Aggregation: Back to the Future

Aggregation was dead. Except for the recent acquisition of RealTick/Townsend Analytics by Lehman Brothers, the aggregation business has been in the doldrums for the past year and a half. Why do you need to aggregate if there are only two or three execution venues? Besides, most of the platforms have been acquired by brokers anyway.

This will change, however, with the implementation of Reg NMS, which changes equity order routing to prioritize fast markets (exchanges and ECNs) over slow markets while creating a more-even playing field across fast markets. This breathes new life into regional exchanges, creates an opportunity to develop new ECNs, and allows both ECNs and exchanges to rebate large order flow providers with market data and access-fee payments.

This will fracture the recently consolidated exchange infrastructure. Since the announcement of Reg NMS, we have seen broker investments in the Philadelphia and Boston Stock Exchanges, and acquisitions of the Attain ECN and OnTrade (NexTrade's ECN). We also are seeing investments in the American, Chicago and Cincinnati Stock Exchanges. Is there a correlation? I think so.

But what do these investments mean? Brokers that invest in or own exchanges and ECNs will favor these venues because they either derive value from ownership or receive lucrative market data and access fee rebates.

So what? Who cares if there are a dozen trading venues? Don't they all need to be linked to support NMS? The "so what" is this: These rebates will motivate brokers to route their order flow through particular venues. Citi just bought OnTrade, and Knight bought Attain (which is now called DirectEdge), so you can guess where their flow will go. If order flow and ownership align, what we easily can envision is a time when each broker routes to a different venue in which it has invested, and finding the other side of the trade will be significantly more challenging—not to mention more data-intensive.

Here is where aggregation reenters the game. With only two or three trading venues, aggregation is not very interesting. However, with the existence of three major execution venues, and another six or seven regionals and ECNs, in conjunction with an empowered SEC focused on best execution, and now you have a horse race.

Actually, it is more than a horse race. In fact, not only won't the aggregation technology of yesteryear be enough to create a virtual central limit order book across eight or 10 execution venues, it won't be able to manage where to place limit orders or how to move them from venue to venue either.

Yesterday's smart order routing generally was focused on taking liquidity, as placing liquidity was fairly straight-forward, revolving around rebate schedules and managing complex order types like pegging, discretion and reserves. Tomorrow's aggregation platform will need a whole new layer of sophistication around order placement, which will be impacted not only by the location of liquidity, but also the rebate schedule, whether the price is the top of book, and whether it is protected or not. These platforms will need to monitor not only where each order is, but the activity in other books, how market movements (including massive quantities of cancellations) have affected the placement and status of an order, and whether an order should be moved somewhere else.

This will not be easy. It will need to be done by some of the most sophisticated equity trading infrastructure and connectivity players. So aggregation providers, get ready—your ship, the SS NMS, has come in. While we expect it will be a fantastic ride, it will be a long, hard and convoluted sail to the finish line. Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio