Guest Contributor: Renée Colyer, CEO, Forefactor
As if it wasn’t complicated enough before – now, because of the OPR (Order Protection Rule) in Canada, there are two types of smart order routers (venue and broker offered) that the buyside needs to understand. On top of that, the use of algorithms has prompted much confusion about SOR (Smart Order Routing) as there is the widespread belief that the algorithms themselves are doing the intelligent liquidity seeking.
And let’s not forget DMA (Direct Market Access), extraordinarily difficult to disentangle from algorithms, especially since many buyside traders only use algorithms for DMA.
It is not without good reason that the buyside is often not entirely sure of what they are using. We see it whenever we conduct research and the continent is irrelevant. Some of the buyside don’t believe they use DMA but they do use algorithms (which is technologically impossible unless you are telling the desk to execute algorithmically which never seems to be the case). Some believe that you are not using an algorithm unless it is a broker algorithm (even though they have proprietary algorithms in place).
One thing that is easy to remember is that all roads lead to the Smart Order Router. Algorithms are typically (but not always) built “on top of” the SOR. The router is what is responsible for getting the order filled, for ensuring best execution and completing the execution audit trail.
However, in Canada, the decision on whose SOR to use is now more challenging. Almost every broker offers a router and now the venues (TMX, Alpha, etc.) offering a routing solution leave the investment community left wondering – “what’s the difference?”
Venue Smart Order Routers
1. Venue routers do not offer the added benefit of algorithms.
2. If you are buyside you still need to use your broker’s DMA to get to the venue’s SOR.
3. They may argue that they are an unbiased alternative but of that I am not so certain since the fees would benefit them if a client used their SOR and printed the order on their market.
4. An explanation of how their technology works would serve the user well as I am unable to comment on each individual SOR’s logic and some are far “smarter” than others. For example, some SORs do not automatically check each market’s price, the user is required to “point and shoot”, while others have technology so advanced that they know in which market a particular security has traded most often and the router goes there first.
Broker Smart Order Routers
1. It has always been their job to seek best execution for their clients – I believe this puts them in good stead for ensuring that service remains.
2. Using your broker’s technology facilitates payment for products and services provided.
3. Again, I am hard pressed to say a broker will ever be unbiased with smart order routing, especially in jurisdictions that permit them to interrogate internal flow before routing it out to the lit markets. They also have “liquidity partners” in many cases which limits access to all pools of liquidity at first sweep.
4. An explanation of the router’s logic should be requested from all broker dealers in order to properly assess which one best suits your needs.
TMX Group has kindly provided a diagram on their website to demonstrate how their SOR works. It is somewhat rudimentary but provides the basics as a beginning point for further discussion.
Forefactor has created an example of what happens at a Broker-describe the imageDealer BEFORE it goes to the lit and dark trading venues:
So, while all components work together to aid those buyside traders who wish to maintain control of their trade activity, 
smart order routing seems to me, to be the key to getting the trade done. That is, algorithms that are liquidity seeking and SORs that have built-in logic to pinpoint appropriate venues in an optimal sequence are a necessity in this ever-evolving global market.
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