BestEx Artists

A trader discovers an interesting feature in an ABS indenture that means there is hidden value in the bond. She has several choices for how to proceed on buying that bond. How will she know if she has achieved “Best Execution” from a regulatory perspective?

She could go out broadly with an OWIC (conversely, if she discovered a problem in the indenture of a bond she owned she could go out with a BWIC). But then she would be broadcasting to the market that she had interest in the bond. Other buyers might begin to ask why, investigate, and ultimately discover the same hidden value she had uncovered. This would especially be true if it were known that she was at a large, reputable shop – and this information leaked to the market.

It might also be the case that the bond traded only very rarely. There would probably be some comparable prices for similar bonds that traded. But maybe even these only traded intermittently over the course of weeks. And those comparable bonds might not have the same feature that she discovered in her target bond. Illiquid structured credit trading in some ways is more like buying real estate than it is like trading treasuries.

It might be optimal for her to work with one trusted broker only. It might be more efficient for this one party to keep his eye out, to work the axe “quietly” and alertly, to gather information and solicit interest more subtly than a blast that simply asked for a best bid on a certain date. He might spend weeks or months helping to accumulate the position, essentially investing a sort of “sweat equity” into the trade.

The result might be that he helps the trader acquire bonds several points better than she might have otherwise, and as the broker he might receive a portion of the economics as his commission. What is best execution in that context?

The truth is that bond trading in illiquid markets in many ways remains an art rather than a science. It will be interesting to see how the regulatory landscape plays out.