Chi-X Plans for European Cross-Market Routing

With the introduction of more trading destinations and market fragmentation set to result from securities being traded on multiple venues, Chi-X officials say that firms in Europe will drive the development of a system similar to that currently used in the U.S. for routing between venues to ensure that trades are executed at the best price on behalf of investors, regardless of where that best price is quoted.

"The European market is starting to evolve toward smart order routing, [with] players like Instinet Europe and Credit Suisse [already offering] production smart routers," says Hirander Misra, a director of Instinet's Chi-X business. "But the markets are different here to the U.S. so [Chi-X will] have to take into account … cross-border quirks."

U.S. ECNs have broker-dealer status, which allows them to assume risk and pass on orders in their own name, but MTF's in Europe generally don't carry the same status. Although it is possible for European MTFs to apply for regulatory authorization as a broker dealer, once they become exchange members, that exchange will have the authority to supervise its activities, which creates a conflict of interest, says Misra. "What we can do is put in place a process where we onward-route in the best possible way, but in the members' own name," he says.

To provide trading firms with a single view of a security's best price across multiple markets, venues may have to create their own datafeeds that consolidate data from other markets. "It's essential. ... And you have to take into account iceberg orders and things like that as well. That's definitely an area that I see the leading MTFs—including ourselves—moving into," Misra says.

However, he says any data carried on these feeds should be truly executable, rather than indicative. "If you are order routing, the quotes that you can't trade against mean nothing to you. As far as you are concerned, they are not even an event. If you try to send something there, you just can't," he says.

The feeds would also need to have filters to identify quotes and trades on order books—for example, for algorithmic traders trading volume-weighted average price (VWAP)—from off-exchange trades that could skew prices, he says. "On Chi-X, we obviously have on-order book data, but when we introduce trade reporting later this year, we will flag the off-exchange trade report data to identify off-order book from on-order book data," he adds.

He also says that smart order routing logic should include peripheral trade costs as well as prices, as some venues charge for cancellations as well as order entry, and filling a trade partially across different venues could result in additional costs compared to a trade that is filled on just one venue.

Yet, there may be a barrier to smart routing in Europe in the form of the existing exchanges. "Today, if we went to the London Stock Exchange as a start-up and said, 'If you have a better price, we'll send the order to you, but vice-versa, if we have a better price … you send the order to us'—you know the response we would get," he says.