US equities brokers and trading venues have united against the ‘trade-at’ rule proposed by the US Securities and Exchange Commission (SEC) in its recent Market Structure Concept Release, claiming it will stifle innovation and add to investors’ costs.
In its concept release, issued on 14 January, the SEC asked for the market’s views on the possible introduction of new rules to encourage on-exchange trading to support public price discovery. The regulator has frequently expressed concern that wholesale market innovations such as dark pools and high-frequency trading are creating a ‘two-tier’ system that disadvantages retail users that trade on traditional stock exchanges.
The SEC’s proposed trade-at rule would prohibit any market centre – lit or dark – from executing a trade at the national best bid and offer (NBBO) unless it was displaying that price at the time it received the incoming contra-side order. If the venue was not displaying the NBBO, it could either execute the order at a “significant” level of price improvement, such as the minimum tick size, or route ‘intermarket sweep orders’ to the full displayed size of NBBO quotations and then execute the balance of the order at the NBBO.
This means that a dark pool that could not offer price improvement of more than a penny for stocks trading over $1 would have to route out any displayed liquidity at the NBBO before filling any outstanding amount in its own book.
In his firm’s written submission to the SEC, Dan Keegan, co-head of global electronic trading sales at Citi, asserted that investors’ interests would be damaged by restrictions on internalisation, the process by which brokers match client orders without recourse to an external exchange. While this was traditionally carried out manually, it is now largely an automated activity conducted via brokers’ the dark pools.
“Fierce competition to attract order flow has resulted in many benefits to the investing public,” observed Keegan. “Spreads are tighter, price/size improvement opportunities abound and costs have decreased. Internalisation should not be artificially constrained to the benefit of the for-profit exchanges, such as through the implementation of a trade-at rule.”
Keegan predicted that many of the trading venues’ business models developed over the past decade would not be able to survive in a ‘trade-at’ environment, resulting in higher costs in particular for institutional investors looking to trade in size.
The rule would “significantly impact” the ability of investors to use non-displayed trading venues for sensitive, i.e. large in size, order flow, according to Keegan, who claimed that routing of orders to full, displayed size of NBBO quotes would both incur access fees and “signal other market participants that such orders existed at the non-displayed trading venue, thereby increasing costs for institutional investors”.
Kimberly Unger, executive director of the Security Traders Association of New York, which represents both buy- and sell-side institutions, questioned the need for a change in regulation on grounds that the claim that non-displayed liquidity harmed price discovery was unsubstantiated. Unger also called for a thorough review of the impact of a trade-at rule on liquidity providers and market participants, warning of higher costs for retail and institutional transactions.
“Uses of lower cost alternative venues may be forced to execute on exchanges and pay access fees.
It should also be noted that when access fees are taken into account, the NBBO quote is not necessarily the best available quote,” she added.
A number of responses posted to the SEC website suggested that the trade-at rule would drive more business to the established displayed trading venues, but neither Nasdaq OMX nor the NYSE Euronext, the US’s two largest equities markets, fully endorsed the proposed rule.
Nasdaq OMX’s submission claimed that the growing share of US equities trading being conducted in dark pools was “placing in peril the public market’s ability to serve an accurate and open price discovery mechanism for the nation”.
Joan C. Conley, senior vice president and corporate secretary at Nasdaq OMX, said the SEC should take steps to support trading in the public markets, but suggested that the regulator should consider rules that require internalising dealers to either simultaneously display a protected quote at the NBBO or provide “meaningful” price improvement over the NBBO.
NYSE Euronext also regarded the adoption of the trade-at rule to be “a very strong step”.
The trade-at rule is one a number of proposals contained in the 74-page concept release, which reviews all aspects of the structure of the US cash equities markets. The comment period has now closed and the SEC will review submissions from market participants before issuing finalised rules that will be voted upon by commissioners.