Can a Firm Demonstrate Best Execution If Only One Counterparty Responds to an RFQ?

Concept

An institutional trading desk faces a critical test of its operational architecture when a Request for Quote (RFQ) for a significant or illiquid position yields only a single response. The immediate question is not one of convenience, but of fiduciary duty and regulatory compliance. Can a firm credibly demonstrate it has achieved the best possible result for its client under such constrained circumstances?

The answer is a definitive yes, but it requires a fundamental shift in the evidentiary basis for best execution. The focus moves away from direct, contemporaneous price competition toward a rigorous, documented validation of process integrity and contextual market analysis.

In a multi-dealer RFQ scenario, the competitive tension among counterparties provides a clear, defensible data point for price discovery. The winning bid or offer, when selected from a pool of competing quotes, serves as powerful evidence of achieving a favorable price. When that competitive tension vanishes and only one counterparty remains, the burden of proof intensifies. The firm must now construct a robust analytical narrative, using a different set of tools to prove that the single available price was fair and represented the best possible outcome given the prevailing market conditions for that specific instrument at that moment in time.

A single quote transforms the best execution challenge from a simple price comparison into a comprehensive audit of the firm’s market intelligence and procedural discipline.

This situation is particularly prevalent in markets for instruments that are inherently less liquid, such as certain corporate bonds, complex derivatives, or large blocks of securities outside the most active issues. In these segments, the number of natural counterparties may be structurally limited. A firm’s ability to navigate this reality is a direct reflection of its systemic maturity.

It requires an operational framework built not just for the ideal state of high liquidity and multiple bidders, but engineered for the complex realities of fragmented, over-the-counter (OTC) markets. The demonstration of best execution becomes an exercise in assembling a comprehensive evidentiary file, proving that all sufficient steps were taken to achieve the optimal result.

What Constitutes Best Execution?

Regulatory frameworks, such as MiFID II in Europe and FINRA Rule 5310 in the United States, define best execution as a holistic obligation. It is a mandate to secure the most favorable terms reasonably available for a client’s order. This extends far beyond just the headline price. The key factors that a firm must consider and balance are:

• Price The ultimate price paid or received for the financial instrument.
• Costs Explicit costs like commissions and fees, as well as implicit costs like market impact.
• Speed of Execution The timeliness of the transaction, which can be critical in volatile markets.
• Likelihood of Execution The certainty that the trade can be completed, especially for large or illiquid orders where failing to trade can be the worst possible outcome.
• Size and Nature of the Order The specific characteristics of the order, which influence the choice of execution method and venue.
• Any Other Relevant Consideration A catch-all that requires firms to use their professional judgment to account for all pertinent factors.

In the context of a single-responder RFQ, the “likelihood of execution” often becomes a dominant factor. For a large, difficult-to-trade block, securing a firm quote from a single credible counterparty might represent the best, and perhaps only, path to completing the transaction without causing significant adverse price movement. The firm’s task is to document why this single path was the most advantageous one available.

Strategy

Successfully demonstrating best execution from a single quote requires a deliberate and systematic strategy. This strategy is built on two pillars a robust pre-trade analytical framework and a meticulous post-trade documentation process. The objective is to create an unassailable audit trail that justifies the execution decision, proving that it was the product of disciplined analysis rather than passive acceptance. The firm must operate as if it will be called upon to defend every aspect of the trade, from the initial decision to use an RFQ to the final execution.

The core of this strategy involves creating an independent, data-driven benchmark before the trade is executed. This benchmark becomes the primary tool for evaluating the fairness of the single quote received. Without multiple competing quotes to serve as a reference, the firm must manufacture its own reference price from available market data. This proactive approach shifts the firm from a reactive price-taker to a proactive validator of market fairness, even when dealing with a single liquidity provider.

The Pre-Trade Analytical Framework

Before even sending out the RFQ, the trading desk must establish a clear and documented rationale for its execution strategy. For a large or illiquid instrument, this involves assessing various potential execution methods. The RFQ protocol is often chosen to minimize information leakage and market impact, a strategic decision that itself is a component of the best execution process. The pre-trade framework must systematically evaluate and record the following:

1. Venue and Counterparty Selection Rationale The firm must document why it chose specific counterparties for the RFQ. This could be based on historical data showing their activity in the specific asset class, their balance sheet capacity for large trades, or their demonstrated reliability in providing liquidity. This process shows diligence in attempting to create a competitive auction.
2. Pre-Trade Price Benchmarking This is the most critical element. The firm must construct a fair value estimate for the instrument before receiving any quotes. This benchmark can be derived from a variety of sources, depending on the asset class. The goal is to establish a reasonable price zone against which the quote can be judged.
3. Market Condition Assessment The desk must contemporaneously document the state of the market. This includes noting overall market volatility, liquidity in the specific security or related instruments, and any relevant news or events. This context is essential for justifying the final execution price, especially if it deviates from the pre-trade benchmark.

A pre-trade benchmark serves as the analytical anchor, allowing a firm to objectively measure the fairness of a single quote in the absence of competition.

