By Jeffrey Alexander and Linda Giordano Execution Consultants, Barclays

In our role as execution consultants, the most frequently asked questions that our clients are asking lately are all about venues. Traders constantly ask us how they should measure venue toxicity, which venues attract predatory flow, and what should they do upon discovering they frequently transact with toxic counterparties. Our initial thought was, Toxicity-shmoxicity liquidity is liquidity. But, upon deeper analysis, we have found that there is a cost to interacting with predatory flow; and while no one venue harbors all of the predatory boogeymen, there are characteristics of particular venues which could make it easier for predators to find and step ahead of institutional orders. While there are no pat answers to dealing with this issue, the first step is to analyze and understand the facts. In partnership with 20 large buy-side firms, we have established a framework for analyzing venue performance and, as a by-product, have introduced an industry standard for buy-side firms to request uniform trade data across all their brokers.
Overview
In the wake of high-profile scandals involving alternative trading systems and the debate and discussion regarding high frequency trading (HFT), buy-side traders are increasingly being asked to understand what happens to their order once they hit the send button. While some buy-side traders are experts on every smart order router, algorithm, order type and venue that their order may touch, most have been satisfied with a working knowledge of the pipes and plumbing that connect them to their brokers and their brokers to the trading venues. When clients, supervisory boards, and portfolio managers begin to raise questions about predatory counterparties and the safety of dark pools, buy-side traders have found that there is a pressing need to better understand order handling rules and exceptions. By necessity, most traders rely on their brokers to sort out the myriad technologies involved with executing a trade. A large buy-side firm typically employs dozens of brokers, each with some sort of smart router and set of proprietary algorithms. The time and energy involved in understanding each bit of technology is daunting, which is why this detailed knowledge has been outsourced to the sell side. The rationalization is that most routing and algorithmic trading technology is similar so similar such that execution is considered a commodity. In fact, when looking at standard transaction cost analysis (TCA) measures to evaluate algorithms, there isnt much of a difference between them. In aggregate, all algorithms perform within one standard deviation of their advertised benchmark. This fuels the incorrect perception that broker performance is fungible. To measure best execution, buy-side traders receive monthly reports from their brokers, each highlighting how that particular brokers VWAP and implementation shortfall-type algorithm are nearly flat to the selected benchmark. This is akin to measuring the speed of light with a sundial. Long-term TCA measures like comparisons to interval VWAPs or arrival prices are not capturing immediate impact, which heavily influences follow-on fills. Once you start delving deeper into the trade and market data, you find that the nuances that differentiate algorithms and venues actually have significant consequences on execution costs. The framework we have developed expands upon traditional TCA measurements to further draw out the differences in execution performance, not only between algorithms, brokers, and traders, but also between venues. However, in order for a buy-side firm to draw a meaningful comparison of their performance between venues, they would need to analyze their routing data across multiple brokers. Broker-specific TCA reports have the shortcoming that they are just that: broker-specific. Thus is born the buy sides need to collect data from multiple sources in a standardized format.

Assessing Venue Footprint

Quantifying whether a trader has received a poor execution at a particular venue requires us to first make assumptions about post-trade price movement and its relationship to predatory activity. Typically, price reversion after a trade indicates that market impact was created or trade timing was off. While this is true for blocks, this is not the case for smaller fills, especially in the context of an algorithm execution where trades immediately following need to be considered. There are others who assume that if price moves in your favor following a fill (e.g., price rises immediately following a buy fill) then that was a good fill because of the alpha generated after the trade. In our venue analysis, however, we assume that positive short-term alpha immediately following a fill could actually indicate the presence of predatory flow. If your order was identified and then traded against more informed flow, price would rise immediately after a buy fill (or fall after a sell fill). If price stays constant or has negative short-term alpha, then we assume that the order did not trade against more informed flow. It is also important to look at market volume after each fill. We have observed that following a fill at certain venues, there is an immediate uptick in market volume of up to 25%, which raises questions about whether the order was detected and traded against. These measures are heavily influenced by market activity, and in the case of post-fill momentum, a traders own impact. Short-term alpha and post-fill market volume are not particularly valuable for evaluating a single order. However, when like orders are aggregated and analyzed at the venue level, the pattern or venue footprint that emerges forms a powerful basis for drawing comparisons across venues.

