveillance (TREATS)
- Pre-Trade Information (XBLR)
- Trade Matching (Matching on T)
Best Execution, Trade-through, and Reporting Obligations involving Multiple Venues creates a framework for the operation of marketplaces such as traditional exchanges, ATSs, and inter-dealer bond dealers to provide trade transparencies including recording and reporting trade information electronically.
The proposed regulations clarify how advisers and registered dealers can use client brokerage commissions and include guidelines regarding disclosure of ʻsoft dollar ʼ arrangements.
With multiple marketplaces, consolidated pre-trade, and post-trade information is required to facilitate ʻBest Executionʼ and market integrity. ʻBest Executionʼ rules require this information be sent to an information processor or vendor. Currently, there is no information processor for the equity marketplaces. Regulatory approval for information processors is expected very soon.
Market Regulation Services (RS) does real time surveillance of the markets that it regulates. RS and other regulators also need access to historical trading information. The regulators have initiated The Transaction Reporting Electronic Audit Trail System (TREATS) project to provide historical information. Real time and historical data is needed to monitor ʻBest Execution.ʼ
TREATS involves extracting, managing, and accessing large volumes of data. This mostly impacts brokers and marketplaces. A TREATS solution is planned for December 2009.
The regulators have been looking at a business reporting language (XBRL) for communicating business and financial data in a format that can be read electronically and fed automatically into other applications.
Rapid access to corporate reports will result in better trade decisions by investment managers able to rapidly receive and analyze this information electronically.
Achieving industry and regulatory consensus on trade matching began as a securities industry initiative to implement Straight Though Processing (STP) for trade matching and settlement.
Current regulatory and industry focus is on achieving trade matching on Trade Date (T).
This will improve ʻBest Execution,ʼ but can only be achieved by more efficient and accurate back office processes.
Best Execution Game Plan
To achieve ʻBest Executionʼ in a multiple marketplace environment, pension and investment managers must:
- Understand the features and characteristics of the new trading venues
- Review your portfolio and trading patterns and determine how all available trading venues can assist you in achieving ʻBest Executionʼ
- Determine if your current trading processes and methodologies will continue to serve your needs going forward
- Work with the parties who execute orders on your behalf to reach an understanding of what ʻBest Executionʼ means for various trading scenarios
- Review your current business processes and technology infrastructure to ensure that it supports trading in multiple marketplaces
- Examine how electronic trading processes may help you achieve ʻBest Execution ʼ and operational efficiency
- Understand how electronic trading uses order management systems, networks, and communication standards such as the FIX Protocol as a facilitator of ʻBest Executionʼ
Will it Work?
While many of the pieces are in place, several gaps currently exist. The regulatory framework has been identified, new trading venues are being launched, and essential technology is available. However the Information Processors are missing and connectivity to the new trading venues has not been tested.
Before we can say that ʻBest Executionʼ is working, investment managers, brokers, and regulators will have to come to a common understanding of what constitutes ʻBest Executionʼ under varying trading situations across multiple marketplaces as the new environment evolves throughout 2007.
We will also need to confirm that systems being developed to route trades to multiple marketplaces work. This is a key unknown, given there have been no industry-wide tests thus far.
Rather than being an issue of ʻwill it work,ʼ it is an issue of ʻit must work.ʼ Ultimately, the beneficiaries of pension plans and investment accounts will demand that the securities industry meets their highest expectations for ʻBest Execution.ʼ Failure can only occur if we fail to understand what they expect ʻBest Executionʼ to be. ■
Robert Smythe is vice-president, research and market development, at Stratix Consulting. He is also the organizer of the 3rd Annual FPL Canadian Electronic Trading Conference, which will be held in Toronto May 31 and June 1.
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