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OES, Lava Trading Emerge as Dominant Vendors in Order Routing

Brokers, exchanges and other vendors are relying on Order Execution Services and Lava Trading for their Reg NMS compliant order routing. But does this pose a risk?

By July 9, when the Pilot Stocks Phase of Reg NMS goes into effect, the entire securities industry -- exchanges, brokers and market makers -- must be capable of routing orders for the 250 pilot stocks to most exchanges and ECNs under Reg NMS' best price requirements. Rather than build the necessary connectivity to all 10 required equity market destinations, many firms are turning to third-party vendors.

So far, the vast majority of exchanges have chosen Princeton, N.J.-based Order Execution Services (OES) and Lava Trading (now part of Citi Electronic Trading Solutions) to provide the connectivity and smart-order routing to sweep the various destinations. OES has signed up several exchanges -- including NYSE Arca, the Philadelphia Stock Exchange and the ISE Stock Exchange -- to provide outbound order routing, while Lava is handling outbound routing for the American Stock Exchange (Amex), the Boston Equity Exchange and the National Stock Exchange.

But now that the private linkages are replacing the Intermarket Trading System (ITS), broker-dealers also are relying on OES and Citi's Lava offerings for connectivity to the automated trading centers and for sending intermarket sweep orders (ISOs) to take out displayed top-of-book liquidity. "The reason is that many brokers have connectivity for Nasdaq and New York, but they want to use OES for the other destinations," says Michael Barth, the firm's EVP. "We're also getting a lot of interest where we have smart routers, then using the ISO order types to smart route and seek liquidity at many price levels pretty quickly."

With the proliferation of so many destinations, market participants have had to weigh the costs of connecting to every regional, Barth notes. "We're connected to all the required exchanges and the ADF [Alternative Display Facility], DirectEdge, Track ECN and Lava Flow [Citi's ECN], and also we connect to the two largest ECNs, BATS and Bloomberg TradeBook," he says. "And then we also connect to dark pools."

But several sell-side executives have raised concerns that the industry is putting too many of its eggs in one -- or two -- routing baskets by relying so heavily on OES and Lava. Hypothetically, if OES were to go down, for example, three or more exchanges could be inaccessible.

Adding to the concerns, there has been speculation that Lava Trading relies on OES to connect to certain destinations. One sell-side institutional sales trader compares this to placing backup systems in a building that shares the same electricity grid with the primary data center. Further, other third-party order-routing vendors apparently are relying on OES to reach certain destinations as well. "OES has gotten such a concentration of clients -- but how do they protect clients from the downside in case of a systems outage?" asks the sell-side trader.

"Anybody that puts all their eggs in one basket is probably making a critical error," adds Shane Swanson, director of compliance for Automated Trading Desk (ATD), an electronic market-making firm and institutional brokerage in Mt. Pleasant, S.C. He points out that smaller broker-dealers would have the highest vulnerability since they tend to rely most heavily on a single order-routing vendor.

As a precaution, brokers need alternate routes, Swanson asserts. "You need to have your own connections, and those have to be redundant," Swanson says. As an option, many of the execution venues -- including DirectEdge, BATS ECN and Nasdaq -- are offering firms outbound routing to other markets for a fee, he notes.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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