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smart order routing and best execution

Switzerland, 30th May 2019.

The Evolution of Smart Order Routing in Capital Markets

Smart Order Routing (SOR) isn’t exactly a new concept in capital markets. Although used as more of a compliance box-ticking tool as opposed to a statistical product, it has been gaining traction among financial institutions in the US and Europe and has become a vital differentiator as markets expand and trading tools become more consolidated.

Historically, there have been conflicts of interest in the routing process, as venues charged different fees for taking liquidity or even offered rebates for posting it. Thus, for the broker charging a flat rate to their clients, there was an incentive to achieve the lowest possible exchange costs they could while satisfying their best execution policy. RTS 28 (one of MiFID II’s technical standards) requires a broker to publish the volumes executed on its favourite venues. This additional transparency has taken scrutiny and accountability to a new level.

Under this new regime, brokers who still trade primary-only or outsource their smart order routing to other brokers are in need of their own solutions which provide this crucial differentiation and enable them to take control of their routing processes.

In particular, SORs need to be connected to and justify their routing decisions between multiple types of venues (primary, MTFs and Systematic Internalizers) and execution types (lit, dark and periodic auctions). Making the right routing decision now requires more inputs than price alone.

At Itarle, we have a Smart Order Router of which we are proud and it’s well-suited to this new environment. Our offering combines state of the art components of machine learning with the appropriate best execution practices, ensuring banks are meeting all required compliance mandates.

However, we understand that some of our clients wish to overlay their own proprietary statistical signals or house view in real time. That’s why we have designed our SOR with a clear separation between signals and routing rules in order to readily incorporate our clients’ signals via a range of technologies. This provides the best of both worlds for our clients who have some great ideas but do not have the time or the resources to build an SOR from the ground up.

SOR is no longer a ‘mature, commoditized’ product. It is an essential tool for not only making intelligent decisions in the evolving liquidity landscape but justifying them as well, which is equally as important.