July 9, 2024

Best Execution and Fixed Income ATSs

Alan Reed

General Counsel & Chief Compliance Officer


“Best execution” is a term that is core to the trading industry and, while simple in concept, one that is subject to broad interpretation. At its heart, it embodies the duty required of every broker-dealer handling customer orders and serves as an underlying principle that must be considered across all security types, including those that trade exclusively over the counter (OTC) or that have limited consolidated market information. Since fixed income securities generally are traded OTC in a fragmented market, broker-dealers handling these orders encounter certain challenges when fulfilling their best ex obligations. The purpose of this article is to summarize: (i) the best execution obligation; (ii) FINRA’s and the MSRB’s guidance around best ex and fixed income alternative trading systems (“ATSs”); and (iii) certain elements of the OpenYield ATS that we believe will support best ex analysis. 

The Duty of Best Execution

As a general matter, broker-dealers must determine whether the execution of a particular transaction is “best” for its customer. The duty of best execution flows from a broker-dealer’s general obligation to act in the best interest of its customers and the codification of this duty in FINRA Rule 5310 and MSRB Rule G18 (collectively referred to as the “Best Ex Rules”). FINRA has provided limited guidance on the topic over the years; however, in 2015 FINRA published reasonably detailed (and thoughtful) advice on the topic in Regulatory Notice 15-46 (“FINRA Guidance”). Significantly, RN 15-46 sets forth suggested procedures that should be considered or adopted by broker-dealers to support their best ex obligations in connection with fixed income securities and routing to fixed income ATSs. 

When the MSRB adopted Rule G-18 to codify the best execution obligation of municipal bond dealers, it published interpretive guidance in its 2015 Implementation Guidance on MSRB

Rule G-18, on Best Execution (“MSRB Guidance” – and combined with FINRA Guidance, “Best Ex Guidance”). Rule G-18 substantially parallels FINRA Rule 5310 and prescribes best execution obligations for broker-dealers handling customer orders for municipal bonds that align with the corporate bond requirements under the FINRA Rule. As discussed below, the MSRB rule diverges a bit from the FINRA Rule to address transactions in certain highly illiquid municipal bonds.

Reasonable Diligence

At the core of Best Ex Rules and Guidance, a broker-dealer is required to apply “reasonable diligence” when determining the “best market” for executing a customer order. FINRA and MSRB rules state that the following elements should be considered when determining whether a broker-dealer has met the reasonable diligence standard: 

  • the character of the market for the security (e.g., price, volatility, relative liquidity and pressure on available communications);
  • the size and type of transaction;
  • the number of markets checked (note: no minimum number is prescribed);
  • the accessibility of the quotation; and
  • the terms and conditions of the order which resulted in the transaction, as communicated to the member and persons associated with the member

While these factors are not exclusive or exhaustive, they establish a basic framework for meeting the reasonable diligence standard.

Regular and Rigorous Review – Corporate Bonds – FINRA

FINRA Rule 5310 also requires that broker-dealers conduct “regular and rigorous review” of their customer orders routed to other broker-dealers for execution (see note .09 to Rule 5310). For the purposes of conducting this review, executions by a third-party broker-dealer (including one that operates an ATS) must be examined in comparison to executions at other broker-dealers or market centers to be deemed “rigorous” and verify that the execution quality is better than or consistent with the alternatives. This review must be conducted on at least a quarterly basis to meet the “regular” requirements of this approach. While regular and rigorous review does not supplant the duty to perform pre-trade diligence, it is crucial to monitoring execution quality in fragmented markets such as fixed income, where pre-trade price information can be opaque and impractical under time constraints. Furthermore, regular and rigorous review also complements a firm’s use of available smart order routing technology by providing a check on the effectiveness of determinations made by these systems.

Similar Securities Review – MSRB

The MSRB Rule does not include the regular and rigorous review requirement and creates a more flexible framework for broker-dealers to meet their reasonable diligence requirements. This reflects the MSRB’s acknowledgement that the market for munis differs from that of corporate debt in its diverse population of dealers and lower level of pre-trade price transparency. Nonetheless, the MSRB strongly encourages dealers to employ some level of pre- and post-trade price reviews that are reasonable for their specific business. Consistent with this flexibility, the MSRB notes that dealers may use comparable securities for price comparison. Ultimately, muni dealers must capture the practices they employ for best ex review in their written supervisory procedures (WSPs), as required by the MSRB Rule, and review these WSPs on at least an annual basis (discussed below).

Written Policies and Procedures

As a core requirement of the Best Ex Rules, broker-dealers must adopt WSPs that establish their process for meeting their best ex obligation. These WSPs set forth the steps or factors undertaken to meet the reasonable diligence and regular and rigorous review standards. In this context, broker-dealers are expected to adopt policies and procedures that: (i) establish the supervisory structure related to best ex oversight; (ii) identify the factors that are included for reasonable diligence and regular and rigorous review of executions; and (iii) set the frequency or timing of reviews. Many firms form an internal best execution committee, meeting regularly to review both new trading venues and customer executions in the most recent quarter.

Fixed Income Best Ex – Facts and Circumstances

Consistent with the general industry understanding, FINRA has highlighted and the MSRB has echoed that the fixed income market is quite different from the equities market in terms of market structure and regulation and that as a result, best execution analysis for fixed income securities requires an approach that reflects these differences. Among other distinctions, the U.S. fixed income market does not have a national best bid and offer (NBBO) that broker-dealers may use as a point of reference for a prevailing fair market price. In contrast, the U.S. public equities markets are supported by a publicly available consolidated tape that aggregates order information across all equities market centers, including ATSs. Furthermore, much of the public equities market is governed by Regulation NMS, which prohibits executions outside of the prevailing NBBO (without an exception).

