Controversy over so-called ‘flash’ order types, where trading venues briefly display unfilled orders to select participants before routing elsewhere, flared up again in the US this week when a New York senator called for their abolition. However, some feel certain concerns about these order types apply equally in Europe, despite the structural differences between the two markets.
On Monday, Senator Charles Schumer wrote to Mary Schapiro, chairman of the US Securities and Exchange Commission (SEC) requesting that the commission act to prohibit flash order types such as BATS’s BOLT, fellow US exchange Nasdaq’s FLASH and equity trading platform Direct Edge’s Enhanced Liquidity Provider (ELP) programme.
Chief among Schumer’s concerns is that flash order types display unfilled orders to select market participants for a short period of time, typically 25 milliseconds, before routing elsewhere. This, he argued, gives firms with high-speed trading systems who see the flashed orders ample time to use the information and trade in front of the original order. “If allowed to continue, these practices will undermine the confidence of ordinary investors and drive them away from our capital markets,” he wrote in his letter to the SEC.
Equivalents of flash order types have started to emerge in Europe. Nasdaq OMX Europe introduced its BLNK routing strategy, a version of parent firm Nasdaq’s FLASH order type, which posts orders on Nasdaq OMX Europe’s order book for 25 milliseconds before routing elsewhere.
Europe is immune from some of the concerns expressed about flash order types in the US because the market lacks Regulation NMS’s order protection rule, which stipulates that orders must be routed to the venue with the best price. The New York Stock Exchange, one of the most vocal critics of flash order types, argues that they contravene the spirit of Reg NMS because venues using them do not immediately onward-route unfilled marketable orders.
However, some argue the concerns voiced in Schumer’s letter about order information being displayed to high-speed traders ahead of execution are just as valid in Europe as they are in the US.
“We will not be using that service in Europe as a default, and don’t use flash order types in the US,” Owain Self, head of algorithmic trading for the Americas and EMEA at UBS, told TheTRADEnews.com. “The reason is that we are not trying to maximise rebates paid to us, we are trying to maximise best execution, and information leakage in that 25-millisecond flash period could be significant.”
A potential advantage of flash order types is that they present users with an additional 25-millisecond opportunity to execute passively before routing, which would earn them a maker rebate. Immediate onward routing would result in a trader paying not only the routing charge, but also the aggressive execution fee levied by the destination venue.
While acknowledging that the amount of information leakage from flash orders is difficult to quantify, Self said, “We would rather not deal with the unknown when it comes to our clients’ orders.”
Many have categorised flash orders as a type of dark trading because in some of the schemes, orders are displayed to a select audience before being sent to public markets. As a result, some feel flash orders could attract the attention of Europe’s regulators because of their general concerns about the impact of dark trading on equities markets.
“MiFID is very geared to transparency and there is a lack of comfort with dark liquidity in certain areas of Europe,” said Miranda Mizen, principal at research and consulting firm TABB Group. “CESR [The Committee of European Securities Regulators, which harmonises the activity of Europe’s securities regulators] has said there will be a review of MiFID and flash orders will certainly form part of it because it is a form of dark trading. If there is any potential for a deterioration of the public quote because people see more opportunities to trade in the dark rather than the lit market, I suspect that will become a MiFID issue very quickly.”