Traders Value Exchange Executions Over ECNs

A new report from Aite Group, LLC examines the execution performance of U.S. exchanges and ECNs over the first six months of 2008. Based on data supplied under Securities Exchange Act of 1934, Rule 605 (formerly 11Ac1-5), the report reveals insight into the value provided by trading venues in the process of executing orders.

Securities Exchange Act of 1934, Rule 605, requires exchange specialists, over-the-counter (OTC) market-makers, electronic exchanges, electronic communications networks (ECNs), and alternative trading systems to publicly disclose a range of basic standardized performance-related data on a monthly basis. The SEC adopted this rule in 2001 to provide retail investors with a set of standardized data that could be used to compare the relative execution quality of trading venues in a more thorough manner than simply by using the consolidated quote.

In the report, Aite Group provides an analysis of the relative performance of trading venues in the execution of market, marketable limit, and non-marketable limit orders subject to the limitations noted above. These order types account for a majority of common order types that are handled similarly across trading venues.

The analysis reveals that for all covered order types – marketable and non-marketable – traders appear to value the execution certainty associated with the liquidity at venues known for depth-of-market – NYSE and Nasdaq – versus less liquid ECNs and regional exchanges that, on average, may provide better price quality, price improvement, and a favorable market bias.

For liquidity takers using marketable orders, the relative benefit of routing to a less liquid trading venue with a protected quote is overlooked. At such venues, an order, at the inside market would most likely receive better execution priority than at NYSE or Nasdaq and execute more quickly against the inside of the consolidated quote. If that venue is not at the inside of the quote, unique alternative possibilities for execution exist before the order is finally routed out to the executing venue.

With regard to liquidity providers, the quality of standing limit orders is more difficult to assess. The results were less clear for inside-the-quote, at-the-quote, and near-the-quote limit orders, as no clear trends were evident and execution quality varied from venue to venue.

Explicitly ranking trading venues is meaningless as different people weight metrics differently. One person may prioritize speed and execution certainty while another may value price improvement.

Accordingly, the Aite Group report highlights market center performance based on generally accepted metrics. The reader decides his or her own ranking based on his or her own viewpoints.

Rule 605 requires trading venues that execute national market system securities to disclose a range of performance-related information on basic order types including market, marketable-limit, and non-marketable limit orders executed during normal trading hours.

Orders that require special handling, market open and close orders, and orders of 10,000 shares or more are exempt from these requirements. Data mandated includes a range of generally-accepted metrics used to examine market, marketable limit, and non-marketable limit orders.

The usefulness of Rule 605 data has been a topic of debate since implementation in 2001. A number of trading venues emphasize that the data is of limited use for several reasons including that the data represents only a portion of their business, that orders of 10,000 shares or greater are excluded, that only a limited range of order types are included, and that certain metrics are inherently biased against particular operating models.

Data limitations in the securities industry are the norm. Transparency is limited and deficiencies exist in most available data sets. Nevertheless, the data provided by trading venues in accordance with Rule 605 is the most comprehensive and standardized equity market data made available to the general public.

Despite certain deficiencies, the SEC encourages trading venues to release any additional information they believe might be helpful in remedying shortcomings in the data so that the quality of comparative analyses can be improved. Aite Group believes that, despite limitations, meaningful analysis and conclusions can be drawn on orders and executions covered by the Rule.