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February 1, 2012

Cover Story: Full Disclosure

By James Armstrong and John D'Antona Jr.

Electronic tools such as algorithms and smart order routers can break up trades and send them to different venues, but the exact path a trade takes can still be opaque for the buyside. Traders feel in control, because they get to decide which tools to use, and trade-cost analysis can help them evaluate how well those tools work. Still, the way in which the tools work usually remains a mystery to the trader.

Buysiders today want more than just TCA. It isn't enough to know the end result of a trade. They want to know each step an order took along the way to execution. That way, they can be sure there are no weak links in the chain where information leakage could occur.

"If execution was favorable, it's not a problem, but that does not mean it won't generate questions while evaluating the execution, good or bad," said Craig Jensen, principal and head of trading at Armstrong Shaw Associates, a New Canaan, Conn.-based firm that focuses on large caps and has about $3.4 billion in assets under management.

Schack said buyside traders can do themselves a great service by more closely tracking orders. It can be important to know not just where a trade was executed, but also why it was executed in that venue and what the economics associated with that execution were.

Recently, buyside firms have taken more initiative, and made it clear to the sellside that this information is important to them. It can be easier to get such information now, though getting it is still not easy, he added.

"There are a lot of inconsistencies in the way individual brokers keep track of some of this information and present it," Schack said. "Do they do it in real time as opposed to end of day? Are they able to produce for you all of the hops along the path to execution, all the different stops your order took at various venues where it went unexecuted?"

Some of the big brokers are doing this now, Schack said, but others aren't, or are only providing the information for certain customers.

Brian Fagen, head of North America execution services sales for Deutsche Bank, said there are different levels of engagement with buyside clients. Some clients really don't care about order routing. Others are interested in it, but only superficially. Then there are some clients that are very interested and actually take data off of FIX Protocol messages and build processes to track where orders get routed.

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Deutsche Bank has its own internal system known as Trade Pad that can show in real time where executions are occurring, what size they're occurring at and where price slippage is happening. While the application displays what is going on with an order, the firm's smart order router automatically recalibrates itself to move away from toxic venues.

"Right now, it's only internal, but we're working on making it more of a client-facing application," Fagen said.