BEST EXECUTION IN TRADING: WHAT IT MEANS AND WHY IT MATTERS
Best execution ensures your trades get the best available prices. Here’s why order routing decisions are critical in investment outcomes.
What is Best Execution?
Best execution is a legal and regulatory obligation in financial markets requiring brokers and investment firms to execute client orders under the most favourable conditions available at the time. This involves considering a range of factors beyond just price, including execution speed, likelihood of execution and settlement, trading venue selection, costs, size and nature of the order, and other relevant conditions that might impact the overall result of the transaction.
The concept was formalised under the Markets in Financial Instruments Directive (MiFID II) in the European Union and has similar counterparts in the United States, such as the SEC’s Rule 605 and 606. These regulations compel broker-dealers to act in the best interests of their clients when executing their orders, and to have robust policies in place to consistently achieve this aim.
Although brokers are not required to guarantee the absolutely best possible price on every order, they must demonstrate they took reasonable steps to attain the best result, considering the available alternatives. Documentation and review of execution policies are also essential, as regulators conduct assessments to evaluate compliance with best execution obligations.
For retail investors, best execution translates into fairer trade outcomes, reduced implicit trading costs, and protection from potential conflicts of interest. For institutional clients, the impact may be even more profound, given the size and sophistication of their orders.
It’s also worth noting that some brokers employ internal execution mechanisms or direct orders to affiliated trading venues. If not properly governed, these practices can introduce conflicts of interest and harm execution quality. Therefore, transparency and active monitoring of execution routes are fundamentally tied to fulfilling best execution duties.
As such, best execution is not a one-size-fits-all process—it must be tailored to different asset classes, market conditions, and client profiles. Firms are required to justify their choices and update their execution strategies as markets evolve.
Why Order Routing Is Important
Order routing refers to the process brokers use to determine where and how to send client orders for execution. The quality and logic of this routing can significantly impact whether an order is executed quickly, at the best price, and with minimal associated costs.
In today’s fragmented markets, particularly for equities and ETFs, trades can be carried out on multiple venues including traditional exchanges (like the NYSE and LSE), alternative trading systems (ATS), multilateral trading facilities (MTFs), and dark pools. This proliferation of venues makes routing decisions more complex and more crucial to achieving best execution.
Brokers typically rely on sophisticated smart order routing (SOR) technology to direct orders to the most advantageous venues. These algorithms evaluate a series of real-time data points, such as:
- Bid and ask prices across different venues
- Time priority and fill probability
- Historical liquidity patterns
- Market impact and latency
- Venue fees, rebates, or execution incentives
Routing decisions that prioritise fastest execution at the lowest cost often depend on these factors being constantly balanced and recalibrated. For instance, pursuing the seemingly best price might come with a higher risk of failure or longer delay, which may ultimately worsen execution quality.
Order flow arrangements also play a central role. In some jurisdictions, brokerages may receive payment for order flow (PFOF)—essentially, a fee for directing trades to a specific venue. Without adequate transparency and disclosure, these arrangements can create conflicts of interest, with brokers potentially prioritising their financial interests over client outcomes.
To mitigate these risks, regulations often require broker-dealers to disclose execution metrics, such as average speed of execution, percentage of orders price improved, and where orders were routed. Investors—both retail and institutional—are encouraged to regularly review these disclosure reports to assess the reliability and fairness of their broker’s execution performance.
Ultimately, effective and ethical order routing helps ensure that trades are executed efficiently, costs are minimized, and client trust is preserved in the long term.
Evaluating Execution Quality and Transparency
Assessing execution quality involves examining a range of pre- and post-trade metrics that provide insight into how well a trade was handled. Investors and compliance officers typically evaluate this through execution quality reports, independent transaction cost analysis (TCA), and performance benchmarking against relevant market conditions.
Key metrics used to evaluate execution quality include:
- Price improvement: The extent to which executed prices exceeded the quoted bid or ask at the time the order was placed
- Fill rate: The percentage of the total order that was successfully completed
- Execution speed: The time elapsed between order initiation and completion
- Slippage: The difference between the expected price and the actual executed price of the order
- Venue analysis: Comparison of execution outcomes across routed venues
For professional investors and firms, post-trade analysis through TCA enables detailed breakdowns of trading costs, including both visible (e.g., commissions and fees) and invisible costs (e.g., market impact and timing risk). This data is crucial for optimising trading strategies and vendor selection.
Regulatory reporting obligations like the EU’s RTS 27 and RTS 28 require firms to publish quarterly data on their top execution venues and detail how these achieved best execution for clients. In the U.S., Rule 605 and Rule 606 promote similar transparency measures by obligating market centres and brokers to disclose order execution statistics and routing practices.
In addition to raw data, many sophisticated platforms now offer scorecards that map broker performance against peers, identify possible execution deficiencies, and flag issues that may require further investigation. For instance, consistently poor price improvements or higher-than-average slippage may suggest inefficiencies in routing logic or potential conflicts of interest.
Clients—especially institutional ones—often use this information to renegotiate service-level agreements (SLAs) or change trading partners altogether. For retail clients, transparency and standardised reporting can guide the selection of discount brokers or trading platforms with the most investor-friendly practices.
Ultimately, transparent execution reporting and rigorous evaluation are essential for ensuring that best execution is not merely a regulatory box-ticking exercise, but a meaningful component of investor protection and competitive financial service delivery.
