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July 15, 2007

Sellside OMSs Get Ready

Addressing Compliance and Regulatory Changes

By Nina Mehta

Also in this article

After priming for Regulation NMS for at least a year, sellside order management systems are in the initial stages of enabling their broker-dealer customers to be Reg NMS-compliant and effective in this new era. For brokers, the new era started on July 9. "Reg NMS raises the bar in terms of what brokers expect of their OMS," says Chris Kelley, an executive vice president at Fidessa, a large sellside OMS vendor. "These new functions are critical in the restructured environment." The Securities and Exchange Commission's Reg NMS requires broker-dealers to avoid trading through protected quotes. At the same time, liquidity has fragmented across dozens of trading venues. The quote-protection obligation, coupled with brokers' best-execution duty, has made finding and aggregating liquidity more complex.

But the quote-protection rule's biggest impact for broker-dealers lies in the challenge it poses to block trading. OMSs have stepped up to solve this problem.

In general, broker-dealers are taking different paths to pursuing best execution under the new regulatory scheme. The largest firms, like Morgan Stanley, Merrill Lynch and others, have direct connections to market centers and have built their own smart order routers. Many broker-dealers are turning to their OMS vendors for solutions. Others are relying on the execution services of their clearing firms or third-party routing and direct-market-access vendors. Some brokers are counting on exchanges to route out to better-priced quotes for them.

In the new trading environment, OMSs must provide brokers with connectivity and access to protected venues. They must help ensure that clients avoid trading through protected quotes and that they route out intermarket sweep orders when necessary. Most OMSs are also capturing and saving the audit trail for each order, as well as data about the best prevailing quotes at the time of every execution-to be able, for the client's compliance needs, to demonstrate how that client handled the orders it received.

"Reg NMS is forcing firms not only to change how trades are executed but to maintain a detailed understanding of how trades are performing from a regulatory and best-execution standpoint," says Chris Walsh, head of the OMS division of Nyfix, a routing and trading services company. "We're all investing a lot of time, money and energy to help our clients achieve this."

Block Risk

The brokerage business most threatened by Reg NMS is block trading. Unlike in the past, blocks can no longer trade through protected quotes. Brokers, consequently, must know what their quote-protection obligation is likely to be before they quote a price outside the national best bid or offer to a customer. Brokers say that if they can't do that, or can't do it efficiently, their pricing will be less competitive.

Figuring out brokers' quote-protection obligation for blocks and instantaneously sending ISOs to multiple market centers to execute against those quotes has become an important task for sellside OMSs. That has upped the technology demands for those OMSs.

"Reg NMS requires elaborate integration between historically disparate parts of a broker-dealer's trading environment-the smart routing and market-access system and the core OMS," says Fidessa's Kelley. "We already offer tight integration between these functions, but Reg NMS makes this level of integration an absolute necessity."