BlackRock calls for exchange status change

The world’s largest buy-side firm by assets under management wants policymakers to consider a minimum market share for US venues to maintain their exchange licence, in order to reduce market fragmentation.

The world’s largest buy-side firm by assets under management wants policymakers to consider a minimum market share for US venues to maintain their exchange licence, in order to reduce market fragmentation.

The global asset manager cited the fact that five of the 13 US equity exchanges enjoy benefits of their status despite attracting less than 1% market share, in a comprehensive market structure research note published last week.

Under Regulation National Market System (NMS), these benefits include market data revenue sharing and protection through the ‘trade-through’ rule, requiring orders to route to all exchanges to find the best price. These benefits are not extended to alternative trading systems (ATSs).

“BlockRock encourages policymakers to examine whether exchanges should be required to maintain a minimum market share in order to retain ‘exchange status’ and any associated benefits,” the research paper read.

Removing these protections for venues attracting little flow would reduce costs, market fragmentation and lessen the impact of potential system outages, such as that experienced in August when a securities information processor managed by Nasdaq went down, causing a three-hour pause in US equity trading.

Sang Lee, managing partner at research consultancy Aite Group, told such a mechanism would offer benefits, but tapped into wider market structure questions.

“The market as a whole is trying to establish a balance between encouraging competition and innovation, while not fragmenting the market so much that it becomes detrimental to participants,” he said. 

Lee questioned whether the number of venues – currently 13 exchanges and more than 40 dark pools – was beneficial to end-investors. He said the existence of similar threshold regimes may increase the attractiveness of such a measure for policymakers.

“If you’re an ATS and you cross a certain threshold you have to apply to be an exchange, or if you’re a dark pool, you have to start publishing quotes. From that perspective, why not require exchanges to meet a minimum percentage of daily volume?” Lee said.

Concentrated liquidity

Commenting on the research, Joe Gawronski, president and COO of brokerage Rosenblatt Securities, said US venues with exchange status would have to innovate to grow or maintain their share, or would not survive.

But, he said fewer venues would not equate to better buy-side crossing on lit exchanges.

“Theoretically this would concentrate liquidity in fewer venues and increase the buy-side’s ability to find each other, but in reality the exchanges that would potentially go away have a small amount of market share – significantly less than 1% in a number of cases. 

US exchanges that attract such small amounts of market share include the Chicago Stock Exchange and American Stock Exchange, to which participants are required by regulation to route orders to, but which attract limited liquidity.

Gawronski said the Securities and Exchange Commission, which has stated it will initiate a holistic review of US equity market structure in the near future, would consider such a mechanism.

“This change to market structure, at least in the context of a holistic review by regulators, would have a decent chance of being implemented because there would be little to no opposition, apart from the affected venues,” he said. 

“End-investors and brokers would benefit modestly through reductions in connectivity costs, complexity and fragmentation.”

Key concerns

In the research, BlackRock also broke down high-frequency trading strategies into four groups, ranking them in order of negative impact on end-investors. Most constructive was passive market making, which provides the buy-side with liquidity driven in part by exchange rebates, while latency arbitrage and flash orders were listed as most harmful to investors. 

The firm also differentiated between dark trading that occurs on-exchange and off-exchange and said misinformation around the latter in relation to price discovery should be addressed in future regulation.

“BlackRock emphasises that any consideration of this issue should apply to all dark liquidity, not just dark pools. Exchanges also support hidden order types which account for 11% to 14% of exchange-based volume,” the research paper read.

Gawronski said BlackRock’s contribution to these pressing market structure issues was a positive sign given the amount of assets under management. He cited the firm’s labelling of the US equity market as one of the most efficient globally as a sign of constructive criticism.