The absence of an equity-like market structure requires broker-dealers to conduct additional analysis as part of the best ex review of fixed income securities. For this purpose, the Regulatory Guidance suggests that “facts and circumstances” play a material role. This approach reasonably incorporates factors relevant to customer transactions that provide a basis for concluding that the executions of customer orders for fixed income securities were “best” at the time of execution. While the precise facts and circumstances are up to the firm, the procedures generally incorporate market factors such as other available prices for the same sized transaction and the speed of execution for immediately executable orders.

Best Ex and Fixed Income ATSs

As the presence of fixed income ATSs has grown in the market, broker-dealers have adopted methods to analyze the facts and circumstances of transactions on these platforms to meet best ex obligations. Both regulators acknowledged this trend in their respective Best Ex Guidance, as well as the fact that ATSs contribute to increasing pre-trade transparency for bonds. In particular, ATSs that offer displayed prices and automatic execution may provide certain benefits for customer orders (particularly smaller or retail-sized orders), but additional diligence is needed to verify that the displayed prices are “best” under the circumstances and market conditions.

A. Reasonable Diligence

Applying reasonable diligence to the prices available on an auto-ex ATS requires a comparative evaluation of prices available from other markets (e.g., dealers, similar ATSs, etc.). FINRA specifically cautions that the price displayed on an ATS for immediate execution should not be accepted as “the presumptive best price of that security for best execution purposes”. Similarly, the MSRB notes that simply relying on a price available from a single ATS does not constitute “due diligence” and that municipal bond dealers must incorporate other data to meet the obligation. Notably, the regulators do not expect broker-dealers to subscribe to every available market, but they must take reasonable steps to incorporate other available prices for comparison. The regulators have stated that they will take the accessibility of alternative prices into consideration when determining whether the obligations have been met. Thus, to the extent that sources of pricing are easily or reasonably accessible, they likely should be included as part of reasonable diligence.

The method employed for comparison of price information with an ATS’s pricing may apply an array of market factors for a particular security, such as: 

(i) liquidity of the secondary market;

(ii) availability of pricing information in the market;

(iii) relative size of the order involved in the review; and

(iv) other factors deemed relevant for the security (e.g., frequency of secondary trading).

All of these factors contribute to how a particular execution price compares to other available prices. Together, they serve to provide a reasonable basis to support a conclusion that routing to a particular ATS is consistent with the best execution obligation.

B. Regular and Rigorous Review

As mentioned above, FINRA requires its members to regularly and rigorously review executions of customer orders on an ATS. The MSRB Rule does not expressly prescribe the regular and rigorous review standard, but it does establish that member firms must have a reasonable basis to believe that they have met their best ex obligation, which similarly may be achieved through regular review. Procedures adopted by a firm for this purpose may incorporate the following factors (as applicable) in connection with specific execution prices on an ATS: 

  1. the price obtained, including the extent to which an execution results in price improvement or dis-improvement versus concurrent prices (if available) from other markets;
  2. the likelihood that an order will be partially or fully executed;
  3. the speed of execution;
  4. the size of execution;
  5. transaction costs; and
  6. customer needs and expectations.

The regulators recognize that the fixed income market has unique characteristics and defer to member firms to use reasonable judgment when determining the elements employed for their ongoing reviews. Procedures for routine review of ATS executions should be clear on particular aspects of the market included in the analysis.

OpenYield ATS

OpenYield recognizes that its subscribers have an independent obligation to ensure best execution and has built its ATS to account for this requirement. As a preliminary matter, the OpenYield ATS operates a transparent central limit order book and only supports immediate execution (i.e., no requests for quotations (“RFQs”) or “last looks”). It has no minimum size for transactions and is designed for the efficient execution of all orders, including particular smaller lot sizes. Set forth below are certain characteristics of the OpenYield ATS that subscribers may incorporate in their due diligence and ongoing obligations under the Best Ex Rules.

The OpenYield ATS:

  • aggregates firm, competitive orders from all subscribers into a price/time priority central limit order book
  • accepts only firm (limit or market) orders, which means they are immediately executable at the price and size displayed/made available
    • The OpenYield ATS does not support “last looks” or RFQs
    • Market orders (or marketable limit orders) execute against the best available order
  • has multiple market makers as subscribers that submit continuous firm orders (“quotes”)
    • OpenYield reasonably expects that the number of market makers participating on the OpenYield ATS will continue to increase over time
    • The market makers participating on the OpenYield ATS are generally algo-driven and, as a result, have the ability to continuously update their firm orders to reflect current market conditions
  • has been purpose-built to be a low-cost venue, which OpenYield believes translates into competitive pricing of orders by subscribers
  • incorporates a synthetic current market price aggregated from third-party sources for the purpose of monitoring the prices of orders on the OpenYield ATS
    • OpenYield sets a price tolerance limit versus this synthetic price that is designed to block orders with prices outside of this tolerance
  • conducts regular and rigorous review of executions for the purposes of analysis and market competition

OpenYield is continuing to build additional tools and analytics with best execution in mind. In support of this effort, OpenYield is actively seeking opportunities to work with its subscribers to provide the tools or information needed to help meet this obligation. OpenYield is committed to providing an efficient, competitive source of liquidity and welcomes subscriber feedback. 


This article is provided for informational purposes only and does not constitute legal, regulatory, or professional advice. The information presented is accurate as of publication date, but may change as regulations evolve. Readers should consult official regulatory sources and qualified professionals for guidance on their specific situations. OpenYield Inc. and OpenYield Trading LLC do not guarantee the accuracy or completeness of this information and are not responsible for any actions taken based on its contents.

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