Buy-side warns brokers on SOR rebates

Almost half of buy-side traders say their primary consideration when using brokers’ smart order routers (SORs) is that orders are routed to support best execution, rather than covering sell-side costs.
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Almost half of buy-side traders say their primary consideration when using brokers’ smart order routers (SORs) is that orders are routed to support best execution, rather than covering sell-side costs. A total of 47% of respondents to’s June poll indicated that rebates for placing liquidity on trading venues should not skew routing by SORs at the expense of best execution.

“These results are very consistent with feedback we have received from our institutional clients,” said Michael Seigne, head of European algorithmic trading, Goldman Sachs. “Clients want to be sure that their brokers are prioritising client order execution quality over and above the brokers’ own cost when optimising smart order routers.”

In recent months, European multilateral trading facilities (MTFs) have increasingly competed on price to secure market share. On 22 June, BATS Europe announced an extension of its inverted price promotion for Euronext indices and exchange-traded funds, which will now run throughout July. Also in June, rival MTF Nasdaq OMX Europe introduced a tiered rebate scheme to reward participants for posting liquidity on the platform.

Other trading venues, such as Turquoise and Chi-X Europe, also include a number of large brokers among their shareholders. But Rob Maher, head of Advanced Execution Services sales for EMEA at Credit Suisse, said brokers had demonstrated their commitment to client execution quality.

“Twelve to 18 months ago, clients were concerned that the brokers with equity interests in the new MTFs would route orders there both to gain rebates and to support their investment. It’s now been proven categorically that this has not been the case and that brokers’ SORs have prioritised liquidity in pursuit of best execution for clients,” he said.

One broker asserted that long-only asset managers had benefited from price promotions through the additional liquidity generated on new trading venues. “The incentives offered by trading venues have reduced the cost of trading for stat arb firms and made many more trading models viable. Our institutional clients have benefited because they’ve been able to interact passively with that flow,” the source said.

A quarter of poll respondents (25%) said that the ability to direct flow between venues dynamically was the most important factor when deciding between brokers’ routers.

Betsy Anderson, head of centralised dealing, Ignis Asset Management, who recently undertook a detailed SOR selection process, said there are significant variations in quality across sell-side SOR offerings.

“Some routers weren’t smart at all and some stood out ahead of the rest,” she said. “SORs that just rely on historical data to place passive liquidity will always lag those that are more dynamic and intuitive and can take advantage of opportunities as they arise.”

SORs’ dynamic routing of order flow in response to or anticipation of changes in liquidity and price levels across trading venues has improved notably over the past six months, according to Graham Dick, head of business development at Chi-X Europe.

“Previously, a lot of SORs could identify the venue with the best price but not a great deal more. Now the ability to switch between venues dynamically to pursue liquidity is being written into the best SORs,” he said. “Nevertheless, large parts of the European market are still using inefficient routers and there are plenty of firms that are not using routers at all.”

Seigne of Goldman Sachs said that the posting of passive liquidity on trading venues is the key battleground for SORs. “Passive order placement logic is one of the biggest challenges from an execution quality perspective. To do this well, you have to invest heavily in your quantitative resources. Only using simple logic such as historical venue market share data is not sufficient,” he said.

Credit Suisse’s Maher also suggested that the ability to place passive flow cost-effectively often comes down to resource. “Compared with taking liquidity, posting liquidity via an SOR is like placing a calculated bet,” he said. “One of the key components of a quality SOR is the ability to adjust its trading by learning from the orders and executions it sends and receives. The more order flow it handles, the better the odds that you will be executed in the right place at the right time.”

Sixteen percent of poll respondents cited breadth of venues reached as their primary concern, while latency was the most important factor when choosing between SORs for just 12% of readers.

Although a relatively small proportion of respondents viewed breadth of reach as a major issue, Maher of Credit Suisse said that clients were keen to understand how SORs were accessing new venues. “With the number of dark books going live in recent months, clients have shown more interest in SORs accessing dark as well as lit liquidity,” he said.

Ignis’s Anderson said that protection of orders against information leakage had been a high priority when the firm undertook its analysis of competing broker SOR functionality. “Security is absolutely crucial to prevent information leakage when using smart order routers. We’ve favoured brokers that could evidence clear anti-gaming and security processes and in some instances had obtained an independent audit verifying the anti-gaming logic of their SORs,” she said.

A number of brokers concurred that security had grown in importance. “I expect an increase in the number of questions from clients on the anti-gaming logic of SORs in the coming months, due to concerns over the role of high-frequency traders and the recent introduction of ‘flash’ order types by some venues,” said one.

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