The consequences of Regulation NMS (National Market Structure) continue to be seen years after its adoption, with fragmentation and sourcing of liquidity top of the agenda for all market participants.

The business case for smart-order routing (SOR) and algorithmic trading is built on the need to source liquidity when it’s scattered across multiple markets.

“Changes to market structure over the last 10-15 years have arguably brought both good and bad,” said Ryan Larson, head of equity trading, U.S. at RBC Global Asset Management. “Of the good, technology has allowed buy-side desks to source more tools in the quest to access liquidity.”

But the buy side is no more confident that information leakage can be prevented when their order flow is being sliced and diced by computers than it did when it dealt with human traders on the floor.

“In stocks where liquidity tends not to be a problem, scheduled trading algorithms or straight DMA tends to be the easiest and cheapest way to source liquidity,” said Alex Hagmeyer, equity trader at Franklin Templeton Investments. “In less liquid stocks, sourcing liquidity is more challenging and other channels must be used to avoid unnecessary signaling.”

Equity market quality has improved markedly over the past two decades, and the competition spurred by the adoption of Regulation ATS and Regulation NMS has benefited the average investors.

Fragmentation makes for a more efficient market place, but it can also make it more expensive for the broker-dealer community because they have to connect and route to more venues to ensure that they’re providing best execution to their customers.

“Firms must embrace a mix of both technology and human capital in their trading process to allow traders to effectively source liquidity in the multiple-venue, geographically-fragmented environment that exists today,” Larson said. “Yet, no matter how technical markets get, trading is equally about relationships as it is about technology. As such, buy-side traders must also maintain strong, trusted relationships with their sell-side counterparts to effectively source liquidity.”

In the U.S. it is now possible to trade stocks at 300 different venues. Of these, only 13 are exchanges, the rest are broker operated alternative trading systems (ATS) and other broker operated systems which are known as “dark pools” and account for over 35% of share volume traded in the U.S.

The number of dark pools has grown substantially in the years following Regulation ATS, which institutionalized the concept of alternative trading systems, and especially Regulation NMS (National Market System), which prevented “trade throughs,” or the execution of trades at prices inferior to protected quotations displayed by other trading centers.

The idea of institutional traders being able to trade large blocks anonymously, and therefore avoid the information leakage that would otherwise occur in the lit markets gave rise to the original dark pools, which were purely institutional-focused.

Today, the diversity of lit and dark markets, with varying shades of gray, has resulted in a much greater reliance on algorithmic trading, whereby an algorithm can slice a gigantic order into thousands of smaller pieces.

“In less liquid types of stocks, the mindset of the trader is completely different: in order to avoid a footprint, traders must tactically manage their orders and be willing to reassess their trading strategy throughout the life of the order,” Hagmeyer said. “Agency-only sales traders, electronic crossing networks and capital commitment are avenues to source block liquidity, all of which increase the shares-to-signal ratio.”