The Global Market Portfolio (GMP)
The global market portfolio is a theoretical representation of the aggregation of... Read More
All asset managers should have a trade policy document that clearly and comprehensively articulates the firm's trading policies and escalation procedures. The curriculum can be quite wordy in this section. The heart of the message is simply this:
“Firms need to have a written document that outlines how to handle all aspects of trading”
An asset manager’s trade policy ensures that its execution and order handling procedures align with the duty of best execution it owes clients. The following items should be covered by the policy:
While achieving the best trade price for the client is essential, it’s a bit too simplistic. We must also factor in the trade’s nature. Is it urgent? Is there a risk of information leaking? What are the overall trading costs?
Clients should not be disadvantaged, but different service levels can be offered as long as they are paid for and disclosed to all clients. This might involve using different approaches based on the trade’s size and characteristics.
The curriculum emphasizes the importance of firms having a written set of factors to consider when making order execution decisions. These factors go beyond just getting the best price; they guide how trading is managed.
The 2020 CFA Level III Program curriculum outlines the following factors:
Once again, the curriculum states that firms should have a written policy in place about who they use to transact their trades. The curriculum outlines the important considerations in choosing a broker. Perhaps a firm should just use these very criteria?
Trading firms are advised to regularly assess their brokers. They should have systems for monitoring and assessing trade execution efficiency, like using benchmarks such as VWAP. The curriculum suggests establishing a committee to stay informed about current and potential brokers and keeping approved broker lists updated with new information.
Additionally, firms should retain trade records for several years, and the curriculum highlights key aspects to consider in trade records.
Question
In terms of choosing an optimal broker, willingness to commit capital and act as a dealer to facilitate trading for a client is particularly important for which of the following trade types:
- Less liquid; more urgent.
- More liquid; more urgent.
- More liquid; less urgent.
Solution
The correct answer is A.
When dealing with less liquid assets (which are harder to buy or sell without impacting the price) and more urgent trade situations (where quick execution is necessary), the involvement of a broker who is willing to commit capital and act as a dealer becomes particularly important. This is because in such scenarios, a broker’s ability to hold inventory and facilitate the trade is crucial to prevent substantial market impact and achieve a favorable execution.
B is incorrect. In more liquid markets, there is generally less need for a broker to commit capital and act as a dealer because liquidity makes it easier to execute trades without the need for a dealer’s intervention. More liquid markets often allow for efficient execution without a dealer’s assistance, even in urgent situations.
C is incorrect. In situations where trading is both more liquid and less urgent, the need for a broker to commit capital and act as a dealer is further reduced. In these cases, the client may have more time to execute the trade without resorting to a dealer’s services.
Reading 11: Trade Strategy and Execution
Los 11 (i) Evaluate a firm's trading procedures, including processes, disclosures, and record-keeping with respect to good governance.