Friday, August 27, 2010

Smart Order Routing : Endevour for Optimum Liquidity and Best Price

Smart order Routing refers to completing the orders using multiple exchanges in such a way that clients get its order completed at best price at a given time. It means client can get best price and liquidity using Smart Order Routing (SOR). 

SOR is an algorithm which takes into account 

a) Price of the Stock on All Stock Exchanges
b) Available liquidity available in stock on all stock Exchanges
c) Impact on price, liquidity  upon such order
d) Cost consideration for execution on particular stock Exchange (maybe different Charges, Rebates on particular stock Exchange, Brokerages, Statutory Cost ). Some may be true for India (Like Stamp Charges, Exchange Transaction cost)
e) It may also take into account different settlement modes (DVP, Counter Party, Spot, Dark Pools) and Settlement Conditions (T2T, Auctions)
f) Probability on likely execution (Price and Quantity) which may result in distribution of Orders.
g) Size of Order, Order conditions (Limit Order, VWAP, TWAP, IOC, GTC)
h) It may also look in some complex calculation of timing in case the broker has co-location in particular exchange.

After taking in account, the above mentioned points, it will release orders in exchanges in such a way that the client gets best price , grabs the required liquidity and volumes.

SEBI has allowed smart order Routing on Indian Exchange. This a natural extension of Algorithm Trading for Buy Side clients. This was expected from SEBI as Indian exchanges are liquid and has required  IT infrastructure to incorporate this facility.

The Salient features of SEBI circular on SOR are
a) This facility is available for all categories of Investors and not only Institutional Investors.
b) Any broker can offer this facility after taking relevant permissions from Exchanges.
c) Broker cannot be biased towards certain Exchange for order routing , and they have to be neutral.
d) Broker - Client Agreement has to specify use of SOR , along with its features, rights and obligations.
e) Brokers will have to maintain Audit Trail for SOR.
f) If client do not intend to use SOR and entering in contract it has to be documented. (To avoid future litigation)
g) SOR can only be used for recognised Stock Exchanges (To avoid Dark pools, trade by broker as counter party, Dabba trading)
h) Broker has to put proper Risk Management in Place
i) In case of any disruption in trading through SOR, broker will have provide its clients alternate trading mechanism.
j) This facility can be given through CTCL facility 

It is a right step for best execution of clients, but we would need clarity on below mentioned query 

It means Clients now need not specify the exchange it wants to trade in , but has to give order for quantity and price and SOR will decide the exchange to trade, which will fetch him best price for entire order.

The SOR is available to all client, including HNI and Retail Investors. Such investors do not mandatorily  take delivery on all positions and they may close their position intra day, What would be SOR guideline for such cases.

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