Clients DASH Financial and STA comment on the new US regulatory requirements for brokers to give investors more information on trade routing decisions under the amended Rule 606.
With less than a month left to prepare for the April 1 deadline for collecting data on discretionary “look-through” trades under the Securities and Exchange Commission’s new Rule 606, introducing and executing brokers are deciding which data format and how much information they will use. Fund managers won’t be seeing any new reports until May 26 at the earliest. For now, IT directors are the ones doing the heavy lifting to figure out how firms can create and accept the agreed-upon data exchange. They have two options: a format designed by trade execution reporting vendor S3 and the New York-based regulatory technology and compliance consultancy Financial Information Forum (FIF), or proprietary formats agreed upon between introducing brokers and executing brokers.
The new Rule 606(b)3 report will show institutional investors where the executing broker routed its order, how it sliced its order, any the fees and rebates involved. The ultimate goal is to provide investors with an understanding of potential conflicts of interest on how their orders are routed depending on fees paid and rebates received by either introducing or executing brokers from trading venues. That level of transparency hasn’t been available under the current reporting format which is primarily designed to provide the basics of where trades were routed and at what price they were executed.
The so-called second hop of the trade order routing process is considered the most suspect, according to Jim Toes, president of the trade group Security Traders Association (STA) representing trading desks at broker-dealers and asset managers. That second hop, he explains, can refer to orders sent by introducing brokers to executing brokers in which introducing brokers tell executing brokers how to handle the order. Alternatively, the second-hop can also be an order which one executing broker sends to another executing broker with a “better-tier” meaning the second executing broker will receive a higher rebate from the trading venue than the first executing broker would have trading on the same venue. That rebate will be split between the two executing brokers.
“We are in discussions with introducing brokers about the data fields we need to populate and how they want to receive the data,” says Venu Palaparthi, chief compliance officer for Dash Financial Technologies, a New York-based executing broker offering real-time order routing and trade analytics. “We need to strike a balance between providing the data in a common format and in more broadly accepted formats.” He could not verify whether his introducing broker clients were providing the firm with the format designed by S3 and FIF or their own formats.
It remains to be seen whether the FIF format gains widespread acceptance and just how fund managers will react at the first glimpse of their new Rule 606(b)3 reports. Chances are they will require far more hand-holding from introducing brokers to decipher all of the data.
Ask the right questions and hope to get the right answers will likely become the industry mantra for Rule 606(b)3 reports. Even the best-crafted industry formats might not be enough to do the trick when it comes to discerning conflicts of interest in order routing decisions. As usual, the SEC’s good intentions come with some difficult practical ramifications to solve.
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