High Broker-Affiliated ATS Order Routing Associated with Lower Fill Rates, Higher Costs

Institutional orders routed by brokers that send a relatively high percentage of such orders through affiliated alternative trading systems (ATSs) tend to receive lower order fill rates and higher execution costs, according to a newworking paperbyFINRAs Office of the Chief Economist.

The working paper analyzed detailed order-handling information over the life of 330 million institutional orders routed by 43 active institutional brokers for a size-stratified sample of 273 stocks during October 2016. The study noted that while not all brokers with affiliated ATSs show a preference to route institutional client orders to affiliated ATSs, some brokers exhibited a persistent pattern of routing orders to affiliated ATSs. Brokers with high affiliated ATS routing were seen to be associated with lower order fill rates.

The authors divided brokers into three groups based on affiliated order routing. The group with the most routes to an affiliated ATS filled an average of 16.9 percent of an order, significantly lower than the 29.8 percent of the middle group and 43.5 percent for the group least likely to route orders to an affiliated ATS. The differences existed even after the authors controlled for issue and order characteristics and market conditions.

The authors noted that the institutional orders experiencing lower fill rates are associated with higher trading costs when accounting for the lost opportunity costs resulting from unfilled orders.

The evidence from this study does not support the idea that when a broker sends a high proportion of orders to an affiliated ATS, these venues necessarily offer a lower-cost option that avoids other market participants from learning of an institutional order, said Jonathan Sokobin, FINRAs Chief Economist and Senior Vice President. The difference across brokers in routing decisions, fill rates and trading costs are persistent over time, indicating that past routing behavior is predictive of future behavior.

The study pointed to the potential value of better disclosure on broker routing practices in general, and a higher level of scrutiny when brokers show a preference to route orders to affiliated venues.

Order routing, execution quality and the potential for conflicts have been the subject of continuing focus for FINRA for several years. FINRA conducted targeted sweep exams regarding these areas in2014,2015and2017and included the subject in its2019 Annual Risk Monitoring and Examination Priorities Letter.