A comparative analysis of the US and EU retail banking markets - Wsbi
A comparative analysis of the US and EU retail banking markets - Wsbi
A comparative analysis of the US and EU retail banking markets - Wsbi
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The best execution rule was first mentioned in <strong>the</strong><br />
1934 Securities Exchange Act <strong>and</strong> upheld by <strong>the</strong><br />
NMS, however without specifying <strong>the</strong> actual scope<br />
<strong>of</strong> <strong>the</strong> company’s responsibility when executing its<br />
client’s order. For <strong>the</strong> first time, in <strong>the</strong> 1996 Order<br />
Execution Obligations Act, <strong>the</strong> SEC stated that “<strong>the</strong><br />
duty <strong>of</strong> best execution requires a broker/dealer to<br />
seek <strong>the</strong> most favourable terms reasonably available<br />
under <strong>the</strong> circumstances for <strong>the</strong> execution <strong>of</strong> a<br />
customer’s transaction” 202 . Although this definition<br />
indicates <strong>the</strong> core <strong>of</strong> <strong>the</strong> best execution rule, one<br />
could argue that it is also ra<strong>the</strong>r vague, as it does not<br />
provide a detailed description <strong>of</strong> <strong>the</strong> steps which an<br />
investment firm is expected to take to satisfy <strong>the</strong><br />
requirement imposed by <strong>the</strong> rule. The SEC justified<br />
<strong>the</strong> lack <strong>of</strong> a precise definition by stating that “<strong>the</strong><br />
scope <strong>of</strong> this duty <strong>of</strong> best execution must evolve as<br />
changes occur in <strong>the</strong> market that give rise to<br />
improved executions for customer orders, including<br />
opportunities to trade at more advantageous prices.<br />
As <strong>the</strong>se changes occur, broker-dealers' procedures<br />
for seeking to obtain best execution for customer<br />
orders also must be modified [...]” 203 .<br />
A number <strong>of</strong> parameters which can affect <strong>the</strong> best<br />
execution were also identified (among which price,<br />
speed <strong>and</strong> probability <strong>of</strong> implementation), although no<br />
clear priority was assigned to any <strong>of</strong> <strong>the</strong>m. To introduce<br />
some order, <strong>the</strong> SEC empowered Self Regulatory<br />
organisations (SROs) to define <strong>the</strong>ir own definition <strong>of</strong><br />
best execution adapted to <strong>the</strong>ir trading mechanism 204 .<br />
In addition, each investment firm is required to define<br />
its best execution policy.<br />
Moreover, <strong>the</strong> SEC undertook some actions to link<br />
<strong>the</strong> prices on different <strong>markets</strong> <strong>and</strong> to make <strong>the</strong><br />
system more transparent. It set up a national best bid<br />
<strong>and</strong> <strong>of</strong>fer (NBBO) mechanism through which <strong>the</strong> best<br />
available ask price <strong>and</strong> <strong>the</strong> best available bid price is<br />
collected from all significant market centres <strong>and</strong><br />
disseminated to <strong>the</strong> public. It is important to note<br />
that <strong>the</strong> best price available in <strong>the</strong> market is not<br />
necessarily NBBO <strong>and</strong> that <strong>the</strong> traders in <strong>the</strong> <strong>US</strong><br />
are obliged to consider <strong>the</strong> possibility <strong>of</strong> price<br />
improvement, i.e. to obtain a price better than <strong>the</strong><br />
NBBO through alternative <strong>markets</strong>.<br />
The SEC found that “at some market centres as<br />
many as 50% <strong>of</strong> certain orders, particularly market<br />
orders for small sizes (less than 500 shares), are<br />
executed at prices better than <strong>the</strong> public quotes” 205 .<br />
In its constant effort to enhance best execution rules,<br />
in 2001 <strong>the</strong> SEC adopted a rule to improve public<br />
disclosure <strong>of</strong> order execution 206 . Namely, it introduced<br />
an obligation on trading centres that trade national<br />
market system securities to publish monthly electronic<br />
reports with uniform statistical measures <strong>of</strong> execution<br />
quality in order to enable investors to judge for<br />
<strong>the</strong>mselves whe<strong>the</strong>r best execution has been<br />
achieved 207 . Such uniform information should enable<br />
<strong>the</strong> investors to compare prices on different <strong>markets</strong><br />
as well as to encourage a fair competition between<br />
trading centres. This information is necessary as <strong>the</strong><br />
same securities are nowadays traded on different<br />
<strong>markets</strong> (e.g. on exchanges, over-<strong>the</strong>-counter market<br />
makers, electronic communication networks, etc.)<br />
making it harder to keep track <strong>of</strong> all <strong>of</strong>fer prices <strong>and</strong><br />
trading conditions.<br />
Finally, on <strong>the</strong> same day as <strong>the</strong> order execution rule,<br />
<strong>the</strong> SEC also adopted a rule on routing practices.<br />
It requires investment firms that route customer<br />
orders in equity <strong>and</strong> option securities to publish<br />
quarterly reports with a list <strong>of</strong> venues to which <strong>the</strong>y<br />
routed a significant percentage (more than 5%) <strong>of</strong><br />
clients’ orders 208 . Brokers must also identify <strong>the</strong> nature<br />
<strong>of</strong> <strong>the</strong>ir relationship with those venues, enabling <strong>the</strong><br />
clients to observe <strong>and</strong> evaluate whe<strong>the</strong>r brokers’<br />
routing practices are acceptable. This rule was imposed<br />
after <strong>the</strong> practice showed that some brokers who<br />
<strong>of</strong>fer <strong>the</strong> lowest fees <strong>and</strong> a quick execution might<br />
not be <strong>the</strong> best choice for <strong>retail</strong> investors. A decision<br />
based only on <strong>the</strong>se two parameters (low fees <strong>and</strong><br />
quick execution) might limit opportunities for<br />
investors to obtain <strong>the</strong> best price <strong>and</strong> might lead to a<br />
conflict <strong>of</strong> interest between <strong>the</strong> broker <strong>and</strong> investor.<br />
4.3.2.2.2 Order h<strong>and</strong>ling rules<br />
Order h<strong>and</strong>ling rules include <strong>the</strong> quote rule <strong>and</strong> <strong>the</strong><br />
limit order display rule. Their purpose is to increase<br />
<strong>the</strong> information that is publicly available concerning<br />
<strong>the</strong> prices at which market makers are prepared to<br />
trade <strong>the</strong>ir securities.<br />
202 <strong>US</strong> SEC, Order Execution Obligations Act, Release No.34-37619A, 6 September 1996.<br />
203 Idem.<br />
204 Each SRO can create unique rules to regulate <strong>the</strong> business conduct <strong>of</strong> its members with regard to equities trading, but on <strong>the</strong> condition that it recognises<br />
national securities laws <strong>and</strong> various directives issued by <strong>the</strong> SEC. Some examples <strong>of</strong> SROs are NYSE, AMEX, NASD <strong>and</strong> regional stock exchanges.<br />
205 <strong>US</strong> SEC, Disclosure <strong>of</strong> Order Execution <strong>and</strong> Routing Practices, Release No. 34-43590, 17 November 2000.<br />
206 <strong>US</strong> SEC, Disclosure <strong>of</strong> Order Execution <strong>and</strong> Routing Practices, Release No. 34-43590, 17 November 2000.<br />
207 Disclosure <strong>of</strong> Order Execution <strong>and</strong> Routing Practices, Rule 11Ac1-5.<br />
208 Order Execution <strong>and</strong> Routing Practices, Rule 11Ac1-6.<br />
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