The Securities and Exchange Commission's Best Execution proposal is receiving significant pushback from the muni market for its overlap with existing rules at the Municipal Securities Rulemaking Board and the Financial Industry Regulatory Authority and for other concerns unique to fixed income markets that advocates say could lead to significant consequences.
That's according to comments submitted by broker-dealer groups in which they urge the Commission to abandon the proposal altogether and if not, exempt municipal securities markets from it and abandon certain concepts such as "conflicted transactions," and quotation-based elements due to their incompatibility in fixed income markets.
"SIFMA does not support a Commission level best execution rule for fixed income securities," said Leslie Norwood, managing director, associate general counsel and head of municipal securities at the Securities Industry and Financial Markets Association. "A third separate rule for best execution would make compliance more challenging and more difficult and more expensive for regulated parties. We do believe that if the proposal moves forward, regardless, it should include broad institutional investor exemptions comparable to the MSRB's concept of sophisticated municipal market professionals."
Michael Decker, senior vice president for research and public policy at the Bond Dealers of America argues that the requirements for broker-dealers such as having policies and procedures that govern their compliance with best execution, identification of "material potential liquidity sources" and "how the broker-dealer will determine the best market for customer orders received" are already required under MSRB and FINRA rules.
"There is no evidence that existing FINRA and MSRB best execution rules are insufficient for ensuring prices to customers are as favorable as possible under prevailing market conditions, what better customer execution would look like under the proposal, or how the proposal would address the issue of variability in customer pricing."
Mark Kim, chief executive officer of the MSRB said that if the Commission were to adopt a third best execution rule, amendments would likely need to be made to existing rules.
Decker also argues that the proposal's treatment of "conflicted" transactions is incompatible with fixed income markets and that under the proposal, "most fixed income trades with retail investors would be classified as conflicted and subject to the 'conflicted transaction' regime," the BDA letter said. "Certain other categories of conflicted trades such as trades involving payment for order flow may not apply to the fixed income markets."
"The conflicted transaction proposal does not work and is not justified for fixed income securities, primarily because virtually all fixed income transactions occur on a principle basis and occur in a decentralized market," Norwood said. "In the fixed income markets, customer negotiation process order, placement handling and trading practices are very different from those for NMS securities."
The Proposal would require that brokers conduct a best execution analysis based on comparisons to quoted bid-asked spreads. "But because of the quoting and trading characteristics of fixed-income markets, and unlike NMS equities markets, there are no industry-wide sources of fixed income quotation data," the SIFMA letter said. "Even post-trade data for fixed income securities varies widely by asset class."
It would also mandate that broker-dealers conduct execution quality reviews at least quarterly, which FINRA Rule 5310 already requires firms to do. And MSRB Rule G-18 requires dealers to conduct annual reviews on execution quality.
"The SEC has not demonstrated how a more frequent review schedule than is required under current SRO rules, especially the requirement for annual reports to board of directors, would improve customer execution quality," the BDA letter said. "Indeed, a better audience for best execution reports would be an executive manager like the dealer's president or CEO. Generally, a dealer's CEO is FINRA- or MSRB-tested and licensed. That's not the case for directors. The Commission would be in a better position to hold licensed professionals accountable in the case of a best execution violation."
The SEC states in the proposal that the costs of the rule could advantage larger broker-dealers and increase the barrier to entry for smaller broker dealers. BDA believes this is almost guaranteed and that were it to go into effect, increased compliance costs would be passed on to customers.
Plus, it would not only force small dealers out of secondary fixed income markets, it would also virtually bar them from serving as underwriters as well as it is "simply not possible to run an underwriting business without a corresponding secondary trading business," BDA said.
The SEC can choose to drop its proposal, adopt it as is, or to adopt a final version that has undergone changes following the comment period.
