Venue Analysis Holy Grail

By Enrico Cacciatore, Senior QuantitativeTrader – Head of Market Structure & Trading Analytics, Voya Investment Management

Routing Transparency Initiative – Unlocking the routing decision

1. Introduction
Twenty nineteen is poised to be a very eventful year in market structure. Factors such as technological advancements, optionality in venues, Reg NMS1, and increased usage of quantitative methods are significantly shaping the evolution of equity market structure. The next few years will be very pivotal in tackling several obstacles that are inhibiting equity markets from transitioning to the next phase. This year, in particular, could have substantial influence on shaping the market’s future direction. We can anticipate the continued growth of systematic trading, the SEC evaluating the maker/taker model as well as the enhancements to Rule 606, to highlight a few key events in the year ahead.

1.1 Reg NMS, Technology and Quant methods
The interest in market structure and its impact on how market participants transact to achieve an investment goal continues to have ever-increasing significance. Reg NMS was a major catalyst in seeding the landscape for technology and quantitative methods to dominate the trading process. Without an equity market structure that is fluid and efficient, the growth and dominance of systematic investing, whether it be in a large systematic quant fund or an automated market maker, would not have been able to grow as it has over the last thirteen years.

From this highly efficient and relatively low-cost market structure, investors are able to transact with venues and a cost structure most suited for their investment objective. If an investor2 is patient and passive in seeking liquidity, one is able to capture both the Bid/Ask spread but also a rebate fee3 for providing liquidity on that specific venue. However, if an investor is very aggressively seeking liquidity, one could just take passive liquidity resting on an exchange.

Alternatively, one can queue jump by resting on an inverted exchange that flips the maker/taker model, requiring liquidity providers paying a fee to make. This structure provides, what I call, “optionality in venue liquidity”. The fragmented structure does have its drawbacks, but is outweighed by having equity markets that allows liquidity shoppers and vendors to provide both an economic and transactional experience best aligned with the purpose of the trade. Depending on the intention, the investor can find a venue that best fits their objective. In some cases, the cost is a critical factor, while in others it is the highest probability of a fill. The result allows the investor to align a trading strategy that best captures the alpha profile of the investing decision.

2. Venue Analysis – Current State
Venue analysis should never be a starting place to evaluate performance or toxicity of execution at the venue level, but should provide the forensic details of potentially why certain orders or even a broker algorithm in aggregate are under-performing. Using a top-down approach to broker-dealer algorithm performance, we can replay the intent of the algorithm’s order placements and determine what impacted performance based on the investors communicated urgency.

Just because the broker-dealer has an efficient smart router that does well in capturing the routed intent does not equate to a strong placement level performance. The placement level performance may be poor due to the broker-dealer’s strategy urgency level not being aligned with the investor’s alpha profile. In this scenario, this would not be a bad problem to have. The investor can simply synchronize the optimal urgency level for given order profiles and expect to see a performance increase.

However, poor placement level performance may be due to the broker-dealer using an algorithm developed around clock-time rather than volume-time. In the clock-time approach, we would see some sort of increment of time set used to trigger additional algorithmic instructions such as after five seconds at the bid, move to mid. Under a volume-time approach, actions are triggered by events, and actions tend to be more dynamic and random. Using a clock-time approach in stocks that have large gaps in events such as small cap illiquid securities, timed triggered instructions are highly detectable. With the volume-time, one would expect algorithmic interaction with the market place to correspond directly with the stock specific events.

By connecting algorithmic event intentions with actual stock specific events such as a quote, move or large block print becomes a powerful tool when evaluating placement level performance.

2.1 The push for greater transparency
Various incentives are providing the push for broker-dealers to provide greater transparency around child order routing to venues. In a press release on December 19, 2018, the SEC released information regarding the Transaction Fee Pilot: “The Pilot will study the effects that exchange transaction fee and rebate pricing models may have on order routing behaviour, execution quality, and market quality.”4

Additionally, the SEC “adopted amendments to Regulation NMS, [Rule 606(b)(3)], [that would] require additional disclosures by broker-dealers to customers regarding the handling of their orders.”5 The most vocally expressed justification around both SEC actions is the view that there is an embedded conflict between broker-dealers, access fees and best execution. The view is that broker-dealers may prefer specific venues based on economics and not in the best interest of performance.

This does not solely influence routing to regulated exchanges (lit market), but also Alternative Trading Systems (ATS – Dark Pools). FINRA recently released a paper titled “Institutional Order Handling and Broker-Affiliated Trading Venues” that “…examine[s] whether the use of affiliated ATSs that may have benefits for the brokerage firm affects execution quality of institutional clients.”6 All of these concerns and potential conflicts produce valid justification to question routing decisions. No matter, transparency around routing must be improved to help broker-dealers remove this view of conflict as well as provide critically missing data in evaluation routing and venues quality.

Broker-dealers must adopt a standardized intention/reason code for why they routed an order to a venue. This would remove or validate any conflicts as well as provide the missing component to true venue analysis. As stated in the FINRA paper, “our data are not sufficiently detailed about client intent or the extent of broker-dealer discretion associated with an order.”6 If we have both filled intention codes real-time as well as all routed orders stored and available in a standardized format, both investors and broker-dealers have the ability to step-through the routing decisions and analyze the impact on those decisions.