1,100-share fill is preceded by multiple smaller fills. Price increases (price continuance) after each of the smaller fills and then reverts after the 1,100 shares are traded.
Figure 1: Sample Buy Order Price and Fills
Price $20.06 $20.05 $20.04 $20.03 $20.02 $20.01 $20.00 $19.99 9:59:59 10:00:00 10:00:01 10:00:02 10:00:03 10:00:04 10:00:04 10:00:05 10:00:06 10:00:07 10:00:08 100 100 200 100 0
Price Continuance

Fill Size

Fill
Price

Price Reversion

2,000

1,500 1,100 1,000

500

Time

Weighting by market value. If we were to weight the price impact by market value of the fills, the aggregate effect of the series would be reversion. Looking at this measure in isolation might lead one to draw the wrong conclusion: that this was a good fill because there was no price increase on the buy and therefore no informed flow. With this measure, the impact of the large fill overshadows the impact inherent in the entire pattern of the smaller fills. Better prices were available early in the series, and therefore we should conclude that the counterparty to this trade was indeed more informed. Weighting by equal value. Equal value analysis would weight each of the prints the same, with the result that 80% of the fills would result in price continuance (e.g., continued increase in price after a buy) and 20% would be followed by reversion. The result of using this methodology, different from the market value weighting, suggests the presence of informed flow. Alpha distribution. This analysis charts the distribution of short-term alpha across multiple executions at a particular venue. The likelihood of trading against toxic or informed flow is visible in how much the measures of dispersion (e.g., mean, convergence, tail size) skew toward higher shortterm alpha. This analysis is useful for drawing comparisons between venues. See Figure 2, where executions on Venue B have a greater tendency to be followed by positive short-term alpha, suggesting the presence of more predatory flow.

Data Analysis
After the portfolio manager creates an order and sends it to the traders desk, that order is then routed or forwarded to one or more destinations this is known as a route (e.g., an algorithm, a broker, a dark pool). Each route spawns one or more sub-routes. A sub-route is the process of sending an order to a venue for execution. Executions come back in the forms of fills. In Venue Footprint Analysis, we segment the sub-route and fill data in multiple ways to tease out the differences between venues. Aggregating multiple fills When analyzing multiple fills in succession, we can look at three different measurements to understand the aggregate impact of those fills. For example, in Figure 1, the large

Figure 2: Sample Alpha Distribution of Two Venues

50%

Reversion

Continuance

completed and have a greater impact on the price. The second through fourth quartiles will generally fall in line with decreasing levels of price continuance. And price movement after the final fill will often result in price reversion instead of continuance.
Figure 3: Sample Quartile Analysis by Sequence of Fill
3.00

40%

A
30%

B
20%

2.50 2.00

First Quartile Second Quartile Third Quartile Final Quartile Final Fill

10%

Fill price vs. Market

1.50
1.00 0.50 -

0% -25 -15 -9 -7 -5 -3 -1 1 3 5 7 9 15 25 60-Second Alpha

Grouping Like Orders In order to draw meaningful conclusions about a particular venue footprint, it is important to group like orders that share certain characteristics. In our analysis, we group orders by order type, position in a sequence, completeness of fill, and whether they are odd lot. By order type Different order types should be analyzed separately. IOC and ISO orders, which last milliseconds and have few fills, should not be lumped together with pegged orders, which may play out over a more extended period of time. The difference between IOC and pegged orders also has implications for the data that you request from brokers. While it is possible to gain an approximation of venue performance using route-level metrics for IOC orders, pegged orders require fill level data to assess signaling and participation that occurred within the order. By sequencing Our analysis shows that the position where a fill occurs within a sequence of fills results in different short-term alpha. Therefore, we bucket all sub-route fills associated with a parent order into quartiles based on their position in the sequence. When we analyze post-trade momentum, some very clear patterns emerge. (See Figure 3.) We measure short-term alpha at multiple post-fill intervals (typically 100 milliseconds to one minute) to detect price trends. As one would expect, the first quartile of an order will result in the greatest amount of post-trade price continuance. Three-quarters of the fills will occur after these fills are

(0.50) 15s 100 ms 500ms 30s 1m 1s 5s

Time post-trade

Additionally, we will analyze fills with no subsequent fill separately than those within a close sequence of fills. For example, if you are viewing 60-second alpha, you would isolate fills where there were no fills in the following 60 seconds. By completeness of fills We also group routes together by their outcome, i.e., completed, partial, unfilled. (See Figure 4.) Partially filled routes typically have the highest price continuance, likely because (1) the executed portion left a footprint, (2) they werent fully executed because the market was already moving away, and (3) there is additional market impact in the subsequent trades necessary to complete the order. A fully completed route provides information, which can result in market impact. In theory, unfilled routes should not leak information (especially IOC or ISO orders) as they have no interaction with flow. In practice, however, we have observed differences between venues that suggest otherwise.

