Some of the top users and vendors of electronic trading services gathered at the TradeTech India 2010 conference last week. Right on top of their wish list (frustration list, actually) was to be able to use smart order routing technology.
What is smart order routing technology? India is among the very few markets in Asia where the same stocks are listed on two different exchanges. When an investor wants to trade a security, he/she would want to execute at the best possible price, which at times would be on the National Stock Exchange (NSE) and at others on the Bombay Stock Exchange (BSE). This decision is, typically, made by the broker executing the order on behalf of the investor. For example, if the order book on NSE displays an offer to sell 100 shares of Infosys Technologies Ltd at Rs2,700 and BSE displays an offer to sell 100 shares at Rs2,695, someone with a buy order of 100 shares would expect his/her broker to execute it on BSE.
With the advancement of electronic trading in the country, an increasing proportion of orders is being sent to exchanges by automated systems. Smart order routing technology enables these systems to choose the best possible price, just like their human trading desk counterpart, but at machine speed.
The benefits of smart order routing are immense for investors in Indian markets since the same security trades at two different venues. James Rae, director and head, AES sales for Southeast Asia at Credit Suisse, points out, “Liquidity on NSE is 2.5 times greater than that of BSE. Even so, quotes on BSE offer better execution opportunities at times. Studies done by Credit Suisse’s quantitative analysts show that for the 30 most liquid stocks in India, the best bids and offers are available on BSE 35% of the time.”
He adds that smart order routing is the logical next step in the evolution of the Indian market: “Algorithms determine when to execute, how much, and at what price—depending on the goals of the strategy. Smart order routing simply determines where the best price exists, or is most likely to exist, at a given time. Just as it is the fiduciary responsibility of a sell-side trading desk to seek out best prices on the client’s behalf, so should it be for electronic trading. Smart order routing allows this.”
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If the benefits are huge and obvious, why the delay? BSE officials have said at conferences, such as TradeTech, that NSE is dragging its feet in allowing smart order routing. NSE currently enjoys the majority of the order flow in the Indian markets and may lose some of that once smart order routing technology is allowed. NSE, on the other hand, says that there first needs to be an understanding on an audit trail and a common timestamp so that any investor dispute related to this can be addressed.
Illustration: Shyamal Banerjee / Mint
These safeguards will act as proof of which exchange offered a better execution price at any given point. In a recent interview, NSE’s managing director Ravi Narain said, “We and BSE are in the middle of writing down a common framework and once we both agree on this, we can start this process.”
But BSE and NSE have been talking about this for months with no signs of a resolution. What’s the regulator’s role in all this? A spokesperson from the Securities and Exchange Board of India (Sebi) says, “Sebi feels that what is best for the investors has to be achieved. Sebi is working with the exchanges to take smart order routing forward.” Clearly, some pressure from the regulator should speed up the process. The differences between the exchanges should have been sorted out by now.
Having said that, issues such as a common timestamp and audit trail process aren’t trivial and must be deliberated upon for the larger good of the market. In trying to reconstruct the 6 May flash crash, the US Securities and Exchange Commission has found the process of calibrating different timestamps of different trading venues challenging. In fact, it has proposed a consolidated audit trail system to capture orders and transactions on all of the multiple trading venues in the US. It has conceded that it would have got a better picture of what occurred during the flash crash if such a system was in place.
This is an important learning for the Indian market regulator, which is in favour of competing trading venues and is now working towards allowing smart order routing, which will enable seamless execution of orders at the best available price across multiple venues. Having a consolidated audit trail system will enable it to have a better handle on what’s happening in the market place.
Sebi needs to take a holistic view of the market and proactively come up with policies that enhance the functioning of the market. In case of smart order routing, the market is screaming for it and Sebi is now working towards it. Actually, the regulator should be mandating brokers to execute for their clients at the best possible price, like Regulation NMS in the US requires.
Also, its approach of having exchanges talk to each other and sort out differences will inevitably lead to delays. MCX Stock Exchange has a court case against NSE and has also complained to the Competition Commission in another case. With all that bad blood, imagine getting the two of them to talk and sort differences out. It’s time Sebi becomes more proactive and involved in a lot more areas.
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