3. Venue Analysis – Future State
A committee of sell-side and buy-side peers are working to create, normalize and adopt a “Routing Transparency Initiative”. The goal is to provide more transparency and standards to routing FIX orders to venues as expressed in the 606 amendments and to add a quantitative layer to the behavioural changes in routing for the SEC’s empirical evaluation of Reg NMS Rule – 610T.

The use of a descriptive numerical framework using five two-digit sequence codes to categorize the actions in numbers would allow many combinations and flexibility to handle a new normalized standard to the FIX protocol with the standard applied globally. Each two-digit descriptor would provide up to 99 possible sequence code values allowing for enough expansion for future expansion. The translated numerical string essentially becomes a readable phase describing what the broker is attempting to accomplish from the routed order. Figure 2 would have a ten-digit string of “0501081903” to represent a Midpoint Ping, ATS, Market w/ Minimum Execution Size (MEQ), Seek oversized Block, with Medium urgency.

Our committee has begun to spec out a conceptual descriptive routing framework to communicate the broker-dealer’s intentions. The broker-dealer’s proprietary routing codes would need to be translated and standardized into a predefined sequence code and corresponding value. With this standardization adopted across all broker-dealers, we would look to integrate this information into existing protocols. The attempt would leverage existing protocol from ITCH, OUCH, UTP Direct, etc. Additionally, and standard fix protocol would help determine how best to adopt these standards into the Financial Information eXchange (FIX®) Protocol.

The Routing Transparency Initiative committee will leverage knowledge from developers, fix engineers, systematic traders, market structure heads, and participants to define a descriptive numerical framework that is both extensive and flexible enough to handle all possible routing intentions defined by broker-dealer’s proprietary routing behaviours converted to a normalized standard.

4. Conclusion
In the current investment life cycle, all decision points are very transparent and are captured and stored for further analysis. We can systematically improve performance by evaluating these decision points in an optimization process. Aligning the parent order’s alpha profile vs. optimal algorithmic strategy results in an iterative systematic improvement in parent order performance. Having consistent algorithmic strategy performance is a critical factor in this process. The Routing Transparency Initiative adds a transparency layer into the investment life cycle that would help broker-dealers improve their routing, investors understand and evaluate routing practices, and a critical component to the SEC Rule 610T empirical evaluation.

Hear more opinions on this topic:

Phil Mackintosh, SVP, Chief Economist, Nasdaq

Phil Mackintosh,
SVP, Chief Economist, Nasdaq

In the past 20 years, markets globally have automated and modernized. Computers are now responsible for the majority of executions in stocks around the world, and the quantity of data that is available to analyze trading has exploded. There are now more than over 50 venues for trading, and over 35 million trades every day in the US equity market. Just recently FINRA highlighted that they had 135 billion records in a single day. At the same time, transaction costs have also fallen significantly. That makes squeezing the last basis points out of your trading desk increasingly more complicated.
Read more
Ryan Larson, Head of Equity Trading (US), RBC Global Asset Management (US)

Ryan Larson,
Head of Equity Trading
(US), RBC Global Asset
Management (US)

Nasdaq recently offered their recommendations on creating a more modern market structure; and separately, a collective group of market participants launched the Routing Transparency Initiative. These efforts should be applauded as contributing to the debate as to how to improve our markets. A collective group of diverse market participants should agree to adopt common ground to deliver a global standard to routing FIX orders that provide additional transparency and build upon the efforts of the SEC’s Rule 606 enhancements, ultimately providing child-order routing decision transparency.
Read more
Stephen Cavoli, Execution Services, Virtu Financial

Stephen Cavoli, Execution Services, Virtu Financial

By supporting the RTI, we hope to raise the standard of transparency in the industry by providing normalized data for clients to analyze, as we believe that transparency helps market participants make better, more informed trading decisions. Initiatives like the RTI are very much in line with our Enhanced TCA and Transparency Report, where we were the first to provide granular insight into the decision making process of Virtu’s algorithms and how the clients’ execution objectives and market conditions map to an algo’s order routing decisions. Read more
[1] Regulation NMS – Regulation National Market System (NMS) is a set of rules passed by the Securities and Exchange Commission (SEC), which looks to improve the U.S. exchanges through improved fairness in price execution as well as improve the displaying of quotes and amount and access to market data. –
[2] Investor – As an institution or retail investor, market access rules require registered member to provide access to venues. Unfiltered or naked access have become prohibited –
[3] Maker/Taker Model – The Broker-Dealer or Member Firm are the direct recipient of net cost of trading with venues. Only institutions with a cost-plus arrangement will benefit from the net cost of exchange maker/taker fee structure.
[4] “SEC Adopts Transaction Fee Pilot for NMS Stocks.” U.S. Securities and Exchange Commission, U.S. Securities and Exchange Commission, 19 Dec. 2018,
[5] “SEC Adopts Rules That Increase Information Brokers Must Provide to Investors on Order Handling.” U.S. Securities and Exchange Commission, U.S. Securities and Exchange Commission, 2 Nov. 2018,
[6] Anand, Amber, et al. “Institutional Order Handling and Broker-Affiliated Trading Venues.” FINRA Office of the Chief Economist, Financial Industry Regulatory Authority, 22 Feb. 2019,

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