There is an emerging regulatory mechanism coming into the Canadian, as well as global, marketplace which should help pension plan sponsors, and necessarily their trustees, improve returns. In an investment management world that is constantly grappling with the risk/reward trade-off, a best execution transaction environment will offer productiviy gains, and therefore an increase in returns that will come with no incumbet increase in risk. But there is ongoing debate—and much confusion—concerning the definition of best execution of securities transactions, and to whom it applies. While regulators within respective domains are crafting legislation geared towards addressing the state of current market mechanics within their own jurisdictions, the “best execution” definition continues to vary amongst industry participants, and across jurisdictions. But why even get hung up on definitions? Because to say you have achieved best execution, you must be able to prove it. And to prove it, one must be able to define it.

As is typical with many issues involving the United States, the American point of view gets construed as the universal approach mainly due to the country’s size and presence in capital markets. But best execution regulation will be written, however, and it will reside within distinct national and “supra-national” jurisdictions such as the European Commission.

In writing these regulations, measurement is a necessary requirement to assessing the success of their best execution mandates. Market participants can gain a better understanding of how they measure up in the best execution equation— and what they need to do to be successful in meeting a best execution mandate—by examining the similarities and differences of best execution legislation in Canada, Europe and the U.S.


Former U.S. Securities and Exchange Commission(SEC) Chair Arthur Levitt effectively kicked off the process in the year 2000 by releasing the first definition for best execution geared toward the specific act of executing a front-office trade by a portfolio manager. “In placing a trade, the trading desk will seek to find a broker-dealer or alternative trading system that will execute a trade in such a way that the trader believes will realize the maximum value of the investment decision.” By the year 2002, the SEC had updated its own definition stating best execution was “a duty to seek the most favorable execution terms reasonably available given the specific circumstances of each trade.”

The 2002 definition critically shifted the focus in two ways. It emphasized the fiduciary nature imposed on the portfolio manager of the trading decision through the word “duty,” and it introduced a more encompassing cost reference with the “favourable execution terms” phrase.

The seemingly innocuous change of definition achieved two purposes. It created a link into the pre-trade world of the transaction, and also created a link forward into the post-trade worlds of clearing and settlement with the “terms of execution” reference.


The European Commission(EC)has gone even further, and deeper, with its definition of best execution and created a list of specific inputs and attributes which would go into a single transaction. By doing so, it has provided industry participants some much needed guidance and visibility towards what they need to achieve best execution.

Still on the table in the EC’s most recent draft is the recommendation that certain fiduciary aspects on the buy-side of meeting best execution can be “discharged” to the sell side through a written agreement. In other words, even though the buy-side/portfolio manager passes a transaction over to a broker dealer to be executed, the responsibility for the proper execution of that transaction still rests with the portfolio manager(i.e. the “fiduciary buck” stops with the portfolio manager).

However, with the Markets in Financial Instruments Directive (MiFID), a money management firm can contract out the fiduciary responsibility of proper order management and execution to another firm. The other firm(say a broker/ dealer)has to be able to “prove” that it has always managed and executed those transactions with the most favourable economic terms for its client.

In Canada, the Canadian Securities Administrators’ working paper gives us a somewhat less itemized definition visà- vis Europe, but it nevertheless offers a concise definition concerning best execution for Canada. Here, we find four key functional attributes for achieving best execution: price; speed; certainty; and total cost (measurement).


In order to get our arms around this issue, it is possible to use a dual-purpose industry model which can capture the various functional domains across the industry.

This framework provides a starting point for identifying, assessing and measuring the attributes and inputs— not to a million transactions, but to a single transaction. It demonstrates where the traditional components(or services) for the trade exist. Also, it highlights some of the new services, which are available both to improve transaction productivity and to help achieve best execution.

In this framework there are also large areas of “common functional components” that, depending on the respective business model, may reside inside or outside a firm’s trade function domain.

Since we have qualified the “what,” or input costs, to best execution, we are able to realize the fourth element of total cost and, subsequently, measurement. But, to achieve best execution, plan sponsor’s still need to account for the other three elements: price, speed and certainty.

To ensure that these three elements are realized, the mechanical execution environment must meet a high standard of performance, namely through real-time connectivity and a low latency transaction environment. There are certain generic attributes of a transaction which must exist in “real time” to capture, or crystallize, the “what” of trade execution.

Some of these attributes include pretrade compliance and decision support, a recordable instrument order book, with associated prices; recordable market scenarios and order execution algorithms and, of course, access to “liquidity pools”(e.g. traditional exchanges, electronic crossing network, alternative trading system—which could be outside of regulated markets, brokers, etc.)for proper execution. Other(cost)attributes of the transaction to be tracked include the post trade allocation, clearing and settling costs for that transaction.

It is important to note that achieving a great price for a transaction that is offset by an unaccounted for post-trade cost effectively negates the achievement of best execution. Overall favourable execution terms must be considered.


Any entity(for example, plan trustees)participating in the lifecycle of a transaction, will need to be careful if it is warrantying “best execution” as a service. The fiduciary duty, implicit across all the various definitions, creates a link throughout the lifecycle of the transaction, from the decision-making process, right through to settlement. As a result, plan sponsors must pay close attention to their own fiduciary duties.

That being said, lowest cost is not necessarily the final arbiter for best execution. Obviously, different investment objectives along with different fiduciary responsibilities will create different approaches and different best execution equations. The economics of a particular transaction might be such that the input costs might be higher for that transaction, but the portfolio manager or trader has still achieved best execution.

The subjective pre-trade decision costs that go into the slower trade may warrant a higher cost structure. As long as you have met your stated mandate and can measure and subsequently audit its attainment through a transaction cost analysis mechanism, you will have achieved a best execution mandate.

One of the unique features of the best execution regulation is its ambition as it cuts vertically, and horizontally, within and across organizations. Clearly, this is not a back office issue given its penetration into the pre-trade decision domain. It represents a unifying thread throughout the entire trade process, touching all aspects of the trade.

As a result, investment counsel firms, and in general, any portfolio manager needs to examine both the way it is conducting its business, as well as, how transactions are being handled by downstream firms. A result of this may see a redefinition of the respective business model to capture new functionality to support the investment decision. Or, there may be a pull-back away from inefficient functionality(and a “give up”, or outsourcing, of certain functions)that is currently being done because the best execution imperative can’t be met. In any case, an efficient transaction decision strategy, that ultimately meets the plan sponsor’s needs, must be determined.

The last recession coupled with renewed growth left many companies looking more closely at their bottom lines. Notwithstanding these facts, best execution necessarily touches all aspects of the firm, both business and technology domains.

Decisions regarding the solution must be looked at jointly by the heads of business and technology. Moreover, regulatory drivers may require significant investment in electronic trading resources and technology. This is not an option for those offering best execution, as it is driven by ‘stay in business’ criteria. Properly done, however, these investments will simplify administrative process and overhead costs.

Therefore, scoring a positive return on best execution investments does not have to be a wish, since it is a reality for many. A plan sponsor’s initial and overall approach to the issue will be an important determinant to its ultimate success. However, in Canada, when trying to achieve best execution, there is no silver bullet.

Mark Waugh is director, capital markets & risk with Stratix Consulting in Toronto.

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