Matching Within

Automating internalization is all the rage lately. Over the past few months, we've been hearing that some broker-dealers have begun automating the matching of internal order flow by crossing buy and sell orders from various departments, including algorithmic order flow, direct-market-access flow, retail flow, etc. But once we started investigating further, we found that this isn't something that only a few firms are considering. Rather, every large broker-dealer we talked to has either created a network to match internal orders or has drawn up plans to do so. This includes firms from UBS, one of the first to embark on such a project; and Credit Suisse, whose network recently was launched; to Morgan Stanley, which has drawn up specs for an internal crossing platform; and HSBC, which is considering doing so.

And why not? It's better to match the orders with an internal network then route the orders to an exchange or ECN and pay execution fees. In addition, many firms see it as a way to bring in additional revenues by disseminating market data feeds, assuming they file their crossing networks as an ATS (for more on the trend, see this month's cover story, page 28).

Of course, whether you're routing the order outside the firm or matching internally, best execution requirements still apply. And with best execution obligations come the need for appropriate compliance engines and audit-trail technology, which have to be built into the network to ensure that the firm is abiding by all regulations.

Creating the technology to cross orders is not the main challenge. Rather, figuring out how to capture the different types of order flow is. For example, order flow from the algorithmic trading group and retail order flow each have different restrictions, and it's essential that the matching network is able to meet all of the appropriate requirements. Getting all the systems to talk to each other and comply with the different regulations takes considerable effort.

However, most firms seem to have found a solution and are well on their way to launching an internal matching system - if they haven't unveiled their products already. The common denominator is that everyone is jumping on the crossing network bandwagon - but not every broker-dealer is taking the same approach. Some are filing as ATSs to enable them to open their systems to everyone. Others are using the networks solely for their own internal flow, while still others are crossing internal orders while also allowing buy-side traders to use the networks. Despite the nuances (many of which can be uncovered by reading our directory of crossing networks, page 36), one thing is sure: Crossing networks are the hottest trend on Wall Street right now, and if you're a broker-dealer and you haven't thought about creating one, you're missing an opportunity.