Order Handling and Best Execution
The obligation to seek the best outcome
Best execution requires firms to take reasonable steps to obtain the best result for clients, considering price, speed, likelihood of execution, and cost. It is a process obligation, not a guarantee of the best possible price. Candidates must understand that best execution applies to agency orders and to client orders handled by the firm, and that it interacts with the duty of loyalty.
Concepts to master
Understand order priority rules: price, then time, then size, subject to specific exceptions. Know the handling of client instructions that limit the firm's discretion - a specific instruction may override the firm's normal execution strategy for that element. Understand the fair allocation of partially filled orders across clients, and the prohibition on allocating favourable fills to preferred accounts. Know the documentation requirements for order handling and the retention of records.
Traps
A common trap is treating best execution as satisfied by executing on the cheapest venue. Price is one factor among several, and the firm must consider the full execution quality. Another trap is assuming that a client instruction eliminates all obligations; it only displaces the firm's discretion on the element covered. Watch for scenarios where a firm aggregates orders and then allocates fills unfairly - aggregation is permitted, but allocation must be equitable and documented.
Worked example
A firm receives two client orders at the same limit price. Only part of the order can be filled. The firm must allocate the fill according to a documented, non-discriminatory policy, not according to which client generates more revenue. A candidate who selects the highest-revenue client as the answer has confused commercial preference with fair allocation.
Rule of thumb
Best execution is about process, not outcome. If the firm can show a documented, consistently applied process, it has a strong defence.
Risk Management, Margin and Counterparty Credit
Identifying and measuring risk
Candidates must understand the main risk categories: market risk, credit risk, liquidity risk, operational risk, and counterparty credit risk. Know the difference between exposure at default and potential future exposure, and how collateral and netting reduce each. Understand the role of margin in managing counterparty risk: initial margin covers potential future exposure, while variation margin settles current exposure.
Concepts to master
Understand the mechanics of a margin call, the consequences of a failure to meet it, and the firm's right to close out positions. Know the concept of a haircut and how it protects the lender of cash or securities. Understand concentration limits and why a single large counterparty can create systemic risk. Know the difference between a credit limit and a settlement limit, and the role of pre-settlement risk. Understand stress testing and scenario analysis at a conceptual level.
Traps
A common trap is assuming that collateral eliminates counterparty risk. It reduces it but introduces collateral risk: the collateral may fall in value or be difficult to liquidate. Another trap is confusing variation margin with initial margin. Watch for questions where a counterparty posts collateral that is correlated with its own creditworthiness - that correlation weakens the protection.
Worked example
A firm has a derivative exposure of 100 to a counterparty, with collateral of 70 and a netting agreement that reduces exposure by 20. The net exposure is 100 − 20 − 70 = 10. A candidate who ignores netting reports 30 and overstates the risk.
Rule of thumb
Net exposure equals gross exposure minus netting benefit minus collateral. Always compute in that order.
Ethics, Conflicts of Interest and Market Integrity
The foundation of every other domain
Ethics questions test judgement, not memorisation. Candidates must be able to identify a conflict, determine whether it was disclosed and managed, and recognise when a client's interests have been subordinated to the firm's. Know the core duties: loyalty, care, confidentiality, fairness, and integrity. Understand that the duty to the market is separate from the duty to the client - conduct that harms market integrity is prohibited even if the client consents.
Concepts to master
Understand the categories of conflicts: personal trading, outside business activities, gifts and entertainment, research independence, and allocation of investment opportunities. Know the concept of material non-public information and the restrictions on trading and tipping. Understand the wall-crossing process and the obligations that arise when information is shared. Know the whistleblowing and escalation obligations, and the prohibition on retaliation.
Traps
A common trap is assuming that disclosure alone resolves a conflict. Disclosure is necessary but not sufficient; the conflict must also be managed or avoided. Another trap is treating client consent as a defence to market misconduct. Watch for scenarios where an employee's personal account trades in the same security as a client - the issue is not the profit but the misuse of position and information.
Worked example
An analyst learns of an unannounced acquisition and buys shares in a personal account before the announcement. The client suffered no direct loss, but the conduct breaches market integrity and the duty to the firm. A candidate who reasons only about client harm will miss the correct answer.
Rule of thumb
When in doubt, ask: would I be comfortable if this conduct were disclosed publicly and reviewed by the regulator? If not, escalate before acting.