You all must be very tired with market structure as a topic in general. With all the PFOF, Flash Boys, Tick Pilots, NASDAQ Pilots, and venue analysis, it is very easy to be overexposed and numbed. We feel your pain! This is why this morning we want to switch gears, lighten it up, and tell you a new fairy tale, even though there is some market structure involved…

When I was a young boy, any mention of the word “Dutch” conjured up images of the wee Dutch lad who held his finger in a dyke to avert disaster; despite the likelihood that he would incur the wrath of his school should he arrive late. It is a wholesome tale, with its hook being that anyone, even a small child, can act quickly and with self-sacrifice, and affect positive change.

Today, mention of the word “Dutch” conjures up different images for me. I have a young teenage daughter first of all, and so I think of the movie The Fault in Our Stars – a tearjerker involving young teens in love and dealing with cancer (they travel to Amsterdam). I also think of marijuana. (insert smiley face here)

And this morning I think of how we have exported our sub-optimal US market structure globally, and a new tale – one of conflicted stock brokers with payment for order flow, trading venues, and “smart” order routers!

This tale I speak of today involves the largest Dutch online bank (Binck), a feud it is involved in with rival broker (DeGiro), a Smart Order Router called The Order Machine (TOM), and the Flash Boys – esque shenanigans at the center of the tale. Anyways, gather around with some hot cocoa and  toaster strudel, because the story is about to start!

 Once upon a time there were two online stock brokerages, DeGiro and Binck. DeGiro was jealous of Binck – who was quite popular. DeGiro was also upset that on one day, December 9^th 2014, his own stock mini flash crashed! Anyways, DeGiro wanted very badly to be as popular as Binck, and he found out that Binck routed customer orders differently than DeGiro did.

 You see, DeGiro would get an order to buy stock for a client, and would send it for execution to the Amsterdam Stock Exchange (Euronext), a somewhat central stock exchange. It was expensive for him to do so! Meanwhile Binck would also get an order to buy stock for a client, but instead he didn’t just send it to the Amsterdam Stock Exchange; he brought a robot smart order router, The Order Machine (TOM) to life that would route orders to many fragmented trading destinations, and not just The Amsterdam Exchange. The way TOM worked and sent the orders for execution, well it was… flawed.  TOM apparently facilitated the very same type of Flash Boys order racing, from destination to destination, that Michael Lewis and Brad Katsuyama highlighted in the United States. 

DeGiro, as mentioned above, was envious. He looked into how  this mysterious and opaque robot named TOM worked, and he highlighted it very pubicly!  DeGiro actually did tests involving the stock Solvay! And DeGiro explained what was happening publicly using an automobile analogy:

 “Compare it to an entrepreneur who wants to purchase three vans” said Jasper Anderluh of DeGiro last week in the FD. “They are the same price available in three places in the country. Once he bought the first car, the dealer spurt to the next marketing address to buy off the nose of his car for the customer and to offer again at a higher price. “

 So DeGiro blew the whistle publicly – in the press – about what happens when Binck’s little buddy TOM handles an order. He even got the esteemed Professor Menkveld, who studies HFT and markets, to opine:

 “there really seems to be a problem here”

 Binck, very upset by DeGiro’s accusations, vigorously defended itself, and although apparently not disputing the facts of how TOM worked, demanded “rectification”.

 And DeGiro countered with a press release:

With regards to BinckBank’s request for rectification, DeGiro’s position is that there is nothing to rectify.  The findings in our report have far-reaching implications concerning BinckBank’s careless choice of customer order routing.  We believe that BinckBank has chosen to promote great fanfare in order to distract from the core issue.

 The discrepancies we have highlighted should serve to encourage a timely and particularly pertinent debate regarding matters of flash trading and the fairness of trading platforms.  We find any attempt by BinckBank to distract from this kind of debate regrettable.

 For further clarity into the nature of their order routing facility, we have requested post-trade transparency from BinckBank on the other transactions analysed in DeGiro’s report.  To date, these requests have unfortunately been denied by BinckBank.  Part of this post-trade transparency serves to provide a clearer picture of the market at the moment the Smart Order Router came into action.

 With regards to the accusations made by BinckBank towards DeGiro, we respond as follows:

 The charge against market manipulation would mean that we, as a broker, would not be allowed to test the effect of adjusting the order routing for our customers, yet this is precisely one of the primary responsibilities of being a broker.

 And so, to this day, DeGiro and Binck trade barbs and bicker. And TOM has since been shut down!

What is the morale to the tale of DeGiro, Binck, and TOM, aside from the fact that the United States is not alone in possessing market structure issues needing correction?

Well, we hope you see that there are two morals. First, Michael Lewis exactly pegged how our modern markets work. Second, all of us really need to understand brokers’ “smart order routers” and how they work. After all, the Speedy Traders sure have figured all of that out.

TOM may or may not have meant well, but he is a robot, and he was programmed a certain way by somebody. We should all question and understand the details of that programming.

By the way, if you would like to read more about Dutch Flash Boys, DeGiro, Bincks, and TOM, please read the blog of The Amsterdam Trader, and these posts specifically:
http://www.amsterdamtrader.com/2014/12/flash-boy-binck-ignores-law-of-holes.html
http://www.amsterdamtrader.com/2009/06/binck-sells-customerflow-to-optiver-2.html
http://www.amsterdamtrader.com/2015/02/tom-shuts-down-its-stock-venue.html