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.”
The core OMS provides traders with an array of order management and trading support tools. Most OMS vendors have routing networks that bring orders in and route orders out to market centers. OMSs also typically have DMA platforms that enable brokers to execute orders or conduct market making with minimal latency.
Sang Lee, co-founder of financial services research firm Aite Group, agrees that the execution capabilities of OMSs have become more important. “Historically, OMSs weren’t used for low-latency algorithmic trading and fast market access,” he says. But now, tighter integration between OMSs and execution systems is mandatory for many firms.
SunGard’s Brass, Fidessa, Nyfix and their competitors have tackled myriad Reg NMS-related execution issues to enable brokers to trade compliantly and preserve their ability to provide risk capital to their customers. For block trades, OMSs now show traders what their quote-protection obligation is at various price points outside the NBBO.
Citi’s Lava ColorPalette OMS, for instance, incorporates a “calculator” that shows traders their protected-quote obligation in real time. “We display the share and dollar quantity a trader would have to take out to put a trade up outside the NBBO,” says Keith Jamaitis, a director in the sellside OMS and client services group within Citi’s electronic trading solutions unit.
Market Data Snapshots
Lava ColorPalette also has a “smart order type” that allows traders to specify the amount of risk (in shares or dollars) they’re willing to take when doing a block at a certain price. If the trade-through obligation exceeds that, the system cancels the order, Jamaitis says. The trader can then adjust the risk parameters or wait for the market to come within the specified limits.
Sellside OMSs are also taking some of the Reg NMS compliance burdens off their clients’ shoulders. This runs the gamut from capturing audit trail information to storing top-of-book market data snapshots for compliance purposes. In addition, OMSs are providing customers with new reports and monitoring tools to conduct surveillance.
GL Trade, for example, has a “flashback” module that enables customers of GL Stream, the firm’s sellside OMS, to “replay” the market dynamically, with full depth of book, in the case of a compliance concern or disputed execution. Customers can use the software to determine whether their executions were compliant. Paris-based GL Trade, Europe’s largest routing and OMS vendor, now competes in the U.S.
Alan Mangelsdorf, vice president for marketing at Brass, stresses that compliance isn’t just a post-trade focus. “Brokers must make sure traders are trading properly because they know how and that they’re not circumventing the system,” he says. “It’s not the one singular act [of trading through a protected quote] but a pattern of behavior that opens a firm up to a violation.”
More broadly, vendors’ compliance efforts are geared toward increasing efficiencies and lowering costs for brokers whose profits are being crimped by changes in the market. “If we can simplify that process, so brokers don’t need as many lawyers and compliance experts on staff, and can have fewer manual processes, that’s helpful to clients,” says Raj Mahajan, president of Brass.
Brass is now also providing customers with “sponsored access” to the 10 exchanges and the alternative display facility participants through SunGard’s Ascent broker-dealer. Customers that previously traded on just a couple venues can now piggyback on the broker-dealer’s member access to those market centers. Brass charges customers a per-share fee for this service.
Nyfix and Lava already offer customers this capability. Fidessa, which does not have a broker-dealer subsidiary, offers sponsored access through Order Execution Services, a broker-dealer and execution services firm, to clients that are not members of all exchanges or ECNs.
