Imagine sitting at a restaurant enjoying your meal, when you notice smoke coming from the kitchen. Concern creeps in—could there be a fire? But before you can react, the waiter walks over with a smile and says, “Look how beautifully the steak is cooked,” as if that’s all that matters.

That’s why I cringe when I hear representatives from Single-Dealer Platforms (SDPs) tout execution metrics like price improvement and markouts. Brokers typically route marketable child orders (slices of much larger parent orders) to SDPs before taking liquidity on exchanges. Most SDPs do not offer any substantial price improvement, aside from a few newer entrants. And markouts matter more when providing liquidity than when taking it, so they are not a useful metric for execution quality when engaging with SDPs. We have discussed this at length in our papers, Accessing Single Dealer Platforms (SDPs) In Execution Algorithms: Penny-Wise And Pound-Foolish? and Escaping The Toxicity Trap: How Strategic Venue Analysis Optimizes Algorithm Performance in Fragmented Markets.

The real issue when trading with SDPs—the smoke in this analogy—is information leakage. When an order interacts with an SDP, it’s almost a certainty that there’s more behind it–more of the same orders on the same symbol and side from the same sender. Anyone paying attention can see the trail, and that’s where the real cost lies.

When you take liquidity on an exchange or an ATS, the flow is bidirectional—market makers are constantly adjusting their bids and offers, reacting to a mix of retail, proprietary, and institutional order flow. Just because a market maker’s bid is hit or offer lifted doesn’t automatically signal that there’s a larger institutional order lurking behind it. The flow is too mixed for that kind of certainty to form.

But when an SDP receives order flow from an institutional broker, the dynamic shifts entirely. A buy order for 100 shares is not an isolated trade—it’s likely a small piece of a much larger institutional order. SDPs who trade for themselves are of course incentivized to use any information they can to synthesize an effective trading strategy.

The SDP model really took off because it was an easy sell to institutional brokers. Brokers could save exchange fees by routing liquidity-taking orders to SDPs, increasing their profit margins. And for most, that provided an easy justification for routing flow through SDPs without looking too closely at what may be happening behind the scenes.

While brokers benefit from lower explicit costs, the true implicit cost is likely borne by their buy-side institutional clients. The institutional broker is not the one experiencing information leakage—it is the clients whose orders are exposed. And because the buy side may not have direct visibility into how their orders were being handled, the smoke—information leakage—was easy to ignore.

I find it interesting that SDPs are now selling directly to the buy side. On one hand, this shift is a positive development—buy-side firms are likely to ask the right questions. On the other hand, any flow received directly from buy-side firms is even more likely to be single-directional.

By going direct to buy-side firms, SDPs can no longer rely on institutional brokers to act as a buffer. They will have to answer for the information leakage risks that come with their model. And sophisticated buy-side firms will demand real transparency—not just a well-rehearsed pitch.

I’m not against SDPs. They serve a role in the ecosystem, and if their model provides real value they will survive and grow on their merits. The value is clear in the context of a sell-side firm (reduced routing costs), but less clear for buy-side firms. But as the founder of BestEx Research, a firm whose mission is to minimize the implicit costs of institutional investors, my interest is always in how market structure innovations affect the outcomes of my clients. 

The next time an SDP is pitched to you, the right questions to ask aren’t about child orders  metrics—they are about parent order performance. How are they ensuring that your child orders aren’t being reverse-engineered within their models to reveal a larger parent order? That’s the real concern. Only after your questions are addressed can you begin thinking about an optimal routing strategy that may include these trading venues. 

• Maybe SDPs are useful when parent orders are tiny relative to ADV. 
• Maybe they should only be used when you are certain that this is the final leg of execution, with nothing more coming later. 
• Maybe you should exclude your multi-day orders from trading with SDPs. 
• Maybe they are better suited for ETFs where more liquidity sits off-exchange. 
• Maybe ask your brokers who liberally use SDPs to share results from an A/B experiment comparing parent order performance with and without SDPs. 

The right strategy will emerge when the right questions are asked.

I wrote a paper on this subject about three years ago. Not much has changed since then, but the recent coverage on SDPs made it feel especially topical. Just in the last week, three buy-side firms have asked me for my take on SDPs, so I felt compelled to write this. Distractions need to be called out for what they are; if there’s smoke, we should all be asking where the fire is.

‍

Hitesh Mittal

Founder & CEO

BestEx Research

‍

Disclaimer: This article reflects the views and opinions of BestEx Research Group LLC. It does not constitute legal, tax, investment, financial, or other professional advice. Nothing contained herein constitutes a solicitation, recommendation, endorsement, or offer to buy or sell securities, futures, or other financial instruments or to engage in financial strategies which may include algorithms or to route orders to or participate in any particular liquidity pool.