The following table illustrates how different execution methods might be evaluated during the pre-trade analysis, providing a clear rationale for selecting an RFQ protocol.

Documenting the Rationale for Execution

When only one counterparty responds to the RFQ, the execution decision hinges on comparing that quote to the pre-trade benchmark. If the quote is within an acceptable tolerance of the benchmark, the decision to execute is straightforward. The firm’s documentation should simply note the comparison and confirm the execution. However, if the quote is materially different from the benchmark, the firm has two options, both of which require careful documentation.

• Execute and Justify The firm may still proceed with the trade if other best execution factors, like the high likelihood of execution and the risk of market deterioration, outweigh the price deviation. The justification must be explicit, detailed, and recorded at the time of the trade. For example, a note might state “Quote is 5 bps wider than benchmark, but risk of no-execution is high given market illiquidity. Proceeding with trade to secure exit for client.”
• Decline and Re-evaluate The firm may decline the quote and reassess its strategy. This decision also demonstrates diligence. The firm might then attempt to work the order through an algorithmic strategy or approach a different set of counterparties at a later time.

This entire process, from initial analysis to final decision, must be captured by the firm’s systems. This creates a complete and time-stamped record that can be reviewed by compliance, auditors, and regulators, proving that the firm followed a rigorous and repeatable process designed to protect the client’s interests.

Execution

The execution phase is where the strategic framework is translated into a concrete, auditable set of actions. For a firm to successfully defend a single-quote RFQ execution, its operational playbook must be precise, its quantitative analysis robust, and its system architecture capable of capturing every relevant piece of data. This is about building an evidentiary case in real time, ensuring that every step taken is logged and justifiable under scrutiny.

The Operational Playbook for a Single Responder RFQ

When a trading desk is confronted with a single response, a clear, sequential process must be initiated. This playbook ensures that all necessary diligence is performed consistently across the firm.

1. Initial Alert and Verification The trading system should automatically flag any RFQ that receives only one response. The trader first verifies that the lack of other responses was not due to a technical or system error.
2. Benchmark Comparison The trader immediately calls up the pre-trade benchmark calculated for the specific instrument. The system should display the live quote directly alongside the benchmark price, the tolerance corridor, and any relevant market data snapshots.
3. Contextual Market Analysis The trader reviews the documented market conditions. Is volatility expanding? Has liquidity in related securities dried up? This information provides the qualitative context for the quantitative comparison.
4. Execution Decision and Justification The trader makes the decision to accept or reject the quote. This decision is not a simple click. The system must require the trader to enter a justification note, especially if the price is outside the pre-set tolerance. This note becomes a permanent part of the order record.
5. Evidence Capture Upon execution, the firm’s Order Management System (OMS) or Execution Management System (EMS) must automatically capture a comprehensive snapshot of all relevant data. This includes the RFQ request time, the response time, the quote received, the pre-trade benchmark, market data from multiple sources at the time of execution, and the trader’s justification note.
6. Post-Trade Review Flagging The trade is automatically flagged for inclusion in the next periodic Transaction Cost Analysis (TCA) review. This ensures that the execution is not just a one-off decision but is part of a continuous feedback loop for improving the firm’s overall execution process.

Quantitative Benchmarking and Data Analysis

The credibility of the entire process rests on the quality of the quantitative analysis. The pre-trade benchmark must be objective and based on observable data. The post-trade analysis must be honest in its assessment of performance. The following tables provide a simplified model for this quantitative workflow.

Table 1 Pre-Trade Benchmark Calculation Example

This table models the construction of a benchmark for a hypothetical corporate bond prior to an RFQ.

Table 2 Post-Trade Execution Quality Report Example

This table models the review of an executed trade where a single RFQ response of 98.40 was accepted.

How Does System Architecture Support This Process?

The strategy and playbook described are only possible with a supporting technological architecture. The firm’s EMS/OMS must be configured to function as a data-gathering and compliance engine. Key features include the ability to integrate multiple third-party data feeds for benchmarking, configurable rules to flag single-responder RFQs, mandatory justification fields tied to execution permissions, and the automated creation of a detailed, time-stamped audit file for every order. This architecture transforms the best execution obligation from a manual, box-ticking exercise into an integrated, data-driven, and defensible institutional process.

Reflection

The challenge of a single-responder RFQ forces a firm to look inward. It moves the conversation beyond a simple comparison of external quotes and toward a deeper evaluation of internal processes, analytical capabilities, and technological infrastructure. The ability to construct a defensible case for best execution in such a scenario is a powerful indicator of a firm’s operational maturity. It demonstrates that the organization’s commitment to its fiduciary duty is not merely a function of market convenience but is deeply embedded in its systems and culture.

Consider your own operational framework. Is it designed to simply process trades in liquid conditions, or is it a robust system of intelligence, built to provide clarity and justification in the most opaque and challenging market circumstances? The data captured and the analysis performed during these critical moments do more than satisfy a regulatory requirement; they build a proprietary library of market intelligence. This intelligence, in turn, sharpens the firm’s edge, refining its understanding of liquidity and counterparty behavior, ultimately leading to superior execution outcomes for all clients across all conditions.