What is a Smart Order Router (SOR)?

By Magnus Hedin
November 7, 2016

A Smart Order Router (SOR) is software used by banks and brokers to optimize execution by using advanced routing rules and algorithms when directing orders to multiple trading venues. SORs have long been a key technology for equities, but will become important across all asset classes.

The first generation of SORs emerged as a direct result of the introduction of MiFID (1) in 2007.  MiFID opened up the European equity markets for competition, the flipside of which was market fragmentation in this case. To comply with MiFID, investment firms had to deploy SORs to manage market fragmentation and the new Best Execution requirements. The second and third generations of SORs became both faster and smarter (coping with High Frequency Trading flow and dark pools). The fourth generation of SORs is now being designed to enable investment firms to navigate the post-MIFID II trading landscape.

What does a SOR do?

Today’s SORs are much more sophisticated than those built just a couple of years ago. No longer just a plain “must-have” to meet Best Execution requirements and ensure regulatory compliance, today’s SOR actually helps investment firms optimize execution — in the true sense of ”smart order routing”. As the SORs evolve and become even “smarter”, the difference between SORs and algorithms has blurred or even disappeared.

Why does an investment firm need a new SOR today?

MiFID II will cause market complexity to rise even further as will competition, driven by the unbundling of payment for research and execution. Furthermore, execution post-MiFID II will be governed by an extensive list of parameters such as Large in Scale, Liquidity classification, Standard Market Size and many more. All of these parameters must be embedded into the transaction flow in general and into the SOR (and Order Management System) in particular. The post-MIFID II landscape will not only feature “more venues”; there will also be completely new market models such as continuous actions, block dark pools and Systematic Internalisers. This diverse and fragmented set of liquidity providers would be very difficult to reach without a SOR designed for these conditions.

Without a doubt, investment firms must implement a fourth-generation SOR by January 2018 to navigate increasingly complex markets, remain competitive and comply with MIFID II. It is equally clear that the implementation work must begin immediately in order to meet the deadline. However, a large proportion of known and unknown uncertainty remains, complicating the system selection and design process. How does one select the right system when the specific requirements remain unknown? And how does a software vendor know what functionality to build into the system at this time?

Itiviti helps investment firms manage uncertainty and complexity by building for what is known and preparing for what is yet unknown through flexibility. Itiviti’s fourth-generation SOR (and its new OMS) includes information about all MIFID II parameters along with the tools required to adapt them as required. This agile approach will enable investment firms to manage change as it happens, on the floor, without the need for large implementation projects and steering groups.  Advantages include significantly reduced time to market, risk and costs.

Related pieces of the technology stack

  • FIX layer
  • Asset classes: equities, equity derivatives (eventually, especially for systematic internalisers), FX
  • Retail, DEA
  • EMS/OMS
  • Exchange connectivity

Further information on MiFID II transition and Itiviti Analyst is available HERE.

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