Figure 4: Sample Post-Trade Price Movement by Outcome

3.50 3.00 2.50 Completed Unfilled Partial

Figure 5: Sample Distribution of Fills by 60-Second Alpha Round Lots vs. Odd Lots
80% 70% 60% Round Lots Odd Lots

End time vs Market Price

2.00 1.50 1.00 0.50 End End End Time Time Time +100ms +500ms +1s End Time +5s End Time +15s End Time +30s End Time +1m

50% 40% 30% 20% 10% 0% -25 -15 -9 -7 -5 -3 -1 1 3 5 7 9 15 25 60-Second Alpha

Route End Time + x

By odd lots As odd lots are currently not printed to the consolidated tape (this is changing1) and not available in trade and quote (TAQ) data, they fly under the radar in real time and escape historical review2. There is much speculation that odd lots are widely used by HFT predators as these trades are available in for-purchase proprietary feeds from venues and can be used for dark pool pinging or reporting avoidance purposes. Our analysis of reveals that there is a 20 to 25 percent higher probability that price continuance will be higher after an odd lot (See Figure 5). We feel that the above data measurements form the basic set of analytics that can be used to uncover potential venue-related issues. We expect that additional measurements will emerge as venue analysis becomes more pervasive.

A New Industry Standard

We advocate that Venue Footprint Analysis be part of every buy-side firms best execution practices. Putting this type of program in place is not a simple task, but if the industry works together to establish standards for data retrieval, everyones burden will be much easier. In order for the buy side to perform proper venue analysis, sub-route and fill level information must be culled from each broker. This data should include every algorithm route, filled or unfilled, married to specific market data as provided by the broker. It is important to get the brokers particular view of the market landscape at the time their routing decision was made, as opposed to marrying all the trade data to your own market data. Most brokers capture this data with every route. If the broker doesnt save this information, fills will need to be matched to the tape after the fact, but this is not highly accurate at microsecond, or even millisecond, precision. Information such as order type utilized, whether the order was taking or providing liquidity, routing order IDs and destination names should also be attached. This data needs to be captured and stored on a regular basis (preferably daily) and reviewed regularly. It is also important that industry standard tags are used whenever called for (e.g., buys and sells should always be identified by 1 and 2, not B, Buy or any other sort of internal notation; MIC codes should be used to identify venues).

Odd lot orders to be added to U.S. stock data feed,; Reuters, Nov. 20, 2012.
1

OHara, Yao, Ye, Whats Not There: The Odd-Lot Bias in TAQ Data, Jul. 22, 2011.
2

Sub-route data should eventually be transmitted via FIX; however, there is currently no provision for tacking information on to the order record once it leaves the buyside OMS, including a route identifier, order type, or route limit price. Therefore, the buy side will need to retrieve files that include this data directly from each broker. In order to reduce the development burden on every broker, the industry should embrace a standard for these files so that all firms can easily analyze the data. In conjunction with our buy-side working group, consisting of 20 buy-side industry leaders, we have created a standard file specification for this purpose.

only when conditions are identical between two venues. Venue priority in a brokers router will impact a venues momentum profile for that particular broker, especially if the venue is one of last resort. This does present an opportunity to ask questions of your brokers to better understand what type of technology is in place and how they access certain venues. Instead of getting the guided tour, ask why venue A looks better than venue B. It will lead to more specific conversations about venue treatment and routing schema. Routing nuances aside, we are fairly certain you will discover venues that demonstrate higher price continuance relative to their competition and an uptick in volume posttrade. At that point, having conversations with your brokers regarding a possible course of action is appropriate. Shutting off an exchange is not possible, but de-prioritizing the venue across various routing schema might improve performance. Also, optimizing algorithmic trading strategies so that they minimize the number of routes might also be an avenue to reducing information leakage and impact. The venue landscape is constantly evolving and it is important that institutional traders stay engaged. Venue Footprint Analysis will help to shed some light on this extremely complex ecosystem, even if it only leads to more questions. Patience and a healthy dose of common sense will go a long way in the ongoing pursuit to construct the picture of how your orders are executed.

A Journey, Not a Destination

Once you have identified venues that seem to provide inferior performance relative to others, the big questions are (1) is it because of routing behavior, algorithm aggressiveness, momentum bias or nefarious activity? And (2) is there something that can be done about it? To answer the first question, it is important to keep in mind that you need a solid understanding of your data as well as the routing technologies that are predominantly in use for your flow. It is quite possible that venues will look different from broker to broker because of different routing technologies. For example, it is not uncommon for a brokers routing technology to route solely based on fees. By contrast, others might employ a liquidity-based routing scheme for institutional clients, taking in to account cost and rebates

Data Specification File

In collaboration with a working group of 20 buy-side industry leaders, we have developed a standard file specification for the purpose of retrieving sub-route information from a broker. We will gladly provide the specification upon request, as well as help you implement a venue analysis program.

Acknowledgments
We would like to thank all of our colleagues, including Anthony Godonis, Aberdeen Asset Management; Carlos Oliveira, Brandes Investments; Bill Stephenson and David Lewis, Franklin Templeton Investments; Jim Thomas, Putnam Investments; and Eric Yi for the numerous discussions, emails, advice and energy that they have devoted to this project.

Jeffrey Alexander Director, Execution Consulting and Analytics jeffrey.alexander@barclays.com +1 212 526 3769

Linda Giordano Director, Execution Consulting and Analytics linda.giordano@barclays.com +1 212 526 3777

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