Thanks to all the brokers, PRs and others that made it possible for me to pack 20 meetings into three days in New York last week. When you talk to so many people on a relatively narrow range of topics in a short space of time, issues that were blurred or hazy are briefly distilled.
In short, the word of the week was transparency.
Most of the brokers I spoke to seemed to have recently emerged from a paper mountain of questionnaires issued by institutional clients in the hope of clarifying how their orders are routed to trading venues by brokers and subsequently executed on the US’s many trading platforms.
Institutional investors have been seeking more detail on what brokers do with their orders for some time, of course. Over the past half decade at least, the plethora of channels to market, and indeed the proliferation of markets themselves, has seen the possible order-routing permutations – and incentives – skyrocket. It is no more than the institutional investor’s fiduciary duty to understand changes in market structure to limit the cost of the investment process to the end-investor. But the pressure on brokers to go into even more detail and supply even more data has been ratcheted up several notches in recent years.
Buy-side concerns about order routing logic that sought out rebates rather than best price and dark pools that let in a little too much light reached sufficient pitch that they also caught the attention of regulators and legislators, but the flash crash and Dodd-Frank soon dragged their focus elsewhere. Brokers continued to field questions from their institutional clients on an ad hoc basis but the format and depth of enquiries was transformed in October 2011 by the revelation that block-trading platform Pipeline was executing client orders against a proprietary trading affiliate rather than other ‘natural’ buy-side clients.
Suddenly not only execution desks were focused on how brokers executed buy-side trades. Portfolio managers, chief investment officers, pension trustees and board members all became aware of the dizzying range of execution options that have built up around the ‘simple’ act of buying or selling a stock. Cue an avalanche of detailed questionnaires, many drafted by external consultants and auditors rather than traders, some designed to reassure worried end-investors, directors and other lay people, rather than shed light on previously opaque trading practices.
So what’s been achieved by the last four months of form filling? Some brokers say that they have not made any significant changes to how they route orders to trading venues. Others said they have had more honest conversations with buy-side trading desks that have led to a greater focus on best execution than economic incentives in routing logic. Many brokers have shared reams of execution data with their clients but fewer have noticed a change in how institutional investors instruct them. “What do they do with the data? We never quite know,” laughed one broker. Due diligence appears to be the order of the day, not least because the time, skills and technology required to derive more effective execution processes are not available to all.
Is the US equity market a safer place for the end-investor? Again the jury is out. One broker whose firm operates dark pools around the world told me he expects another example to emerge of a trading venue executing trades in a fashion other than advertised. After all, fraudulent data can be manufactured, purporting to demonstrate adherence to best practice. Maybe the truth about dark pools and order routing isn’t so clear cut after all.