Navigating Regulatory Waters - The Crucial Role of Routing Analysis
Yesterday after the market closed, the SEC filed charges against Virtu: (https://www.sec.gov/files/litigation/complaints/2023/comp-pr2023-176.pdf).
The SEC alleges that Virtu had minimal protections in place for a database that had detailed information on institutional customer orders. They also allege that this information could have been used by proprietary traders to trade against these client orders. We don’t know what Virtu did or didn’t do, but we know how the buy side is responding (and we know because our phone started ringing when the story broke yesterday.)
First thing this morning, an army of compliance officers fired off emails to their head traders asking “Have you seen this?” “Were we impacted?” “What protections do we have in place to make sure this doesn’t happen to us?”. Following the compliance officers--and the occasional CIO will be an army of pension funds and pension fund consultants. We have seen this happen time and time again with every major regulatory action. Days of time will be dedicated to constructive a happy narrative that makes the claim that asset managers were not impacted. Most of this analysis will be based on speculation and wishful thinking. We do find it amazing that no asset manager has ever admitted to being impacted by a regulatory event, even those without the means to analyze the data.
There will be traders that take a knee-jerk reaction to this news, halting trading with Virtu as the way of sending a message about how serious they are about regulatory issues. Others may even increase their trading with Virtu, claiming that the firm will be “extra clean” as a result of being “fully investigated.”
This whole scramble exists because in-depth analysis is often given a short shrift at most firms and is considered a nuisance. Metrics that would let heads of desks know that there is a potential problem are not collected and not reviewed.
When Deutsche Bank settled the charges of misleading their clients about their order router in December 2016, there was a similar scramble. We received an email from one of our clients thanking us for giving him the tools to identify this issue well before the settlement. He also knew which other firms were engaging in similar behavior. He showed his compliance officer our analysis, which identified the offending algorithms as underperformers due to their inefficiency, and that he had adjusted usage well in advance of the settlement as a result.
If a firm does the proper analysis, they know to the molecular level how their algorithms behave and have preemptively identified inefficiencies. It should not be a surprise to anyone who effectively analyzes routing data when there are regulatory actions that have performance implications. It is impossible to ascertain the root cause of poor execution without performing in-depth route level analysis. More importantly, it establishes a framework for constant optimization.
It is time to give routing analysis the attention it deserves. Not only can it save traders real money (and we recently presented to a client that we helped to save over $175 million so far THIS YEAR via algo optimization and trader behavior mod), but you won’t be caught flat-footed when there are regulatory actions.
