What is best execution in bond markets?
In fixed income a best execution process matches up trade metrics to the investment parameters.
“Trading is simply how we monetise our research,” as Ken Griffin, CEO of Citadel, recently said to Nicolai Tangen, CEO of NBIM.
In Griffin’s terms, bond investors monetise research by successfully buying all of the bonds needed to fit the profile and size of the investment objective. As their value is not fixed by selling them for profit, the price at which they are bought – which tends to move little – is not the only factor in best execution. It might be far more important than trying to get the best price for them, given pricing is very range-bound.
Why do regulators get involved in trading?
To break up exchanges’ monopolies on trading, regulators allowed trading away from the venue that listed a security. That reduced fees for brokers. A consequence was it became harder for investors to compare prices across multiple venues so regulators had to create rules on trading so investors could understand trading costs.
Why do they talk about best ‘execution’ and not best ‘price’?
In US equity trading under Reg NMS, brokers are obliged to execute trades at the national best bid-offer (NBBO), benchmarked against the consolidated tape of all equity trades. That is intended to provide investor protection.
In Europe, regulators decided that instead of the quantitative ‘best price’ being set for brokers, it would set a qualitative assessment of execution quality, ‘best execution’, defined within a policy of each asset manager. This was first set for equities in 2007 under Europe’s Markets in Financial Instruments Directive (MiFID) and for bonds in 2018 under MiFID II.
If bond markets did not need to have exchange monopolies broken up, why are best execution rules applied to them?
Equality across markets. European regulators broke the connection between trading and investment decisions under MiFID II by separating payment for research and trading. That meant execution decisions needed to have a measure of effectiveness, determined by the best execution policy.
So, do regulators understand best execution in corporate bond markets?
In the US, best price obligations have not been applied to bonds, very sensibly, because many bonds have no live price to base a NBBO on. So, getting the best outcome sits with the buy-side trading desk. FINRA has fined several brokers for failing in their best execution obligations in equity trading.
In Europe, best execution policies have included bond trading since MiFID II, but no firms have been fined for failures.
Given their standoffish approach to getting in the weeds of best execution obligations it is hard to conclude if they understand best execution – but clear they are sensibly not getting too involved.
©Markets Media Europe 2024
