The growing number of European trading venues offering sophisticated order routing and liquidity aggregation services could further complicate the already challenging issue of directing trades for best execution, but some observers argue that broker and venue routers are complementary.
Two multilateral trading facilities, Nasdaq OMX Europe and BATS Europe, now offer routing services, and it seems likely that Turquoise, following its purchase by the London Stock Exchange and merger with the bourse’s existing Baikal dark liquidity initiative, will also offer routing capabilities. Baikal launched its smart order router in June 2009.
Routers offered by trading platforms are getting more sophisticated. On 22 March, BATS Europe added a new routing strategy, RECYCLE, which sends any residual liquidity from its existing CYCLE strategy to an external venue, if it offers an equivalent or better price than that sought by the original order.
As many large brokers also offer sophisticated smart order routing capabilities to their buy-side clients, some feel that the existence of another routing layer at the venue level could cloud the picture and increase the chances of orders being executed in venues or against counterparties that the buy-side trader had intended to exclude.
“You start to run the risk of orders getting double smart routed, and that could be a real problem,” Steve Grob, director of strategy at trading technology provider Fidessa, told theTRADEnews.com. According to Grob, use of multiple routers means that original instructions could get lost in translation between systems. “If I have excluded venue X first time around and it goes on to another SOR, there is a good chance that the second SOR will route it to the venue I wanted to avoid in the first place,” he said.
Furthermore, Grob argues that venue-owned routers could blur the lines between trading platforms and broker. “There is a risk that the market gets confused about whether certain entities are brokers or venues and, if they are both, what capacity it is acting in,” he said. “This is all part of the confusion that MiFID is starting to cause.”
Broker and venue routers co-exist in the US equities market, where venues are required under Reg NMS’s order protection rule to redirect orders to the trading platform with the best price, but Grob argues that the US venue routers are much simpler, leaving the more sophisticated routing decisions to the broker-owned systems.
However, while Europe lacks an order protection rule, others feel that venue routers also complement the services offered by large brokers. Mark Hemsley, CEO of BATS Europe, said that his platform’s router was originally developed to encourage smaller brokers to trade more frequently on a pan-European basis. Such brokers would typically not trade enough volume outside their own country or immediate area to justify developing or licensing routing capabilities.
Equally, while venue routers in Europe are adding functionality, they are not intended to replace the offerings of large brokers, which incorporate a variety of tools to hunt for liquidity. “If buy-side firms want sophisticated algorithms they will need a vendor or broker-dealer system that provides them,” said Hemsley. “There is some sophistication around our routing process, but we don’t have VWAP, TWAP or liquidity-seeking algorithms.”
In terms of double-routing risk, the originator must be vigilant to ensure the order is not sent to places he wishes to exclude.
“It is the responsibility of the sender to understand what is going to happen to his order and where it is going to go and what kind of interaction there will be at the other end,” said Miranda Mizen, a principal at research and consulting firm TABB Group. “You need to know what is happening to your order when you send it out. Knowledge of market structure isn’t optional any more.”
While several venues now offer routing, it is unlikely to be a competitive requirement among Europe’s trading venues, argues Mizen. “Order routing will certainly be a commercial option for trading venues but I don’t think just because one does it they all need to do it,” she said.
“One size is never going to fit all in Europe. It is one other commercial offering that will suit a certain segment of the market and a certain type of order flow.”