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February 3, 2014

Buyside Welcomes FINRA Query

Institutional investors welcome the equities market regulator's probe on broker-dealer order routing methodology.

By John D'Antona Jr.

The answer to the question "Dude, where's my order?" is about to become more clear.

And the buyside trader-who has long asked this question-will be happy to finally get a more clear idea of how orders are routed and handled by brokers. The buyside has long argued that the sellside's order routing choices are driven more by the sellside's own self-interest and rebates, rather than the institutional need for best execution and block volume.

To that end the Financial Industry Regulatory Authority will send select brokers a questionnaire during the first half of 2014, Bloomberg reported in an interview with Thomas Gira, the regulator's executive vice president of market regulation. FINRA wants some clarity on brokers' order routing decision-making processes among the myriad exchanges, dark pools and alternate trading systems where U.S. equities trade.

FINRA will "probably do some type of a sweep, and make sure firms are asking the right questions and looking at the right numbers and doing the right analysis when they're making routing decisions," Gira told Bloomberg. The self-regulatory organization, which oversees its broker-dealer members, wants to ensure "they're not making decisions to put the rebate ahead of the execution quality," he said.

FINRA did not to respond to Traders own request for comment.

David Jennings, senior trader at Houston-based Bridgeway Capital, said the move by FINRA to get the brokers explain their order routing processes was a positive development for the market.

"I'm in favor of brokers having to explain their order routing," Jennings said. "Most brokers will explain their routing methodology if asked. Personally, I'd like to see an end to all forms of payment for order flow and maker-taker rebates, etc."

And it is the maker-taker pricing model that has come under fire recently. Maker-taker is the pricing system of charging brokers who place orders while paying the traders who fulfill the transaction. Maker-taker came about shortly after the Securities and Exchange Commission cut the minimum price increment shares to a penny, down from eighths or sixteenths of a dollar back in 2001. This reduced the spreads and profitability for market makers to make markets. As a result, exchanges started paying electronic liquidity providers to make markets.

"We are looking closely at best-execution decisions in the very fragmented world of the equities side, particularly with regard to limit orders placed with exchanges that may impose significant maker-taker fees," FINRA chairman and chief executive officer Richard Ketchum told Bloomberg.

Cheryl Cargie, head trader at Ariel Investments, told Traders she was also pleased by the decision to probe the brokers. Last year, she made no bones about how maker-taker wasn't good for the marketplace and brokers' decision-making processes for routing orders was opaque at best.

"We've always asked for this clarity on order routing," Cargie told Traders. "Some brokers will give you the logic on how they route or how the routers work-but you have to ask them." It is not provided otherwise, she added. "Honestly, I don't know why they route to a particular broker over another, but I do believe it has to do with rebates and trading volume."

Cargie added that while FINRA is sending out a query on order routing practices, the bigger questions for her are: Will the brokers answer, and will it really change the way business is conducted?

"FINRA can ask for answers and even possibly get some, but if it doesn't produce a positive change for us, then what's the use?" Cargie said. "What will this lead to? It will be nice to get more transparency as to the broker routing methodology."

And the buyside isn't alone in its quest for transparency. At least one alternative trading system is, too.

Donald Bollerman, head of market operations at IEX, an ATS owned by the buyside, told Traders that IEX too supports the idea of FINRA querying the brokers. The dark pool, which prides itself on catering to the buyside's needs for transparency and disclosure, sees the regulatory move as a positive step toward improving the market structure. Also, IEX supports, to an extent, justification of routing decisions.

The time has come, many believe. "Having worked for a number of different trading venues over the years, seeing the venue selection discussion moving beyond pricing/rebates to offered functionality and differentiated market models would be long overdue," Bollerman said.


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