With the implementation of the European Union’s Markets in Financial Instruments Directive, which opened Europe to the widespread use of alternative trading venues, market liquidity dispersed all over the place. For alternative-market vendors it was a blessing and a curse. They finally had equal regulatory footing with established exchanges — but amid a growing sea of competitors. Lit and unlit, or dark, pools jumped aboard to divine where orders lurk.
As self-preservation forces and bravado took over, Europe’s brimming multiple trading facilities claimed to have an impossible 150 percent of the total equity trading market, says Steve Grob, director of group strategy for London-based Fidessa Group. But even more unsettling than outlandish claims is the overall breakdown of traditional natural and artificial monopolies caused by the interplay of regulation and technology, he explains.
The revolution rages on, but “traders on the buy and sell sides need an unbiased source of information about what is happening to their trades,” notes Grob. Fidessa, with $400 million in annual revenue, saw an opportunity to draw attention to its order routing systems and ticker plant technology, which were capturing the data anyway. The result is a free-to-use, cloud-based window on exchanges, called the Fragulator (fragmentation.fidessa.com), which expanded this week to cover the U.S., Canada, Japan and Asia. The Fragulator traces a specific issue, such as Oracle or a whole technology index, showing where its shares were trading on venues during different time periods (in the case of European markets, over a span of two years). Fidessa’s sister product, the FFI or Fidessa Fragmentation index, can express in a single number the amount of fragmentation in the execution of any of more than 200,000 individual stocks or indexes.
By checking liquidity stock by stock as well as by trading venue, Grob says, customers can verify whether their order routing systems are really finding the most liquidity for the stocks they’re trading. Are they paying more than necessary in transaction costs? Grob expects clients to compare the information on the Fragulator with their broker reports and the volume-weighted average prices listed on the Fragulator tables with the share prices they paid. Fidessa is hoping for user input into the product and is supplying an application programming interface so firms can link Fidessa’s underlying data with customized smart order routing systems.
“It’s a step in the right direction,” allows David Lewis, the vice president in charge of U.S. trading for Franklin Templeton Investments, whose European counterparts have been using the Fragulator, which was introduced there two years ago. “We do think this Fragulator is interesting and important. It just needs more disclosure and transparency. We’d like to see it drill down even further,” says Lewis.
Large orders, which often remain open, are commonly rerouted by a large broker to multiple brokers, who will scrape for liquidity in traditional and alternative exchanges, testing lit and dark pools for more-attractive prices. Customers want to know where their shares ultimately execute and the path they traveled to get there.
Templeton can see where its order flow traveled, where its orders executed and what institution printed that information on a tape, as required, through the tags provided by the Financial Information eXchange, a communication protocol that captures these details. But Templeton wants First Boston and the other brokers to supply the information in real time, says Lewis.
But, like other institutional investors, he also wants assurances that orders aren’t being steered to certain exchanges to gain a rebate for the broker rather than the best price for the client. Like regulators, Lewis has concerns that algorithms used in order execution, to locate liquidity and obtain best price, could be open to predatory or reverse engineering. Such practices have recently been suspected of manipulating order pools by indicating false interest and other measures meant to deceive investors or artificially move market prices. Of particular interest to Lewis is that the algorithm he’s paying a major broker to create isn’t being outsourced down the line to a smaller broker. He wants to pool all the information to be sure the best sources of liquidity are being tapped.
Ironically, Templeton’s plans to obtain the same information directly from the firm’s broker will probably replace its need for Fidessa’s service in as little as two weeks. “All brokers should be able to supply this information,” Lewis says. “We were already working on this, for one, because we want to start getting this information before the SEC requires it.”
Says Joe Rosen, president of RKA, a financial technology consulting firm, and editor of the Handbook of Electronic Trading (Capital Markets Media, 2009), of the Fidessa Fragulator: “It’s a brilliant idea. I haven’t seen anything like it before.” He expects that the greater transparency “will translate into lower margins for the players” and more consolidation among exchange venues. “I can’t understand why some aren’t on life support already,” he quips. As for Fidessa’s lead, Rosen says, “Competitors will have to come up with similar solutions. And regulators have to love stuff like this. It’s bringing more transparency into the market.”
Maureen Nevin Duffy is a freelance financial journalist based in New Jersey.
