The Best There Is? An Inquiry into Best Execution Rules

Abstract: Best execution obligations weigh on brokers when they execute orders to trade in shares for clients. These obligations have been seen as an outflow of general agency duties, and have been complemented by regulatory requirements related to best execution, dissemination of trading data, the handling of client orders and – in the United States – an obligation to execute at the best publicly available price or better (price protection).Here, different sets of real-world rules are analyzed with regard to transactional efficiency. Economic analyses are used to compare the effects of different rules, and are underpinned by a detailed analysis of relevant rules in the United States, the European Union, France, Sweden and England & Wales.Several normative conclusions can be drawn. Best execution rules that impose an agency duty on brokers do not seem to contribute in a discernible way to increased transactional efficiency. In contrast, disclosure rules that require both brokers and trading venues to provide ex post information about execution quality, and about how client orders have been routed, may contribute to mitigating the information asymmetry between brokers and clients. The compliance costs associated with such rules are outweighed by the positive effects on transactional efficiency.Lastly, a solution such as the US National Market System, which entails consolidated collection and dissemination of market data as well as price protection, can deliver significant efficiency gains through the virtual consolidation of trading venues. It also allows for more detailed regulations on different aspects of order execution, allow order execution regulations to function better, and is conducive to deeper integration of trading. However, creating such a system entails large initial investments. In the end, the choice whether to create a tightly-knit market system or not has wide-ranging implications for market structure, the design of regulatory rules and market integration.