FINRA Working Paper on Order Routing



A few days back we pointed out to you that FINRA has listed their 2019 Exam Priorities, in which it would look closely at Best Execution, and specifically firms who route substantial amounts of order flow to wholesalers or their own ATSs. FINRA’s focus certainly seemed to arise out of order routing practices at retail firms like Robinhood, which had been selling north of 60% of all its order flow to Citadel. Robinhood has recently cut back that percentage some, no doubt due to the eye-opening scrutiny it has recently received from the industry in general, and regulators.


This morning we want to share an economic study conducted by the Office of the Chief Economist at FINRA. It’s titled Institutional Order Handling and Broker-Affiliated Trading Venues, and was just released. FINRA used the Order Audit Trail System (OATS) database to examine 330 million orders received by 43 active institutional brokers – 2.3 billion “order events in 273 stocks in 2016. FINRA notes that not all brokers who own an ATS route institutional order flow route in a disproportional way to such an ATS. They separated the brokers into three categories, based on their routing to an affiliated ATS – the broker’s departure from the sample-wide routing average:


T1:       The broker routes with the lowest deviation from the sample

T2:       The broker routes with a middle-ground deviation from the sample.

T3:       The broker routes with a high deviation from the sample.


T3 Brokers route 64% of their orders to ATSs, with 50% going to the affiliated ATS.

T2 Brokers route 25% of their orders to an ATS.

T1 Brokers route 10% of their orders to an ATS.


This is interesting. T1 Brokers, when they route to an ATS have a 44% fill rate, while T3 brokers only achieve a 17% fill rate. On the surface it sure seems that T1 brokers, when they route to an ATS, are doing so with some intelligence about where they are likely to get a fill, where as T3 brokers will keep routing to ATSs with less regard to fill rate.


Here are some excerpts from the paper:


The average share received by T3 brokers is routed 16.6 times.

T3 brokers are associated with lower (17%) fill rates

Higher levels of affiliated ATS routes are associated with higher implementation shortfall costs. For institutions that incur an opportunity cost for unfilled orders, our results suggest that trading costs are higher for brokers with high affiliated ATS routes.

Brokers with high affiliated ATS routes have fill rates that are 5.6 percentage points lower and implementation shortfall costs that are 1.13 to 1.95 basis points higher relative to matched brokers. These estimates translate to implementation shortfall costs that are 5.3% to 19.7% higher for brokers with high affiliated ATS routes.

Our results indicate that unaffiliated ATS routes have higher fill rates, and further, are more likely to obtain an earlier fill than the matched T3 broker-affiliated ATS routes. Although the two analyses that explores broker selection examine smaller samples than our main analysis, we do not find evidence that institutions’ preferences for ATS venues explain our results.

We observe a large number of routes associated with each order. An average share received by a broker is routed 10 times during an order’s cycle. Since brokers are not allowed to represent trading intent greater than the order quantity, the statistic suggest that brokers sequentially route the orders to venues.

The effective spread costs of T3 brokers are 3.2 bps, followed by 3.1 bps for T2 brokers and 1.1 bps for T1 brokers. T3 brokers have higher costs than T1 brokers for medium and large stocks while the differences are not statistically significant for small stocks.

Notably, adverse price movements, as captured by post-drift, are significantly larger for T3 brokers relative to T1 and T2 brokers for the overall sample.

Controlling for client’s preference for ATS routing, T3 brokers have higher trading costs when opportunity costs of non-execution are included. The evidence does not support the argument that T3 brokers better manage information leakage and adverse price movements relative to matched brokers with similar ATS usage.


This paper is nothing short of jaw-dropping. While anecdotally many of us may have sensed that brokers are routing in ways that are not in their client’s best interests (and we are not only talking venue costs here, we are also talking broker routing that feeds non-client short term trading alpha), this paper documents it with FINRA OATS data.

It should be noted that certainly the beginnings of this FINRA study has been influenced by the thought leadership of Babelfish. They actually site Babelfish’s 2017 The Truth Behind Broker Routing – Don’t Believe The Hype.

Many of us seek to utilize liquidity seeking strategies that particularly emphasize dark routing/fills over exchange routing/fills. Stock exchanges have their own issues and problems of course, but this study suggest that not all dark routing is created equally.

Additionally, we find it interesting that T3 brokers in the study have low fills rates on first pass, yet continue sequential routing to the same low-yield venues, and then ultimately have higher fill rates later on in exchanges. FINRA points out that even despite routing to affiliated low-yield ATS’s on first pass, such order routing would improve if immediately afterwards, the T3 brokers then routed to high probability exchanges.

We encourage you to read the study unfiltered.