Poor routing decisions costing US investors billions

US brokers continue to route equity orders to trading venues based on execution fees rather than seeking best execution, costing the buy-side's clients up to US$5 billion annually, according to research from Woodbine Associates.

US brokers continue to route equity orders to trading venues based on execution fees rather than seeking best execution, costing the buy-side's clients up to US$5 billion annually, according to research from Woodbine Associates.

The study, called ‘US equity exchange performance 2011’, states differences in exchange performance are rarely considered by smart order routers that direct trades to multiple trading venues.

“[Buy-side firms] must take decisive action to understand how broker/dealer routing practices work and monitor execution quality to ensure their trading objectives are met,” read the report, which studied the equity execution quality of different US exchanges.

The report found that from a market-wide view, BATS and Direct Edge exhibited superior execution quality for Nasdaq-listed securities and small-cap stocks on NYSE Amex Equities.

The Connecticut-based consultancy’s research also found Nasdaq displayed a small degree of unfavourable price movements against liquidity providers post-execution in mid- and small-cap stocks.

Price quality for large- and mid-cap stocks listed on NYSE Euronext was minimal among US bourses, but BATS and Direct Edge again came top for small-cap executions. The research also found a slight advantage for liquidity takers.

Matt Samelson, principal at Woodbine Associates, urged buy-side firms to use the results of the report to take better ownership of where their orders are executed, rather than simply relying on brokers to achieve best execution.

“No one will change their routing behaviour based on annual numbers such as these, but its clear that orders aren’t being routed optimally and it’s costing the buy-side a substantial amount of money,” he told theTRADEnews.com. “The buy-side needs to ask for trading results and factors relating to order handling so that they can monitor execution quality accordingly.”

He added this was not necessarily the result of any “sinister” practices by the sell-side, but rather increasing economic pressure and a continued reduction in commissions despite a more demanding buy-side contingent that expects customised technology solutions, analytics and sophisticated order handling processes from their broking counterparts.

“Brokers have a business to run also, but what these figures do point out is that there are potential conflicts between brokers and their clients,” he said. “Economic troubles are driving brokers to minimise execution costs.”

While he claims the larger buy-side firms are starting to ask for more information relating to the operating structure of different trading venues as well as meeting trading benchmarks but added that smaller firms may find this type of analysis challenging because it is very data intensive.

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