Executing Broker: What it is, How it Works, FAQs

What Is an Executing Broker?

An executing broker is a broker or dealer that processes a buy or sell order on behalf of a client. For retail customers, the order sent to an executing broker is first assessed for appropriateness (automated through parameters for a particular client), and if the order is accepted, the executing broker will then immediately carry out the order. If the order is rejected, the customer is notified, and the security is not traded. For hedge funds or institutional clients that have already been qualified, an attempt to fill an order is immediately processed.

Understanding Executing Brokers

Retail investors typically trade online or through a financial advisor who would send their orders to a broker. Because accounts are set up in a way to protect investors, orders are first screened for suitability. For instance, if a client's goal is capital preservation, an order to buy a speculative biotechnology stock on margin would most likely be rejected. When an order is accepted, it is processed by the executing broker who has the duty of "best execution."

Executing brokers are often associated with hedge funds or institutional clients that need trade execution services for large transactions. These brokers are usually housed under a prime brokerage service, which offers a one-stop-shop service for large active traders.

The executing broker within the prime brokerage will locate the securities for a purchase transaction or locate a buyer for a sale transaction. This intermediary service is essential because a transaction of size must be done with speed and at a low cost for the client. The executing broker earns a commission on the buy-sell spread and passes along the execution to the settlement and clearing group of the prime brokerage.

What Does an Executing Broker Do With a Stock Order?

Depending on the type of stock, an executing broker has a number of options. If the stock is traded on an exchange (for example, the NYSE), it can send the order directly to that exchange, to another exchange, or to a third market maker. If the stock trades in an over-the-counter (OTC) market such as Nasdaq, the broker could send the order to that market maker.

Limit orders can be routed to an electronic communications network (ECN) that is designed to match buy and sell orders at specified prices. Lastly, the broker may try to fill the order from its own inventory by selling a stock that the broker's firm owns or taking in stock on its books that a customer wants to sell. Ultimately, it's up to the executing broker to make the best call.

Executing Brokers vs. Clearing Brokers

Let's say you want to place an order to buy 100 shares of Apple. You will place a market order for 100 shares to be filled, and click submit. Since the security (Apple) is highly liquid, your order should be filled almost instantaneously. Assuming the funds are in your account to be able to fulfill the order, you should see the shares in your account within seconds.

The difference between executing brokers and clearing brokers is something most investors never even think about. In the example, when you place the order to buy 100 shares, that order goes to the executing broker. They review the order for validity, either personally or electronically, and then send the order to the exchange.

The clearing broker then receives the order and ensures it meets the criteria for trade. If it does, then the final transfer takes place: the money is taken from the account, and the 100 shares of Apple are delivered. The executing broker acts as a middle man between the investor and the clearing broker, and the clearing broker acts as the middle man between the executing broker and the stock exchange.

For most transactions, these transfers are done electronically and without a personal review. However, there are some instances that require a human touch. A similar example would be instead of an investor buying 100 shares of Apple, consider a hedge fund selling 100,000 shares. The order would need to be considered by both an executing broker who makes sure it is legal and viable and also the clearing broker, to make sure that funds are available and the shares are there to be bought and sold.

The Bottom Line

Execution brokers are those who check that their client's orders are viable for their brokerage. If they deem that the trade is viable, they will "execute" that trade by sending it to a clearing broker, also known as a clearinghouse. The execution broker must ensure that they are giving their client the best possible trades, but they are also paid on performance and bid-ask spread profits.