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February 1, 2012

Cover Story: Full Disclosure

By James Armstrong and John D'Antona Jr.

The firm's concerns are shared by the buyside. The Investment Company Institute told the SEC in a letter last year that the regulator should "consider means to require new disclosure or to improve existing disclosure ... regarding the order routing and execution practices of brokers and trading venues."

Morgan Stanley's biggest problem is with the dark pools. In a paper it presented to the SEC on March 4 last year, the firm stressed that brokers route to dark pools in order to avoid exchange fees. It estimated that a relatively large brokerage, trading 100 million shares per day, could save $70 million per year routing to a dark pool rather than to an exchange.

That's a lot of scratch.

Such routing practices are at odds with a broker's duty to provide best execution, Morgan contends. Because some dark pools probe other pools or allow probing by traders, their usage can result in information leakage. That could cause price moves and hurt the buyside.

Andrew Silverman, global co-head of Morgan Stanley Electronic Trading, said different clients have different needs. Firms should look at how clients trade, as a venue might be perfectly appropriate for one client, but less appropriate for another.

Morgan Stanley does a toxicity analysis on different execution venues, Silverman said. If a client wants Morgan to dig down into its particular order flow, the firm will do that, too, he added.

Like many large firms, Morgan Stanley maintains complete control as to where an order goes. If it's not filled at one venue, the order goes back to the broker directly for rerouting.

"Under normal market conditions, our liquidity taking orders are sent as non-routable," Silverman said. "We don't use the routers of market centers because we want to maintain control of our customer's order."

Morgan Stanley also offers its own dark pool, MS POOL, which attempts to discourage HFTs by giving priority to orders with a larger size over smaller orders at the same price, even if the smaller orders arrived first.

Of the dark pools tracked by Rosenblatt Securities, MS POOL currently ranks sixth in terms of total volume. Silverman said the company is comfortable with the size of its pool, just as it's comfortable with limiting the number of venues to which it routes orders.

Sometimes, a trader might want to get a trade done as quickly as possible even if leakage potentially impacts price. For Morgan Stanley, however, the quality of execution is more important, Silverman said.

It's the same at Barclays Capital, according to Bill White, who heads the firm's electronic trading effort. Quality of execution and getting the highest possible fill rate are the basis of the trading strategy for the sellside firm. Price or cost is "never" a factor in deciding how or where to send a client's order, he said.

When the buyside comes to Barclays and asks where an order went, White said he's happy to tell them.

"I love when a client comes to me and asks what my routing process is," said White. "For me, it's a selling point of our franchise and I have no concern, as I know what they are looking for."

White consults with clients who execute orders with Barclays to show him pre-trade just what the execution strategy is. Then post-trade, he lays out the specific path of the actual order and why it went where it did. "I'll show them that we executed the order accordingly," he said.

And that is what the buyside is asking for-a little more information about what happens to an order after they hit send.

 

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