Gaining Trade Order Transparency Can Be Costly

Since the dawn of time, or at least since the Buttonwood Agreement, investors have questioned their brokers' trading methods. Traders frequently speculate about misrouted orders, information leakage and even front running. But with limited transparency into the trading process once the order leaves the buy-side desk, the talk rarely amounts to more than typical trading banter.

What Lies BeneathThe January/February 2013 digital issue of Advanced Trading takes an in-depth look at how buy-side firms are using more granular data to track their orders and get more insight into the trading process. To read more, check out Advanced Trading's January/February 2013 digital issue.

One of the most common causes of these suspicions is a lack of transparency into the execution process. Once an order reaches the broker, it can go in a hundred different directions, since the U.S. markets have numerous lit exchanges and 40 or more dark pools. Finding out how many destinations an order passes through before it's executed was almost impossible, until recently.

Today traders are demanding more transparency from their brokers. Faced with a marketplace where profits are elusive, institutions are looking for any advantage they can get to improve returns for investors. Now traders can access data about the entire route an order has taken, and many buy-side institutions are requesting this data from their brokers. However, there's still quite a gap between simply having access to the data and being able to do something with it.

[The Risk and Transparency Tango]

A specific message standard used by the buy and sell sides to transmit their orders, known as Tag 30, contains information that can help traders better determine which brokers are providing the best execution. But the challenge with Tag 30 is that the data collected piles up quickly. A trader or portfolio manager who's adept at data analysis should be able to view a single order and how well, or poorly, it was executed. It takes some time and digging, but it can be done.

However, if an institution wants to collectively analyze trade data for anomalies, best practices and best execution, more robust technology is needed. Tag 30 data for even a medium-sized asset manager would add up fast, since each transaction might visit six or seven trading venues before it finally finds the other side of the trade. Looking for trends in this amount of data will require not only the databases, analytics engines and other tools to sort the information, but also individuals with data-crunching expertise, such as quantitative data analysts and data scientists. As the Harvard Business Review notes, data scientists hold the "sexiest job in the 21st century."

To really gain some transparency into trade routing, buy-side firms must invest in technology and personnel that can leverage the Tag 30 data. This is easier said than done at a time when all companies are closely monitoring expenses.

Would an investment in data analytics help improve trade routing transparency, and will it provide financial benefits to the trading desk? The jury is still out on this, but some asset managers are already reporting success with analyzing Tag 30 data. While some asset managers may not be ready to take the plunge into increasing technology expenditures and hiring expensive data scientists, others feel that it's worth the cost to help improve returns. Only time will tell.