Can a Firm Justify Selecting an RFQ Quote That Is Not the Best Price under MiFID II? ▴ Question

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Concept

The inquiry into justifying a Request for Quote (RFQ) response that deviates from the most competitive price point under the Markets in Financial Instruments Directive II (MiFID II) opens a critical examination of institutional execution protocols. The directive’s framework for best execution compels a systemic view, moving the objective beyond a simple, one-dimensional pursuit of the best headline price. It establishes a mandate for firms to construct and adhere to a process that secures the best possible result for a client. This result is a calculated, multi-variable outcome, where price is but one component within a broader array of execution factors.

At its core, the regulation requires an investment firm to take “all sufficient steps” to obtain this optimal result. This principle transforms the act of execution from a simple transaction into a complex analytical exercise. The firm’s operational architecture must be designed to weigh and balance competing priorities in real-time, tailored to the specific characteristics of the client, the order itself, the financial instrument, and the available execution venues. For a professional client, an execution strategy might prioritize the certainty of completing a large, market-moving order with minimal information leakage over achieving a fractional price improvement that could prove illusory once the full order size is revealed.

The MiFID II best execution standard is a holistic obligation, demanding a demonstrable and consistent process for weighing multiple execution factors to achieve the best possible client outcome.

This systemic approach is particularly relevant in the bilateral price discovery context of an RFQ. When a client initiates an RFQ, especially for less liquid or complex instruments, they may have a legitimate reliance on the firm to protect their interests across the entire transaction lifecycle. The firm’s justification for its chosen quote, therefore, rests on its ability to articulate and evidence a decision-making process that aligns with its established Order Execution Policy and serves the client’s overarching strategic objectives. The focus shifts from defending a single price point to validating the integrity of the execution system itself.

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Strategy

A firm’s capacity to justify selecting a quote that is not the best price is contingent upon a robust and meticulously documented strategic framework. This framework is embodied in the firm’s Order Execution Policy, a core component of MiFID II compliance. This policy is the strategic blueprint that pre-defines the relative importance of various execution factors for different types of clients, orders, and instruments. It provides the ex-ante rationale for why, under specific conditions, factors like speed or likelihood of execution might supersede the raw price level.

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The Calculus of Execution Factors

For professional clients, MiFID II explicitly allows for a nuanced weighting of execution factors beyond price and cost. The strategic decision to accept a quote that appears suboptimal on a price-only basis must be grounded in a calculated assessment of these other variables. A firm might, for instance, accept a slightly wider bid-ask spread from a counterparty known for its reliability in settling complex derivatives, thereby prioritizing settlement certainty over a marginal price gain from a less reliable dealer. This calculus is fundamental to institutional-grade execution.

The table below outlines the primary execution factors and provides a strategic context for their prioritization over the headline price in an RFQ scenario.

Execution Factor	Description	Scenario for Prioritization Over Price
Price	The headline price for the financial instrument.	While always a primary consideration, its sole dominance is more applicable to highly liquid, standardized instruments for retail clients.
Costs	All explicit costs, including execution venue fees, clearing, and settlement fees.	A quote with a slightly worse price may be superior if it connects to a clearinghouse with significantly lower fees, resulting in a better net consideration.
Speed	The latency of the quotation and the velocity of the subsequent execution and settlement.	For time-sensitive strategies, such as arbitrage or reacting to macroeconomic data, securing immediate execution at a firm price is more valuable than waiting for a potentially better price that may disappear.
Likelihood of Execution & Settlement	The certainty that the trade will be completed at the quoted size and settled without failure.	In illiquid markets or for large block orders, a firm quote from a trusted counterparty is preferable to a slightly better but potentially fleeting quote from an unknown source.
Size & Nature of the Order	The specific characteristics of the order, including its volume relative to average market depth.	Executing a large block order requires minimizing market impact. A dealer may offer a single price for the entire block that is less competitive than the price for a small fraction of the order on a lit venue, but which prevents adverse price movement.
Counterparty Risk	An implicit factor concerning the creditworthiness and operational reliability of the quoting dealer.	A firm may choose a quote from a highly-rated dealer to minimize settlement risk, even if a dealer with a weaker credit profile offers a more aggressive price.

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Codifying Strategy in the Order Execution Policy

The Order Execution Policy is not a static document; it is the operational codification of the firm’s execution philosophy. It must clearly articulate how the firm balances the execution factors for each class of financial instrument. This policy serves as the primary reference point for regulators and clients, explaining the logic that underpins the firm’s execution decisions. A well-structured policy provides the necessary foundation to justify a specific RFQ selection.

Client Categorization ▴ The policy must differentiate its approach for retail and professional clients. For retail clients, the policy will emphasize achieving the best “total consideration,” where price and costs are the dominant factors.
Instrument-Specific Logic ▴ The approach for a liquid government bond will differ fundamentally from that for a bespoke, over-the-counter (OTC) derivative. The policy must detail these differences.
Venue & Counterparty Selection ▴ It must list the execution venues and counterparties the firm relies on and explain the criteria for their inclusion. This demonstrates a systematic approach to sourcing liquidity.
Review & Monitoring ▴ The policy must commit the firm to regular monitoring of the execution quality it achieves, ensuring that its chosen venues and strategies remain effective over time.

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Execution

The justification of an RFQ quote selection under MiFID II is ultimately an exercise in demonstrability. A defensible position is built upon a systematic, data-driven execution process that generates a clear and contemporaneous audit trail. Every decision to prioritize a factor over price must be supported by evidence captured within the firm’s trading and compliance systems. This operational discipline is what separates a compliant execution framework from a discretionary one.

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The Ex-Ante Assessment Protocol

Before an order is executed, the firm must conduct an ex-ante assessment. This is a forward-looking evaluation of the available options against the client’s objectives and the firm’s execution policy. For an RFQ, this involves more than just comparing the prices returned by dealers.

It requires a rapid analysis of how each quote aligns with the full spectrum of relevant execution factors. The ability to perform and document this assessment in the brief window between receiving quotes and executing the trade is a core technological and procedural challenge.

A firm’s ability to justify its execution choices rests entirely on the quality and completeness of the data it records at the moment of the trade.

The following table details the essential data points that must be captured to construct a robust audit trail for an RFQ transaction, particularly one where the best price was not selected.

Data Category	Specific Data Points	Justification Purpose
Order & Client Details	Client ID, Client Category (Professional/Retail), Order ID, Instrument Identifier (ISIN), Order Size, Time of Order Receipt.	Establishes the context of the trade and links it to the specific rules for that client type and instrument within the Order Execution Policy.
RFQ Process Data	List of all dealers polled, Timestamps of quote requests and responses, All quotes received (price and size), Quoted settlement cycle.	Provides a complete record of the price discovery process, showing all available alternatives at the time of the decision.
Execution Decision	Selected counterparty, Executed price and size, Timestamp of execution, Explicit reason code for selection (e.g. ‘Settlement Certainty’, ‘Size Accommodation’, ‘Speed’).	Creates a contemporaneous record of the decision and the specific justification for prioritizing a non-price factor. This is the critical evidence.
Market Conditions	Snapshot of relevant lit market prices (e.g. EBBO), Volatility metrics, Market news or events at the time of the trade.	Contextualizes the decision, demonstrating that it was reasonable given the prevailing market environment (e.g. justifying speed in a fast market).

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Post-Trade Review and Transaction Cost Analysis (TCA)

The execution process does not end with the trade. MiFID II mandates a robust post-trade monitoring system to verify the effectiveness of the firm’s execution arrangements on an ongoing basis. Transaction Cost Analysis (TCA) is a critical component of this review. For RFQ flow, TCA must evolve beyond simple price benchmarks.

Data Aggregation ▴ The first step is to aggregate all execution data, including the reason codes for counterparty selection. This data forms the basis for all subsequent analysis.
Performance Benchmarking ▴ The executed price can be compared against various benchmarks, such as the arrival price (market price when the order was received) or a volume-weighted average price (VWAP) over a period. However, the analysis must also incorporate the non-price factors.
Factor-Based Analysis ▴ The firm should analyze performance based on the justification codes. For example, do trades coded for ‘Speed’ consistently execute faster than others? Does prioritizing ‘Settlement Certainty’ lead to a lower rate of settlement fails? This analysis validates the ex-ante judgments.
Policy & Venue Review ▴ The output of the TCA process feeds back into a review of the Order Execution Policy. If the data shows that a particular dealer consistently provides poor execution quality across all factors, the firm is obligated to reconsider their inclusion in the policy. This creates a dynamic loop of continuous improvement.

Ultimately, a firm justifies its RFQ choices by demonstrating that its entire execution workflow ▴ from policy creation and pre-trade assessment to post-trade analysis ▴ is a coherent system designed to deliver the best possible result for its clients. The justification for a single trade is found in the integrity of the overall process.

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References

European Securities and Markets Authority. “Best execution under MiFID.” CESR/07-320b, 2007.
Swedish Securities Dealers Association. “Guide for drafting/review of Execution Policy under MiFID II.” 2019.
International Capital Market Association. “MiFID II/R Fixed Income Best Execution Requirements.” 2016.
BGC Partners. “Good, Better, “Best” Does your Execution stand up to MiFID II?” 2017.
Financial Conduct Authority. “Markets in Financial Instruments Directive II Implementation ▴ Policy Statement II.” PS17/14, 2017.
Lehalle, Charles-Albert, and Sophie Laruelle. Market Microstructure in Practice. World Scientific Publishing, 2013.
Harris, Larry. Trading and Exchanges ▴ Market Microstructure for Practitioners. Oxford University Press, 2003.

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A System of Justification

The question of justifying a quote selection is a prompt to evaluate the entire operational apparatus of execution. The regulatory framework provides the necessary components ▴ factors, policies, and reviews ▴ but the assembly and calibration of this machinery are what define a firm’s commitment to its clients. Viewing best execution not as a constraint but as a design specification for a superior trading system allows a firm to move beyond mere compliance.

It becomes a continuous, data-driven pursuit of optimal outcomes, where every transaction, regardless of its price, contributes to a more intelligent and resilient execution framework. The final justification, therefore, is the system itself.