SEC opens Pandora’s box
Within two weeks of NYSE Euronext launching its
controversial Retail Liquidity Program (RLP), rival US exchange operator BATS
Global Markets filed its own request with the US Securities and Exchange
Commission (SEC) to launch a similar Retail Price Improvement (RPI) program for
its BYX Exchange.
At press-time, the regulator had yet to release the request
for a standard comment period.
Each exchange-backed retail liquidity project has the same
premise: to liberate the captured retail order flow that retail broker-dealers
currently sell to electronic market makers for trade internalization and return
it to the displayed market, says Joe Ratterman, president and CEO of BATS
And although Nasdaq OMX and Direct Edge have not officially
announced their intentions to establish their own retail offerings, Ratterman
expects they will file for a pilot approval in the future.
Now that retail broker-dealers are being presented with a
set of alternative execution venues, market makers such as Citi, UBS, Knight
Capital and Citadel may need to improve their execution quality and lower their
prices to remain competitive.
Yet, these benefits likely will not transfer to the
wholesale buy-side investors, he adds. “I really do not see an impact on the
institutional long-only traders, to be honest. There is a large block of order
flow that's captive today between the retail and wholesale broker-dealers and
theoretically that's what this current incarnation of rules target.”
Institutional participants could potentially interact with
liberated retail order flow, if it moves to the displayed exchanges. “The
institutional order flow that's being executed in the displayed market might
interact with it, but that's down the road a bit,” says Ratterman who
relinquished his role as chairman of the BATS Global Markets after the firm’s
high-profile failure to list its stock on one of its two exchange platforms.
Given his druthers, Ratterman would have preferred that the
SEC and exchange operators found alternative ways to bring the internalised
retail order flow back to the displayed market than launching retail liquidity
When the SEC approved the NYSE Euronext pilot earlier this
year it fundamentally changed the mandate of how exchanges operate, according
to Ratterman. “It opens up a Pandora's Box and we don't know in advance where
this might lead.”
Prior to the establishment of these pilots, exchange members
were equal, had equal access to liquidity and there was no disparity in
functionality or pricing among members, he explains. After the approval, the
regulator acknowledged the exchanges could carve out retail order flow and
treat it differently. Yet there is nothing that limits client segmentation to
these current divisions.
“There is more than retail and 'not retail' when you look at
the market,” explains Ratterman. “There is retail professional, retail
long-term investor, retail active trader, institutional long-term investors,
institutional short-term, institutional high frequency, and so on …."
As such, the SEC’s approach offers up the opportunity for
market operators to introduce on-exchange services that target block liquidity,
thereby potentially tempting even more trading volume back from dark books to
the displayed order books where market traditionalists feels it belongs.
Going with the flow
Despite the changes in store for the markets as a whole,
Ratterman expects relative smooth sailing for his company's RPI filing since
most everything is in line with the elements already approved by the SEC in the
NYSE Euronext RLP pilot filing – namely using the same definition of what
constitutes a retail order as NYSE Euronext did.
“The current definition of what a retail order is seems
pretty well bounded,” he explains. “It's a definition that the SEC accepted.”
However, there are a few material differences with RPI
program that warrant a comment period, he adds.
Unlike the rival NYSE Euronext pilot, BATS plans to allow
all price improvement orders sitting on its BYX exchange's book to interact
with the inbound order flow, including mid-point peg and mid-point hidden
“What is clear and different about our program is when
orders come into our market, they will interact with the best possible price
improvement orders even if they were not put into the system as retail-only,”
Also when filling an RPI order from multiple contra-party
orders, BATS has decided to let the price improvement reflect the individual
price improvement for each contra-party order. As such an RPI order might
receive a $0.003 price improvement for 25% of the order and a $0.002 price
improvement for another 25% of the order while the remaining 50% of the order
might receive a $0.001 price improvement.
The final major difference between the BATS RPI pilot and
NYSE Euronext's RLP pilot is who can participate, says Ratterman adding that
all BATS members will be able to interact with retail order flow without
experiencing different prices or access fees.
“There are designated market makers and supplemental liquidity
providers who will have better economics afforded to them when they submit
orders to interact with the retail order flow, which arguably is a smaller
portion of their customer base,” he adds.