Today’s U.S. equities market is tremendously complex. With a dozen exchanges and three dozen dark pools, routing to all these venues requires nuanced technology that combines both brut speed and tactical order placement intelligence.
Brokers, in particular, are challenged to not only build low latency connectivity directly to all these disparate venues, but to also design sophisticated order placement strategies that adeptly optimize routing in order to maximize fill while minimizing impact. Likewise, institutional investors are faced with repeatedly evaluating their execution options and choosing cutting-edge trading strategies and systems that help them achieve best execution.
Looking forward, the buy-side currently sees the lack of control and reduced transparency relative to so many trading venues as their biggest challenges. Institutional traders have to rely on their best brokers to close this gap. When assessing an electronic trading platform, the buy-side is now paying extremely close attention to their broker’s order handling practices and the quality and depth of their transaction analytics. These key variables will be forever conjoined, and the brokers who succinctly marry the two are likely to capture the lion’s share of institutional electronic order flow.
From glad-handing to order handling
When the U.S. equities market mainly consisted of floor-based exchanges, a broker’s position in the crowd was of utmost value. Likewise, the broker’s relationship with the specialist who determined where in the queue a client’s order may get executed could determine a broker’s livelihood. Today, physical exchange floors have been replaced by electronic trading venues and specialists by rules-based matching logic. The best brokers are still the ones who are adept in maneuvering within the crowd, but success is now predicated on strategic and dynamic technology as opposed to political glad-handing.
The quality of a broker’s order routing relies on a combination of many components, some strictly technological and other more strategic. First of all, trading decisions can only be as good as the data used to determine them and the ability to react without delay. This requires two distinct but equally important technological challenges. To start with, brokers must take direct feeds from all major displayed liquidity venues in order to construct the most accurate inside market. Imprecise market data will likely lead to poor routing decisions. Once that accurate National Best Bid and Offer (NBBO) is established, brokers must also build direct connections to all execution venues, both displayed and dark, so that those initial decisions can reach the appropriate venues without delay. The quality of an execution is predicated on the relationship between NBBO construction and order routing speed. Without these baseline technologies, even the savviest of strategies will have performance slippage.
With the appropriate technology in place, routing decisions rely heavily on order placement across venues. Both the way orders are placed and where they are placed are separate endeavors and can affect a trade’s outcome. Routing can be done sequentially or simultaneously. Sequential routing is slower and increases the chance of information leakage but allows for maximized liquidity opportunities at the best venues. Simultaneous routing reduces the risk of information slippage but can increase impact as more aggressive orders tend to trigger market moves.
Based on a trader’s investment strategy, order routing decisions also have to take into consideration the appropriate venues to target. Algorithmic strategies are configured for numerous combinations of venues and many today attempt to make informed decisions based on historical and/or real-time data. Frequently, orders are routed to dark pools or hidden order types on exchanges to minimize the trader’s footprint. Certain pools are less likely to trigger marketplace responses over others, with dark pools seen often as the safest. For certainty of execution, exchanges are commonly the first route of choice, especially when combined with simultaneous routing configurations to maximize fills at the current price point.
Finally, buy-side traders also have to consider a broker’s rerouting logic. Initial order placement is only the first step to executing an order. Once a portion of an order is filled or once orders are placed in various venues, the original strategic decisions must be reevaluated. Poor rerouting logic can be just as or more impactful than the primary routing decision. For example, highly mechanical rerouting logic can be reverse engineered by proprietary traders who anticipate future routing and order placement decisions which ultimately affect the price of the stock.
With the combination of technological implementations and strategic order routing decisions seemingly endless, buy-side traders who look to strike a balance between faster fills, more liquidity, less information leakage and lower costs are faced with the daunting task of understanding how their brokers handle their order flow and what constitutes best practices for their institutional trades. To increase the transparency into their order handling logic, electronic brokers are now offering transaction cost analysis (TCA) platforms that help traders monitor decision making in real time and give greater clarity into execution quality by venue.
TCA without delay
For years, institutional traders have leveraged TCA tools to aid in post-trade performance reviews as well as compliance and oversight. Commonly, this TCA has been provided to institutions by third-party vendors who are able to aggregate trade performance across all their brokers. Although still very popular for these limited needs, the weakness of third-party TCA is that it is most appropriate for analyzing performance on a higher level, such as on a monthly or quarterly basis.
Recently, though, brokers are now providing the buy-side with TCA platforms that not only track overall performance to various benchmarks, but also give real-time analysis of trades on the venue level, allowing traders to evaluate their strategy choices and avoid toxic destinations that hinder their execution quality. For example, visual cues from heat maps specify where orders are being routed and filled (or not filled). Likewise, alerts indicating child order pricing help traders scrutinize a strategy’s aggressiveness and allow for recalibration on the fly. Rather than waiting months to determine what combination venues and strategies work in synch to achieve best execution, buy-side traders can make more informed decisions without delay.
The marriage of trading and TCA
Although many brokers offer certain bits or a few pieces of electronic trading, only a few provide comprehensive electronic trading platforms that combine a suite of execution strategies with transaction analytics.
FIS offers both highly configurable, low latency strategies as well as venue level transaction analysis tools to help drive insightful trading decisions. Our solutions work orders through algorithms which leverage historic and real-time venue ranking to make second-by-second order placement determinations.
And as orders are rebalanced across venues, traders can track performance and opportunistically adjust flows to maximize fills or capture advantageous prices. AlphaZoom, our TCA platform gives traders the ability to zoom into their execution performance in a comprehensible format that can be viewed anytime. ΑlphaZoom evaluates current and historical data using industry and custom benchmarks so traders can make informed decisions when evaluating liquidity of trading venues.
To square up against the modern marketplace, buy-side traders today are looking for brokers who can provide a dynamic, robust and serviceable electronic trading platform. This includes greater algorithmic controls that allow institutional traders to seamlessly move in and out of the market as well as venue level TCA to provide real-time, actionable transparency. Traders have a much more nuanced understanding of today’s electronic markets and they need the tools to match that level of expertise.
Fox River Execution Solutions and SGN brokerage services offered through FIS' Global Trading Group within the United States and Canada are provided by FIS Brokerage & Securities Services LLC, Member NYSE, FINRA, SIPC.