On the face of it, many of the complexities associated with routing an order to the venue that will deliver best execution are eliminated in the US by rule 611 of Reg NMS (Regulation National Market System), designed by the US Securities and Exchange Commission (SEC) to foster competition between trading venues and protect investors.
Rule 611 – better known as the order protection rule – requires trading venues to route orders to market centres that display the best price on an “immediately and automatically accessible” basis.
With US venues, rather than brokers, obliged to ensure that orders are routed to the best price, US brokers’ smart order routers (SORs) compete on factors such as speed and integration with execution algorithms. Buy-side traders in Europe, confounded by the complexity of achieving best execution in a post-MiFID world, may well look on in envy. Rather than wading through sell-side presentations and proposals in the hope of finding an SOR that will reliably and cost-effectively source liquidity across Europe, wouldn’t the buy-side trader’s job be considerably simpler if best execution was underpinned by diktat from Brussels?
One problem is that, under MiFID, best execution in Europe is based on multiple criteria, so an order protection rule would operate differently than in the US, where price is the only factor.
“In concept, the order protection rule has been a good idea and implemented smoothly in the US,” says Jack Vensel, managing director, electronic execution, EMEA, Citi. “Best execution in Europe is multi-faceted, so an order protection rule would have to take into account depth of liquidity, speed of venue response, multiple posting and integration with algorithms.”
In the US, the introduction of Reg ATS (Regulation of Exchanges and Alternative Trading Systems) in 1999 opened up the country’s exchanges to competition. The result was the birth of electronic communication networks, a new breed of low-latency, hi-tech trading platforms, which were seen to have an unfair advantage over floor brokers on the New York Stock Exchange that took a lot longer to match orders manually. Reg NMS’s Rule 611 was designed to put all venues on a level playing field.
“The order protection rule had its origins trying to marry slow and fast markets,” said Miranda Mizen, principal at consultancy firm TABB Group. “This driver doesn’t exist in Europe under MiFID, so it’s really coming from a different angle and it may not be viable to use the same methods.”
In Europe, only one displayed trading venue, exchange-backed Nasdaq OMX Europe, has adopted onward routing functionality for its multilateral trading facility (MTF). Nasdaq OMX Europe clients are able to route orders out to venues showing a better price based on a European best bid and offer benchmark. Clients are able to choose how and which venues they access through different order types available on Nasdaq OMX Europe. So far, the MTF routes on 15% of its total orders. Figures from Fidessa’s Fragmentation Index, a weekly analysis of where European liquidity is traded, show that Nasdaq OMX Europe accounted for 0.49% pan European market share in the week ending 19 June.
Todd Golub, chief operating officer, Nasdaq OMX Europe, says a European order protection rule would require stricter execution standards and a mandated European best bid and offer data feed. In the US, venues take best price from the single, consolidated national best bid and offer feed operated by the Consolidated Tape Association.
“Because best execution in Europe is loosely defined, there would first need to be an established standard of some type for the protection rule to work,” says Golub. “There would also have to be a single European best bid and offer before we can even start thinking about having such a rule here.”
Another impediment to a US-style order protection rule in Europe is clearing and settlement. In the US, the Depository Trust and Clearing Corporation acts as the central clearer and settlement agent for all equity trades, meaning clearing fees are the same regardless of where a trade is executed. Progress toward an interoperable clearing system in Europe has begun, but is still in its infancy. In a recent report, the Committee of European Securities Regulators, the body responsible for ensuring the regulatory convergence across the region, and the European System of Central Banks noted that the timetable for a more harmonised set of rules may take longer than widely expected to ensure risk management considerations are fully factored into the new framework.
“The European markets aren’t settled yet post-MiFID, and even when all the interoperability deals between central counterparties are implemented, costs – such as the amount of collateral a firm is required to keep at a CCP – will still not be equal,” said Mizen.
Given the different frameworks so far implemented by regulators on either side of the Atlantic, Vensel at Citi says a European version of Rule 611 should not be introduced in isolation.
“We are already obliged to get best execution for our clients, which we do through our SOR, so I would be reluctant to see more regulation in this area,” he notes. “However, if formalising such a rule acts as a catalyst for infrastructure enhancements such as a standard best bid and offer and rationalisation of clearing interoperability then it could work.”
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